Assume you are a venture capitalist who will make a $2.5 million investment toda
ID: 2418815 • Letter: A
Question
Assume you are a venture capitalist who will make a $2.5 million investment today and will recoup your investment in five years. The expected net income of the project hi year five s $1.8 million and the comparable P/E ratio for the industry is 22. Your required rate of return is 55%. Compute the future value of your investment. What is the terminal value of the project? What is your ownership level? Assume the firm originally has 250.000 shares outstanding, what is the total number of new shares after your investment? What is the price per share that you paid? 3. What is the bid-ask spread and why does the spread exist? Discuss when you would use a limit order. What are the advantages and disadvantages? You purchased 100 shares of INTC common stock on margin at $70 per share. Assume the initial margin is 50% and the maintenance margin is 30%. Below what stock price level would you get a margin call (assume no dividends and ignore any interest on the margin account)?Explanation / Answer
2.
a)
FV = (1 + k)n *Investment
FV = (1 + .55)5 * $2,500,000 = $22,366,524.22
b)
Terminal Value = P/E * Net Income
Terminal Value = 22 * $1,800,000 = $39,600,000
c)
Ownership = FV/TV
Ownership = $22,366,524.22 / $39,600,000 = .565 = 56.5%
d)
New shares = (% ownership / 1- % ownership) * old shares
New shares = (.565 / 1-.565) * 250,000 = 324712.64 shares rounded to 324713 shares
e)
Price = Investment / New Shares = $2,500,000 / 324713 shares = $7.70/ share
3.
The bid-ask spread is the difference between the highest price a buyer is willing to pay for a stock and the lowest price a seller is willing to sell the stock for. The spread exists to cover the costs of a dealer who is selling the stocks, such as order processing, inventory and risk aversion costs.
4.
You would use a buy limit order if you’re believe, based on your study of a firm, that the price of its stock is higher than it should be and that it will go down. You would use the sell limit order if you think a firm’s stock is worth more than the current price, and you think it will go up (or maintain its good price), so you set a limit on the lowest price you are willing to sell the stock at. The advantage of this method is that you are certain of your maximum purchasing cost and minimum selling price (buying and selling, respectively), but the disadvantage is that the market may not act in favor of the limits you have set and you may not be able to execute your trade.
5.
Margin call: (100P - $3,500)/100P = .3
70P = $3,500
P = $50