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PROBLEM 10-1

Given
Assets (Invested Capital)
Borrowing rate
Return on Invested Capital
Good state
Bad state
Capital Structures
Alternative #1
Alternative #2

Solution Lege
$

1,500,000.00
9.00%
12.00%
4.00%
Debt/Assets
30.00%
50.00%

Solution

Alternative #1
Net Operating Income
less: Interest Expense
Net Income
Return on Equity
Alternative #2
Net Operating Income
Less: Interest Expense
Net Income
Return on Equity

Return on Assets
12.00%
4.00%
Good State
Bad State

Good State

Bad State

Solution Legend
= Value given in problem
= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

PROBLEM 10-2
Solution Legend
Given
Financing
% Equity

Solution
a. Post-money value
b. Pre-money value

4,000,000.00
40%

Solution Legend
= Value given in problem
= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

PROBLEM 10-3
Solution Legend
Given
EBITDA (0)
Growth rate in EBITDA
VC Required rate
VC Investment
Multiple

Solution
EBITDA (5)
Enterprise Value (5)
VC required $
% VC ownership

750,000.00
30%
40%
1,000,000.00
5

Solution Legend
= Value given in problem
= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

PROBLEM 10-4

Given
Capital needed
Projected EBITDA in year 5
Exit year
EBITDA sales multiple in year 5
Interest bearing debt in year 5
Total debt in year 5
Cash in year 5

Solution Legend
$
$

$
$
$

500,000
1,050,000
5
6.00 times
1,000,000
1,200,000
200,000

= Value given in problem


= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

Analysis of financing structure #1--Straight Common


Stock
VC's required rate of return
Required $ return to VC Firm
Enterprise value of firm in year 5
Equity value in year 5
Part a. Alt #1. Required ownership"share"

45%

Analysis of financing structure #2--Convertible Debt


VC's required rate of return
Coupon rate on debt
Required $ year 5 return to VC Firm
Enterprise value of firm in year 5
Equity value in year 5
Part b. Alt #2. Required ownership"share"

35%
10%

Year
Cash to Conv Debt

0
(500,000)

Terminal cash flow


IRR (Conv Debt)

Analysis of financing structure #3--Redeemable Preferred


Plus Equity
VC's required ownership share
Dividend rate on preferred stock
Required $ year 5 return to VC Firm
Exercise price of warrants
Part c. Alt #3. Required rate of return

40%
8%

Alternate solution procedure for Alternative #3


Given
Estimated Equity Value in Year 5
VCs Share of Equity in Year 5

40%

Note: With redeemable preferred stock the


value of the firm's equity is reduced by the
repayment of the face value of the preferred
stock when it is redeemed.

Solution
Year
Cash Investment
Dividends
Redemption Value
Share of Equity Value - warrant price
Total Cash Flows
IRR--Preferred Investor Return
d.

0
(500,000)

500,000

PROBLEM 10-5

Given
EBITDA 2009
Added EBITDA
Funding need
VC's required rate
Rate on convertible debt
Term
EBITDA multiple
EBITDA growth rate

Solution Legend
$ 4,000,000
1,000,000
5,800,000
25.0%
8.0%
5 years
5
20.0%

= Value given in problem


= Formula/Calculation/Analysis requir
= Qualitative analysis or Short answer
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

Solution
a. What is the value of the combined firm in five years?
Estimated EBITDA
EBITDA 2009
Estimated EBITDA 2014
Multiple
5
Enterprise Value
Less: Debt
$ (5,800,000)
Equity Value in 2014
b. What share of the firm's equity will the VC require?
VC's Cash Flows
Year
Cash Flows
0
(5,800,000)
1
2
3
4
5
Year 5 Conversion Value
VC Rate of Return
VC's Share
c. What share of the firm's equity will the VC require?
Estimated EBITDA
EBITDA 2009
Estimated EBITDA 2010
Multiple
5
Enterprise Value
Less: Debt
$ (5,800,000)
Equity Value in 2014
VC's share

Solved for using Goal Seek such that the VC realizes


the desired 25% return.

Solution Legend

given in problem
la/Calculation/Analysis required
ative analysis or Short answer required
eek or Solver cell
Ball Input
Ball Output

l Seek such that the VC realizes


rn.

