You are an entrepreneur starting a biotechnology firm. If your research is succe

Question

You are an entrepreneur starting a biotechnology firm. If your research is successful, the technology can be sold for $22 milion. If your research is unsuccessful, it will be worth nothing. To fund your research, you need to raise $5.9 million. Investors are willing to provide you with $5.9 million in initial capital in exchange for 45% of the unlevered equity in the firm. a. What is the total market value of the firm without leverage? b. Suppose you borrow $0.4 million. According to MM, what fraction of the firm's equity will you need to sell to raise the additional S5.5 million you need? c. What is the value of your share of the firm's equity in cases (a) and (b)?

Explanation / Answer

a: Total market value= $5.9m*1/(1-0.45) = $10.73 million

b: As per M&M, the total value of the firm will still be $10.73 million. Equity = 10.73-0.4 = 10.33m

Fraction of equity to be sold = 5.5/10.33 = 53.26%

c: Value of your share in case a = 45%*10.33 m = 4.83m

Case b= (1-53.26%)*10.33 = $4.83 m

Hence the value remains the same.

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