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Hi Sir,
Please help.
The managers of QQ have been in discussions with a bank and a VC regarding the financing for the MBO. The proposal is that the managers will put in $45million of equity, and the VC $180m ( class b equity shares). Then the VC and the bank both invest
$112.5M as debt finance. The VC expects a return on the equity portion of its investments of at least 25% a year compound basis over the 1st 4 years of the MBO. No dividend will be paid.Calculate the minimum total equity value of QQ required in order to satisfy the VC expected returns.
Solution.
No sure where to start but firstly I would have a look at the equity from the VC= 180M and the compound return of 25% over 4 years.
(180 * 1.25^4)=439.5
not sure what to do now? Total equity is (180+45)=225. Do I divide the compound return over the total equity?
Thank you.
What you have written is the answer (439.5)!
Sure you have an answer anyway in the same book in which you found the question?
Sir. The questions takes it a step further once it has calculated the compound return.
Answer ” The VC is making $180 equity investment. To generate a return of 25% a year on a compound basis this investment will need to grow to 439.5 (180*1.25^4) at the end of 4 years.
The VC investment represents 80% of the equity, therefore the total equity value will need to be 549.3 (439.5/80%)
The solution says that the answer is 549.3. I do not understand why we divided the compound growth of 439.5 by 80%. What in the question gives the clue that this is what we have to do?
The question is- Calculate the minimum total equity value of QQ required in order to satisfy the VC expected returns.
Yes – the book is correct.
VC’s equity will have to be worth 439.5
However, VC put in 180M our of a total of 180 + 45 = 225M, which is 180/225 = 80% of the total.
So 439.5 will have to be 80% of the total equity. So the total equity will have to be 439.5/80%.
The question asks for the total equity value of QQ.
great. I follow now. I would not of done this in the exam.. but practice makes perfect.
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