PROBLEM 10-6

Given
Capital needed
Projected EBITDA in year 5
Exit year
EBITDA sales multiple in year 5
Interest bearing debt in year 5
Cash in year 5

Solution Legend

500,000
1,500,000
5
6.00 times
1,000,000
200,000

Simulation

= Value given in problem


= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

times

Analysis of financing structure #1--Straight


Common Stock
VC's ownership share

49.00%

Enterprise value of firm in year 5


Equity value in year 5
Required $ return to VC Firm
Part a. Alt #1. Targeted Investor Return

Note: this estimate of enterprise value is equal to 6 times the projected


EBITDA for year 5 plus the $200,000 projected cash balance for year
5. To calculate equity value we simply deduct the interest bearing debt
for year 5.
Alternatively, Equity Value = 6 x EBITDA (year 5) + Cash - Debt
or
Equity Value = 6 x EBITDA (year 5) - Net Debt

Analysis of financing structure #2--Convertible


Debt
Coupon rate on debt
VC's ownership share
Exit value of equity in year 5
Required $ return to VC Firm
Part b. Alt #2. Targeted Investor Return

10.00%
30.00%

Analysis of financing structure #3--Redeemable


Preferred Plus Equity
Share of Equity
Dividend rate on preferred stock
Required $ year 5 return to VC Firm
Exercise price of warrants
Part c. Alt #3. Targeted Investor Return

40.00%
8.00%
$

100,000

Alternative Analysis of Alt #3


Given
Estimated Equity Value in Year 5
VCs Share of Equity in Year 5

40.00%
Year

Cash Investment
Dividends
Redemption Value
Share of Equity Value
Total Cash Flows
Alt#3. Targeted Investor Return
c.

0
(500,000)

500,000.00

PROBLEM 10-7

Given
Target EBITDA sales multiples
EBITDA (Year 5)
Funds raised
Cash (Year 5)
Interest bearing debt (year 5)
Investment horizon for VC

Dividend rate on common


Coupon (convertible bonds)
Dividend rate (convertible pfd)

Solution Legend
6.00
1,200,000
500,000
300,000
2,000,000
5 years

$
$
$
$
$

Alternative Deal Structures


Stated Rate of Return
0.00%
10.00%
10.00%

7.00

Ownership %
60.00%
40.00%
45.00%

Solution
a. Enterprise valuation
6 times multiple
EBITDA x EBITDA Multiple
Plus: Cash
Enterprise value
Less: Interest Bearing Debt
Equity Value in year 5

300,000

300,000

(2,000,000)

(2,000,000)

b. Analysis of alternative deal structures


Common Stock
$ Terminal cash flow (equity ownership)
% Required Return by VC
Convertible Bonds
Annual interest
$ Terminal cash flow (equity ownership)
% Required Return by VC
Preferred Stock
Annual dividends
$ Terminal cash flow (equity ownership)
% Required Return by VC
c. Analysis of pre- and post-money values of Brazos Winery's equity
Common Stock
Post-money value of the firm's equity
Less: Invested Capital
(500,000.00)
Pre-money value
Convertible Debt
Post-money value of the firm's equity
Less: Invested Capital
Pre-money value
Convertible Preferred Stock
Post-money value of the firm's equity
Less: Invested Capital
Pre-money value
d.

e.

7 times multiple

(500,000.00)

(500,000.00)

= Value given in problem


= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

PROBLEM 10-8
Solution Legend
Given

= Value given in problem

Balance sheet data


2009
Cash
Accounts payable
Short-term notes
Total short-term debt
Sr. debt (10%)
Sub debt (12% int rate, conv. into 10% stock, 5 yrs.)
Equity
Total debt and equity
Additional financing needed
Total debt and equity (after new funds are raised)

2014
$

$
$

$
$

Estimated EBITDA
EBITDA Multiple

Capital Costs
Senior debt
Sub-debt--Interest
Sub-debt--Conversion % of equity
Convertible Preferred Stock--Dividend yield
Convertible Preferred Stock--Required rate of return

100,000
150,000
250,000
200,000
100,000
200,000
750,000
250,000
1,000,000

$
$

300,000
200,000
250,000
450,000
400,000
100,000
800,000
1,750,000
250,000
2,000,000

650,000
6.00

10.00%
12.00%
10.00%
8.00%
45.00%

Solution
a.
EBITDA
Multiple
EBITDA value
Plus: Cash
Enterprise value
Less: Interest bearing debt (Short term notes plus senior debt)
Equity value

