Question

The following forecast has been developed as a success scenario in support of a new venture:

	Year
($mm)	1	2	3	4	5
Revenue	$           -	$         1.5	$         8.0	$       35.0	$       54.0
Development Expenses	$         1.2	$         0.8	$         0.6	$         1.5	$         2.5
Marketing Expenses	$         0.4	$         2.0	$         3.0	$         7.0	$       12.0
Content Expenses	$           -	$         0.2	$         0.8	$         3.5	$         9.0
Delivery Expenses	$         0.5	$         1.8	$         3.0	$         5.0	$         8.0
Net Income	$       (2.1)	$       (3.3)	$         0.6	$       18.0	$       22.5

Suppose that, for the above venture, you develop an expected scenario and a failure scenario to go along with the entrepreneur’s success scenario.

In the success scenario, you assume the venture is harvested in year 5 with a net income multiple of 15x. You expect to receive no cash flow before harvest. In the expected scenario, the venture has net income of $13 million in year 5, and the expected multiple is 10 times earnings. In the failure scenario, you expect to liquidate the venture in year 5, in which case, your preferred stock claim would be worth about $1.5 million.

You believe that the probabilities of success and failure are each 0.25 and that the probability of the expected scenario is 0.5.

Using a discount rate of 50%, find the present value of the venture, and determine the fraction of equity you would require (at a minimum) for investing the $6 million.

Answer 1

Scenario	Net income in 5th Year	Valuation (Net income * Multiplier)	Probability	Prob * Valuation	Present Value after discounting at 50% for 5 years
Success	22.5	337.5	0.25	84.375	11.11111111
Expected	13	130	0.5	65	8.559670782
Failure	-	1.5	0.25	0.375	0.049382716
				149.75	19.72016461

From the above table we can seen that the current valuation after taking all the scenarios into account is $19.72 Mln

Hence to invest 6 mln, we require (6/19.72) = 30.43% stake in the venture.