finance-a-few-years-ago-a-friend-of-yours-started-a-small-business-that-develops-gaming-software

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Problem 18.22 (Essay)

FINANCE -A few years ago, a friend of yours started a small business that develops gaming software.png” alt=”http://edugen.wiley.com/edugen/art2/common/pixel.gif”>

A few years ago, a friend of yours started a
small business that develops gaming software. The company is doing well and is
valued at $1.5 million based on multiples for comparable public companies after
adjustments for their lack of marketability. With 300,000 shares outstanding,
each share is estimated to be worth $5. Your friend, who has been serving as
CEO and CTO (chief technology officer), has decided that he lacks sufficient
managerial skills to continue to build the company. He wants to sell his
160,000 shares and invest the money in an MBA education. You believe you have
the appropriate managerial skills to run the company. Would you pay $5 each for
these shares? What are some of the factors you should consider in making this
decision?

Problem 18.26 (Essay)

FINANCE -A few years ago, a friend of yours started a small business that develops gaming software.png” alt=”http://edugen.wiley.com/edugen/art2/common/pixel.gif”>

A friend
of yours is trying to value the equity of a company and, knowing that you have
read this book, has asked for your help. So far she has tried to use the FCFE
approach. She estimated the cash flows to equity to be as follows:

Sales

$800.0

-CGS

-450.0

-Depreciation

-80.0

-Interest

-24.0

Earnings before taxes (EBT)

246.0

-Taxes (0.35 x EBT)

-86.1

= Cash Flow to Equity

$159.9

She also computed the cost of equity using CAPM as follows:
kE = kF + βE(Risk premium) = 0.06 + (1.25 x
0.084) = 0.165, or 16.5%

where the beta is estimated for a comparable publicly traded company. Using
this cost of equity, she estimates the discount rate as

WACC = xDebtkDebtpretax(1 – t) + xcskcs
= [0.20 x 0.06 x (1-0.35)]+(0.80 x 0.165) = 0.14, or 14%

Based on this analysis, she concludes that the value of equity is $159.9
million/0.14 = $1,142 million.

Assuming that the numbers used in this analysis are all
correct, what advice would you give your friend regarding her analysis?

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