650,000
6.00

b.
Sub-debt interest income
Conversion value of the sub-debt
Estimated IRR of Sub-debt (6 years)
c.
Convertible Preferred Stock Dividends (annual)
Required equity conversion value to produce desired rate of return
Required equity ownership percentage
Final Deal Structure (Equity)
Sub-Debt Holders
Convertible Preferred Stockholders
Dub Tarun

Equity Ownership %

d.

e.
Post-money value estimate (2009)
Less: Preferred Stockholder investment
Pre-money value estimate (2009)

(250,000)

Rate of Return

= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

PROBLEM 10-9ab: Valuation Using Industry LBO Model


Given
Earnings Estimates
Current year EBITDA (millions)
Planning Period EBITDA growth rate
Corporate tax rate
Depreciable life of assets
Depreciation expense (Year 0)
LBO Capital Structure
Debt/Assets
Annual Capex

10,000,000.00
10.00%
30.00%
10 years
3,500,000.00
90.00%
4,000,000.00

Acquisition and sale EBITDA multiples


Multiple
Company purchase
Company harvest

5 times
5 times

Capital Costs
Interest Rate on Debt
Unlevered Beta
Risk free rate
Market equity risk premium
Unlevered Cost of Equity

14.00%
- (calculated)
5.00%
5.50%
0.00% (calculated)
Industry LBO Model Valuation

Year
1
2
3
4
5
Firm Selling Price
Equity Value (EOY 5)
Equity Investment
Rate of Return on Equity

EBITDA

Less: Capital
Expenditures
4,000,000.00
4,000,000.00
4,000,000.00
4,000,000.00
4,000,000.00

Depreciation
Expense

Selling price = Year 5 EBITDA x Harvest Multiple


Equity value = Selling price - Loan balance EOY 5
Initial equity investment in the LBO
Compound annual return over 5 years

Note: Corporate taxes are considered in calculating debt repayments (interest paid before tax and principal repaid using a
equity is after corporate but before personal tax. The after-tax return would reflect the tax circumstances of the investor.

Pro Forma Income Statements


EBITDA
Less: Depreciation Expense

Platform Company--Analysis of Equity Free Cash Flow


2009
2010
2011
$
-

EBIT
Less: Interest
Earnings before Taxes
Less: Taxes
Net Income

#VALUE! $
#VALUE! $
#VALUE!
#VALUE! $

Calculation of Equity FCF


Plus: Depreciation
Less: CAPEX
B57: Less principal payments
Equity Free Cash Flow
Equity Investment Cash Flows
Firm investment cash flows

Security Valuation (Enterprise Value = multiple of estimated EBITDA, Debt value = book and Equ
Year
0
1
2
Debt
Equity
Firm Value

Evaluation of IRR on the Platform Company Investment


Year 0
Year 5
Debt
Equity
Firm

Internal Rates of Return (IRR) on LBO Firm's Equity Investment


Equity (with debt)
Equity (no debt)

Problem 10-10: APV Valuation Analysis


Estimation of Operating and Financial Cash Flows
1
EBITDA
Less: Depreciation Expense
EBIT
Less: Taxes
NOPAT
Plus: Depreciation Expense
Less: CAPEX
FCF
Interest Expense

#VALUE! $

(4,000,000.00)

Year
2
-

(4,000,000.00)

Interest Tax Savings

Analysis of the Unlevered Cost of Equity Capital


Analysis of Unlevered Equity Beta
Equity Betas
Debt
Equity Value
1.400
6.58
22.10
1.750
11.34
25.80
1.450
3.42
10.00
1.230
6.59
25.20

Company
Company A
Company B
Company C
Company D
Unlevered Cost of Equity

APV Valuation
PV(OCFs) Planning Period
PV(ITS) Planning Period
PV (TV of firm)
Firm Value
Less: Debt
Equity Value
NPV of the Acquisition

ndustry LBO Model


Solution Legend
= Value given in problem
= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

ation
Purchase Price
Interest

Principal
Payment

Loan Balance

and principal repaid using after-tax earnings). However, the return on


mstances of the investor.

y Free Cash Flow


2012
$

2013
-

2014
-

$
$

$
$

$
$

CF

ebt value = book and Equity value = residual value)


Year
3
4

on Analysis

cial Cash Flows

Year
3

4
-

(4,000,000.00)

5
-

(4,000,000.00)

(4,000,000.00)

