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 $27 million. If your research is unsuccessful, it will be worth nothing. To fund your research, you need to raise $5.2 million. Investors are willing to provide you with $5.2million in initial capital in exchange for 35% of the unlevered equity in the firm. a. What is the total market value of the firm without leverage? b. Suppose you borrow $0.5 million. According to MM, what fraction of the firm's equity will you need to sell to raise the additional $4.7 million you need? c. What is the value of your share of the firm's equity in cases (a ) and (b )?

Explanation / Answer

a). Solution :- Total market value of firm without leverage = 5.2 Million / 0.35

= $ 14.857143 Million.

Conclusion :- Total market value of firm without leverage = $ 14.857143 Million (approx).

b). Solution :- Total value of equity = 14.857143 Million - 0.50 Million

= $ 14.357143 Million.

Fraction of equity of firm needed to be sold in the given question = 0.50 Million / 14.357143 Million

= 0.0348 i.e., 3.48 %

Conclusion :- Fraction of equity of firm needed to be sold in the given question = 3.48 %

c). Solution :- Value of share of equity of firm in the question (a) = 14.857143 Million * 35 % = $ 5.20 Million.

Value of share of equity of firm in the question (b) = (1 - 0.0348) * 14.357143 Million = $ 13.85751 Million.

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