Question

Assume you are starting a business with 1000 shares outstanding. The business is projected to have $80,000 in income by year 3. The industry has an average P/E ratio of 20. A friend is considering investing $50,000 in your venture today and requires 35% return on her investment annually.

a. What is the % ownership acquired by your friend in return of her investment?

b. How many shares to be issued to your friend?

c. What is the price per share?

d. Compute the pre-money and post-money value of the business.

e. Assume you plan to get a second round of financing at the end of year 1 worth another $50,000. Compute the % ownership acquired by the second investor.

f. What is the founder’s new % ownership in the venture?

g. What is the new total number of shares in the venture?

Answer 1

Given:-

Number of Shares = 1000 share

Year 3 Income = $ 80,000

P/E Ratio= Market/EPS = 20 times

Friend's Investment = $50,000 , Required Return by friend (discont rate ) = 35%

Working:- Calculation of Market Value of Company

PV of Year 3 earning (Eo) = $80,000 / (1+0.35)3

PV of Year 3 earning (Eo) = $ 32,515.3686

PV Ratio = Market Value Earnings = 20 times

Therefore, Market Value = Earnings * 20

Market Value = $ 650,307.3718

Part A :- Percentage of Ownership acquired by friend

=(Investment by friend Market Value ) * 100

= ($50,000 650,307.3718) * 100

= 7.688% (approx)

Part B :Number of Shares to be issued to Friend

= 1000 shares * 7.688 %

= 76 Shares (approx) (because shares cannot be issued in fractions)

Part C : Price Per Share

= Amount Invested by friend Shares issued

= $ 50,000 76

= $ 657.895

Part D : Pre Money and Post Money Valuation of Business

Pre Money Valuation = Market value of Company= $ 650,307.3718

Post Money Valuation = Market value of Company + Amount Invested by Friend

= $ 650,307.3718 + $ 50,000

= $ 700,307.3718

Please upvote the answer if it was of help to you.
In case of any doubt just comment below, I would love to help.