Equity Capital

ty Beta
Debt to Equity
29.77%
43.95%
34.20%
26.15%

Marginal Tax Rate Unlevered Beta


30.00%
30.00%
30.00%
30.00%
Average

PROBLEM 10-9c: Valuation Using Industry LBO Model


Given
Earnings Estimates
Current year EBITDA (millions)
Planning Period EBITDA growth rate
Corporate tax rate
Depreciable life of assets
Depreciation expense (Year 0)
LBO Capital Structure
Debt/Assets
Annual Capex

11,000,000.00
10.00%
30.00%
10 years
3,500,000.00
90.00%
4,000,000.00

Acquisition and sale EBITDA multiples


Multiple
Company purchase
Company harvest

5 times
5 times

Capital Costs
Interest Rate on Debt
Unlevered Beta
Risk free rate
Market equity risk premium
Unlevered Cost of Equity

14.00%
- (calculated)
5.00%
5.50%
0.00% (calculated)
Industry LBO Model Valuation

Year
1
2
3
4
5
Firm Selling Price
Equity Value (EOY 5)
Equity Investment
Rate of Return on Equity

EBITDA

Less: Capital
Expenditures
4,000,000.00
4,000,000.00
4,000,000.00
4,000,000.00
4,000,000.00

Selling price = Year 5 EBITDA x Harvest Multiple


Equity value = Selling price - Loan balance EOY 5
Initial equity investment in the LBO
Compound annual return over 5 years

Note: Corporate taxes are considered in calculating debt repayments (interest paid before tax and principal repaid using a
after corporate but before personal tax. The after-tax return would reflect the tax circumstances of the investor.

Pro Forma Income Statements


EBITDA
Less: Depreciation Expense

Platform Company--Analysis of Equity Free Cash Flow


2009
2010
$
-

EBIT
Less: Interest
Earnings before Taxes
Less: Taxes
Net Income

$
$

Calculation of Equity FCF


Plus: Depreciation
Less: CAPEX
B57: Less principal payments
Equity Free Cash Flow
Equity Investment Cash Flows
Firm investment cash flows
Security Valuation (Enterprise Value = multiple of estimated EBITDA, Debt value = book and
Year
0
1
Debt
Equity
Firm Value

Evaluation of IRR on the Platform Company Investment


Year 0

Year 5

Debt
Equity
Firm

Internal Rates of Return (IRR) on LBO Firm's Equity Investment


Equity (with debt)
Equity (no debt)

Problem 10-10: APV Valuation Analysis


Estimation of Operating and Financial Cash Flows
Year
1
EBITDA
Less: Depreciation Expense
EBIT
Less: Taxes
NOPAT
Plus: Depreciation Expense
Less: CAPEX
FCF
Interest Expense

#VALUE!

(4,000,000.00)

Interest Tax Savings

Analysis of the Unlevered Cost of Equity Capital


Analysis of Unlevered Equity Beta
Equity Betas
Debt
1.400
6.58
1.750
11.34
1.450
3.42
1.230
6.59

Company
Company A
Company B
Company C
Company D
Unlevered Cost of Equity

APV Valuation
PV(OCFs) Planning Period
PV(ITS) Planning Period
PV (TV of firm)
Firm Value
Less: Debt
Equity Value
NPV of the Acquisition
Analysis:

NPV of the Acquisition (Revised)


NPV of the Acquisition (base case--Part c)
Increased NPV

aluation Using Industry LBO Model


Solution Legend
= Value given in problem
= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

The reduction in
operating expenses by
$1million per year has
the effect of increasing
the firm's EBITDA by a
like amount.

y LBO Model Valuation


Purchase Price
Depreciation
Expense

Interest

Loan Balance

Principal Payment

Harvest Multiple
n balance EOY 5

paid before tax and principal repaid using after-tax earnings). However, the return on equity is
x circumstances of the investor.

-Analysis of Equity Free Cash Flow


2011
2012
$
-

2013
-

2014
-

#VALUE! $
#VALUE! $
#VALUE!
#VALUE! $

$
$

$
$

ulation of Equity FCF

imated EBITDA, Debt value = book and Equity value = residual value)
Year
2
3
4

10: APV Valuation Analysis

rating and Financial Cash Flows


Year
2

3
-

(4,000,000.00)

4
-

(4,000,000.00)

5
-

(4,000,000.00)

