Question

A Venture Capital firm(VC Inc.) is planning to invest in an e-commerce start-up(EC ltd) VC Inc, wants a large stake in this start-up firm(EC Ltd) and has plans to go for a 21% stake in the company. EC Ltd. owners are willing to give up a 21% stake. Finance Manager Sui at VC Inc. has made cash flow projections for EC Ltd. Sui has suggested the following:

Cash Flows of EC Ltd. will grow at a constant rate of 8% every year for the first five years(From 0-1, 1-2, 2-3, 3-4, 4-5 years). From the 5th year onwards, it will grow at 6% every year, subsequently forever.

The Cash Flow today is $100 million. The discount rate is 12% APR compounded annually. How much is EC Ltd. going to raise from VNC. today if they are diluting their stake by 21% based on the valuation made by Sui?

Note: Calculate the Value of EC Ltd. today 21% of the Value of EC Ltd. is the amount being raised. Do not add the time 0 cash flow

Answer 1

Estimated cash flows for 5 years (growing 8% p.a.) will be as followed :

Terminal cash flow at the end of 4-5 year = Fash flow of 4-5 year * (1+g) / (R-g)

Terminal cash flow at the end of 4-5 year = 146.93*(1.06)/(12% - 6%)

Terminal cash flow at the end of 4-5 year = 155.7458 / 0.06

Terminal cash flow at the end of 4-5 year = 2595.76 (Approximately)

Valuation of EC Ltd. based on discounted cash flows : -

Total (100%) Value of EC ltd. (today) = $ 1921.85 million

So, (21%) of value of EC ltd. (today) = 1921.85*0.21   = $ 403.59 million.

So, EC ltd. will raise $ 403.59 million from VC inc. br diluting 21% of stake.