Question

1. What is the present value of $500 5 years from today if the opportunity cost of capital is 10%?

2. What is the value of $22.5 growing at 5% forever (“in perpetuity”) if the opportunity cost of capital is 10%?

3. What is the present value of $500 million 5 years from today if the target return for an investor is 40%?

4. If the 30-year treasury bill is currently paying 3%, and a firm’s cash flows are perfectly correlated with the economy (i.e. Beta=1), what is the firm’s cost of capital? (Assume a market risk premium of 5%.)

5. Imagine an investor has access to four different projects with capital costs as described above. Only one will succeed and the others will fail, but the investor does not know which project will succeed or fail ahead of time. What IRR will an investor require for each firm in this situation if still discounting cash flows and exit values under a “success” scenario, i.e. you may still assume the firm is forecasted to reach a value $500 million in 5 years.

6. Imaging a firm with a constant cost of $10 per period, which is paid out the same time the cost is incurred. Revenue is $100 now and growing at 5% per period, and Accounts Receivable are about 20% of sales. There are no physical assets at the firm. How much cash will the firm get next period?

7. Using the financial forecasts from the Iron Gate Technologies case, calculate cash flows for FY 2006. (Changes in “Gross fixed assets” is the amount invested in physical capital.)

8. Imagine a firm needs to raise $3M dollars in total and the VC requires a target return of 80% given the risk in the investment. If the firm can reach a value of $500M in 5 years and exit, what percent of the firm’s equity would the VC require?

a.What is the “Post-money” value of the above transaction?

b.What is the “Pre-money” value of the above transaction?

Answer 1

Answer 1.

Amount to be received = $500
Period = 5 years
Interest Rate = 10%

Present Value = Amount to be received / (1 + Interest Rate)^Period
Present Value = $500 / 1.10^5
Present Value = $310.46

Answer 2.

First Payment = $22.50
Growth Rate = 5%
Cost of Capital = 10%

Value of Perpetuity = First Payment / (Cost of Capital - Growth Rate)
Value of Perpetuity = $22.50 / (0.10 - 0.05)
Value of Perpetuity = $450

Answer 3.

Amount to be received = $500 million
Period = 5 years
Interest Rate = 40%

Present Value = Amount to be received / (1 + Interest Rate)^Period
Present Value = $500 million / 1.40^5
Present Value = $92.97 million