(4,000,000.00)

nlevered Cost of Equity Capital

of Unlevered Equity Beta


Equity Value
Debt to Equity
22.10
29.77%
25.80
43.95%
10.00
34.20%
25.20
26.15%

Marginal Tax Rate


30.00%
30.00%
30.00%
30.00%
Average

Unlevered Beta

answer required

PROBLEM 10-11: Valuation Using Industry LB


Given
Earnings Estimates
Current year EBITDA (millions)
$
Planning Period EBITDA growth rate
Corporate tax rate
Depreciable life of assets
Depreciation expense (Year 0)
LBO Capital Structure
Debt/Assets
Annual CAPEX

10,000,000.00
30%
10 years
3,500,000.00
90%

Results of simulation s
bottom. The mean IRR
median IRR is 52.11%
chance that the IRR wi
required returns of 40%

4,000,000.00

Acquisition and sale EBITDA multiples:


Multiple
Company purchase
Company harvest
Market Data
Interest Rate on Debt
Risk free rate
Market equity risk premium

5 Times
Times

14%
5.00%
5.50%
Industry LBO Model Valuation

Year
1
2
3
4
5
Firm Selling Price
Equity Value (EOY 5)
Equity Investment
Rate of Return on Equity

EBITDA

Less: Capital
Expenditure
4,000,000.00
4,000,000.00
4,000,000.00
4,000,000.00
4,000,000.00

Depreciation
Expense

Selling price = Year 5 EBITDA x Harvest Multiple


Equity value = Selling price - Loan balance EOY 5
Initial equity investment in the LBO
Compound annual return over 5 years

Note: Corporate taxes are considered in calculating debt repayments (interest paid before tax and princip
earnings. However, the return on equity is after corporate but before personal tax. The after-tax return wo
circumstances of the investor.

Pro Forma Income Statements


EBITDA

Platform Company--Analysis of Equity Free Cash Flow


Year
0
1
2

Less: Depreciation Expense


EBIT
Less: Interest
Earnings before Taxes
Less: Taxes
Net Income
Calculation of Equity FCF
Depreciation
CAPEX
Principal paid
Equity Free Cash Flow
Equity Investment Cash Flows

Security Valuation (Enterprise Value = multiple of estimated EBITDA, Debt value = book and E
0
1
2
Debt
Equity
Firm Value
Evaluation of IRR on the Platform Company Investment
Year
0

Debt
Equity
Firm
Internal Rates of Return (IRR) on LBO Firm's Equity Investment
Equity (with debt)

PROBLEM 10-9: APV Valuation Analys


Estimation of Operating and Financial Cash Flows
Year
1
2
3
EBITDA
Less: Depreciation Expense
EBIT
Less: Taxes
NOPAT
Plus: Depreciation Expense
Less: Capex
FCF
Interest Expense
Interest Tax Savings

Company
Company A
Company B
Company C
Company D
Unlevered Cost of Equity
APV Valuation
PV(OCFs) Planning Period
PV(ITS) Planning Period
PV (TV of firm)
Firm Value
Less: Debt
Equity Value
NPV of the Acquisition

Analysis of the Unlevered Cost of Equity Capital


Analysis of Unlevered Equity Beta
Equity Betas
Debt
Equity Value
1.400
6.58
22.1
1.750
11.34
25.8
1.450
3.42
10
1.230
6.59
25.2

ion Using Industry LBO Model

Solut

Growth distribution
Min
Likely
Max

0.00%
10.00%
15.00%

Results of simulation shown in a chart at the


bottom. The mean IRR is 49.38% and the
median IRR is 52.11%. There is a 74.64%
chance that the IRR will be greater than the
required returns of 40%.

Use Crystal Ball:


1. Click on "Define Assumption".
2. Click on "All" folder on left.
3. Click on "Custom distribution" in the main window.
4. Click "OK"
5. Type in harvest multiple, e.g., 3 in the values cell. Type
in the probability in the probability cell.
6. Hit the enter tab at the bottom. Repeat entering all
values and probabilities.
7. Click "OK"

O Model Valuation
Purchase Price
Interest

Loan Balance

Principal Payment

d before tax and principal repaid using after-tax


The after-tax return would reflect the tax

ity Free Cash Flow


Year
3

Growth
0.00%

Debt value = book and Equity value = residual value)


3
4

APV Valuation Analysis

Flows
Year
4

f Equity Capital
uity Beta
Debt to Equity
Marginal Tax Rate
29.77%
30%
43.95%
30%
34.20%
30%
26.15%
30%
Average

Unlevered Beta
1.16
1.34
1.17
1.04
1.18

Solution Legend
= Value given in problem
= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

Average
Year 5