Question

Roger Harkel, CEO of Bestafer, Inc. seeks to raise $10 million in a private placement of equity in his early stage venture. Harkel conservatively projects net income of $5 million in year five and knows that comparable companies trade at a price earnings ratio of 20X. If the company has 1,000,000 shares outstanding before the private placement, what price per share should she agree to pay if her required rate of return is 50%? (Note: Assume investment is in standard preferred stock with no dividends and a conversion rate to common of 1:1. Round off to the nearest integer.) Group of answer choices

A.$3/share

B. $11/share

C.$13/share

D. $7/share

E.$9/share

Answer 1

Given

New shares issued with the face value of 10 = 1,000,000

Already existing shares = 1,000,000

Net income after 5 years = 5,000,000 dollars

Price earnings ratio = 20 times

Required rate of return = 50%

Present value of net income ( earnings) = Future Value/(1+rate of return)^number of years

= 5,000,000/(1+0.50)^5

= 658,436.2140 dollars

Total number of shares = 1,000,000 + 1,000,000 = 2,000,000

Earnings Per Share = Earnings/ number of shares

= 658,436.2140/2,000,000

= 0.3292 per share

Given price per share/ earnings per share = 20

Price / 0.3292 = 20

Market price = 6.5844 per share

She can agree to pay 6.584 4 or 7 dollars per share

Hence option D is the correct answer.