Finance Problem Set 2 Summer 2020

Financial Statement Forecasting - EF Chapter 9 and 10

1. Petal Providers Corporation opens and operates “mega” floral stores in the U.S. The idea behind the
super store concept is to model the U.S. floral industry after its European counterparts whose flower
markets generally have larger selections at lower prices. Revenues were $1 million with net profit of
$50,000 last year when the first “mega” Petal Providers floral outlet was opened. If the economy grows
rapidly next year, Petal Providers expects its sales to growth by 50 percent. However, if the economy
exhibits average growth, Petal Providers expects a sales growth of 30 percent. For a slow economic
growth scenario, sales are expected to grow next year at a 10 percent rate. Management estimates the
probability of each scenario occurring to be: rapid growth (.30); average growth (.50), and slow growth
(.20). Petal Providers net profit margins are also expected to vary with the level of economic activity
next year. If slow grow occurs, the net profit margin is expected to be 5 percent. Net profit margins of 7
percent and 10 percent are expected for average and rapid growth scenarios, respectively.

A. Estimate the average sales growth rate for Petal Providers for next year.

B. Estimate the dollar amount of sales expected next year under each scenario, as well as the
expected value sales amount.

C. Estimate the dollar amount of net profit expected next year under each scenario, as well as the
expected value net profit amount.

2. Assume you sell for $100,000 a 10 percent ownership stake in a future payment one year from now of
$1.5 million.

A. What are you saying about the implied return for the 10 percent owner?

B. What is the present value of the entire $1.5 million, using the implied return from Part A?
C. What is 10 percent of the value determined in Part B?

D. Does it matter whether you grow the $100,000 at 50 percent to $150,000 and note it is 10 percent of
$1.5 million, or discount the $1.5 million at 50 percent to get $1 million and note that $100,000 is 10
percent of this present value?

Valuation - EF Chapters 10 and 11

1. Calculate the discount rate consistent with a cap rate of 12% and a growth rate of 6%. Show how
your answer would change if the cap rate dropped to 10 percent while the growth rate declined to 5
percent.

PV 2. A venture investor wants to estimate the value of a venture. The venture is not expected to
produce any free cash flows until the end of year 6 when the cash flow is estimated at $2,000,000 and is
expected to grow at a 7 percent annual rate per year into the future.

A. Estimate the terminal value of the venture at the end of year 5 if the discount rate at that time is 20
percent.

B. Determine the present value of the venture at the end of year 0 if the venture investor wants a 40
percent annual rate of return on the investment.

3. A venture capitalist wants to estimate the value of a new venture. The venture is not expected to
produce net income or earnings until the end of year 5 when the net income is estimated at $1,600,000.
A publicly-traded competitor or “comparable firm” has current earnings of $1,000,000 and a market
capitalization value of $10,000,000.

A. Estimate the value of the new venture at the end of year 5. Show your answer using both the direct
comparison method and the direct capitalization method. What assumption are you making when using
the current price-to-earning relationship for the comparable firm?

B. Estimate the present value of the venture at the end of year 0 if the venture capitalist wants a 50
percent annual rate of return on the investment.

4. A venture capitalist firm wants to invest $1.5 million in your NYDeli dot.com venture that you started
six months ago. You do not expect to make a profit until year four when your net income is expected to
be $3 million. The common stock of FLDeli.net, a “comparable” firm, currently trades in the over-the-
counter market at $30 per share. FLDeli.net‘s net income for the most recent year was $300,000 and
the firm has 150,000 shares of common stock outstanding.

A. Apply the VC comparable method to determine the value of the NYDeli at the end of four years.

B. If VCs want a 45% compound annual rate of return on similar investments, what is the present value
of your NYDeli venture?

C. What percentage of ownership of the NYDeli dot.com venture will you have to give up to the VC firm
for its $1.5 million investment?