Week 7 Homework

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Chapter 14: Exercises/Problems: #1 and #3 pp. 523 – 524

1.[DCF Valuation and Ownership Concepts] The venture investors and founders of ACE Products, a closely held corporation, are contemplating merging the successful venture into a much larger diversified firm that operates in the same industry. ACE estimates its free cash flows that will be available to the enterprise next year at $5,200,000. Since the venture is now in its maturity stage, ACE’s free cash flows are expected to continue to grow at a 6 percent annual compound growth rate in the future. A weighted average cost of capital (WACC) for the venture is estimated at 15 percent. Interest-bearing debt owed by ACE is $17.5 million. In addition, the venture has surplus cash of $4 million. ACE currently has five million shares outstanding, with three million held by venture investors and two million held by founders. The venture investors have an average investment of $2.50 per share while the founders’ average investment is $.50 per share.

A. Based on the above information, estimate the enterprise value of ACE Products. What would be the value of the venture’s equity?

B. How much of the value of ACE would belong to the venture investors versus the founders? How much would the venture be worth on a per-share basis?

C. What would be the percentage appreciation on the stock bought by the venture investors versus the investment appreciation for the founders?

D. If the founders have held their investments for five years, calculate the compound annual or internal rate of return on their investments. The venture investors made a first-round investment of 1.5 million shares at $2 per share four years ago. What was the compound annual rate of return on the first-round investment? Venture investors made a second-round investment of 1.5 million shares at $3 per share two years ago. Calculate their compound rate of return on this investment.