Rick Smith CEO of XYZ Inc wants to raise S5 million in a pri

Rick Smith, CEO of XYZ, Inc., wants to raise S5 million in a private equity in his early stage venture. Smith conservatively projects net income of S8 million in year five (five years from now) and knows that comparable companies trade at a price to earnings ratio of 16X. Marie Wolf of ABC Capital likes Smith\'s plan, but thinks it naive in one respect: to recruit a senior management team, she believes Smith will have to grant generous stock options in addition to the salaries projected in his business plan. From past experience, she thinks management should have the ability to own at least a 11.00% share of the company at the end of year S. If Ms. Wolf now insists that professional managers own 11.00% of the company at the end of year 5, how much of the company is left for investors to own (as a dollar value)? If Ms. Wolf wants her investment in the company to be worth S30 million, what percent of the company\'s equity should she insist on owning? a. b. ..Remember, calculations are performed as if today is after the close of business in year 0 and tomorrow is the start of business for year 1. So, an investmentycars from now would be at the end of year 5.

Solution

a. Company for the investors to own at the end of year 5 (in dollar value) = 8*16*11% = $14.08 million

Since the companies value is 16 times of the earnings, we multiplied earnings(8) with the p/e multiple(16) to arrive at the company\'s value. Investors want to own 11% of the value thus, 11% is multiplied by the price which was computed by the product of earnings and p/e multiple.

b. Percentage of company\'s equity the Wolf should insist for $30 million = [30 / (8*16)]*100 = 23.4375% or 23.44%

Company\'s value is already computed in part (a) above. Wolf want to have $30 million value. So, in order to find out what is the percentage of 30 million dollar in the whole value of the company we divided 30 million with the company\'s value.