1. You are the founder and CEO of “STYLE”, a women shoes, handbags and belts sta
ID: 2726004 • Letter: 1
Question
1. You are the founder and CEO of “STYLE”, a women shoes, handbags and belts startup company. You design your own products and sell directly to retail over the internet. You operate profitably for over two years having funded your company with friends and family and your own capital. You are looking to ramp up production, streamline the supply of raw materials and engage into a profit sharing/co-marketing with Amazon. You estimate that you need to raise a minimum of $2.0 million to realize your immediate growth plan. Your last year financial results are as follows: ASSETS $1.0 M Designs (500,000), Inventory ($200,000), Materials, Receivables ($250,000), Cash ($50,000) LIABILITIES 0, EQUITY $1.0 M SALES $1.5 M, COST OF GOODS SOLD$750,000, OTHER OPERATING EXPENSES $250,000 EBITDA $500,000 -TAXES (25%)-$125,000 NET INCOME (Earnings) $375,000 a) What financing options do you believe are available to you? b) Describe how are you going to approach a venture capital (equity) investor? You can assume that last year S&P500 returned 9.25%, 5yr Treasury Yields are at 1.75% and that the women apparel industry sensitivity to S&P500 is 1.4. What is the minimum annual rate of return that an equity investor is likely to demand? Continue with problem 3 – the Designer Shoes company Assume that after accepting the new investment of $2.0 M, you can grow earnings for 5 years at an annual growth rate of 10% while the residual value of “STYLE” beyond year 5 in today’s dollars is $750,000. a) What percentage in your company the $2.0 M investment is likely to represent? b) What is the current value of STYLE? c) What are your net sale proceeds after you complete the sale of 100% of STYLE at this valuation? (Assume capital gains tax of 20%) d) What is your return on equity (ROE) upon selling the company at this valuation? e) What is the likely ROE for the new company owner at year 6 if the original sales projections prove accurate? Continue with problem 3 – the Designer Shoes company Assume that you actually structure a deal to sell 60% of the company to an SME Private Equity Fund for $1.2 M. The Fund is agreeing to retain you as the CEO on the condition that you agree to pay an annual dividend of $100,000 and take on $800,000 of debt structured as follows: 5yr Bank Loan up to 2x Next Year’s EBITDA at a rate of 5.0% Remaining in a 5yr subordinated debt issued by the PE fund at a rate of 10% a) What would be your return on equity (ROE) upon selling a 60% stake in the company? b) Calculate the WACC for the company – Assume corporate tax of 25% c) What is the likely ROE of the new majority owner one year after taking control of the company? Calculate Leverage Ratio, Debt Ratio and Interest Coverage ratios of the company one year after the transaction is consummated
Explanation / Answer
:
= Net Income / Shareholder’s equity
= $375,000 / $500,000
= 75% or 0.75
WACC = E/V *Re + D/V *Rd *(1-Tc)
Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D = total market value of the firm’s financing (equity and debt)
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate
= $500,000/$1,300,000 * $500,000 + $800,000/ 1,300,000 * $800,000 * (1-0.25)
= $561,480
= Debt / Equity
= $800,000/$500,000
= 1.6
Calculate Debt ratio:
= Liabilities / Assets
=$ 0 / $1,000,000
Calculate Interest coverage ratio:
= operating income / Interest expenses
= $250,000 / $500,000
= 0.50 or 50%
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