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Assume you own 100% of a small business. Your forecast shows that net income will be...

Assume you own 100% of a small business. Your forecast shows that net income will be $900,000 in ten years. You expect that the company will be valued using a PE of 12 ten years from now. If an investor offers you $300,000 for 60% of the business, what would be the investor's return?

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Answer #1

Net Income after 10 years = $900,000

PE after 10 years = 12

PE = Price per share/Earnings per Share = Market value of firm/Net Income

So, in 10 years, value of firm = 900,000 * 12 = 10,800,000

If the investor owns 60% of business, his investment value after 10 years = 6,480,000

Now, using the time value of money concept to calculate the rate of return,

FV = PV * (1 + r)n

6,480,000 = 300,000 * (1 + r)10

21.60 = (1 + r)10

1.3597 = 1 + r

r = 0.3597

Rate of Return = 35.97%

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