You are a venture capitalist and have been approached by Cirrus Electronics, a private firm. The firm has no debt outstanding and does not have earnings now but is expected to be earning $15 million in four years, when you also expect it to go public. The average price-earnings ratio of other firms in this business is 50. a. Estimate the exit value of Cirrus Electronics. b. If your target rate of return is 35 percent, estimate the discounted terminal value of Cirrus Electronics. c. If you are contributing $75 million of venture capital to Cirrus Electronics, at a minimum what percentage of the firm value would you demand in return?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
You are a venture capitalist and have been approached by Cirrus Electronics, a
private firm. The firm has no debt outstanding and does not have earnings now but is
expected to be earning $15 million in four years, when you also expect it to go public.
The average price-earnings ratio of other firms in this business is 50.
a. Estimate the exit value of Cirrus Electronics.
b. If your target
of Cirrus Electronics.
c. If you are contributing $75 million of venture capital to Cirrus Electronics, at a
minimum what percentage of the firm value would you demand in return?
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