Question

Tausi Corporation is about to begin producing and selling its prototype product. The company’s forecasted annual cash flows for the next five years are as follows:

                                YEAR                                                                     CASH FLOW

1. - $ 62,500
2. - $ 25,000
3. $ 125,000
4. $ 500,000
5. $ 1, 000,000

Required:

1. Assume the annual cash flows are expected to remain at $ 1,000,000 level after Year 5 (i.e., Year 6 and thereafter). If Tausi investors want a 40 percent rate of return on their investment, calculate the venture’s present value.                                                                                                                           

2. Calculate the venture’s present value assuming the following:

1. That the Year 6 cash flows are forecasted to be $ 1,125,000 in the stepping-stone year and are expected to grow at an 8 percent compound annual rate thereafter.
2. That the investors still want 40 percent rate of return on their investment.          

3. Now extend part (b) above one step further and assume that the required rate of return on the investment will drop from 40 to 20 percent beginning in Year 6 to reflect a drop in operating or business risk. Calculate the present value of the venture.                                                            

4. Assume that Tausi investors have valued the venture as requested in part (b) above. An outside investor wants to invest $3.75 million in Tausi now (at the end of Year 0). What percentage of ownership in the venture should the Tausi investors give up to the outside investor for a $ 3.75 million new investment?                                                                                                         

                                                                                                                               

Answer 1

Answer:

Part a) NPV = $ 769,080.59

Summation of infinite series formula is used to calculate cash flows from year 6 onwards.

Sum of infinite series = a / (1-r)

Part b) NPV = $957,920.14

Summation for year 6 onwards: (1.08)^x-6 / (1.4)^x

Part c) NPV = $ 4,071,847.01

Summation for year 6 onwards: (1.08)^x-6 / (1.2)^x

Part d) % of ownerhsip which should be given to outside investor = 47.94%

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