Glenn Smith’s Investment Decision ProblemBA569 – Jon DownSally and her business partner Susan have put together a solid business plan to start a company that will sell a new skin care product through “over the counter” pharmacy sales. They developedthis product and hold a patent on its chemical make-up and use.In order to produce product, fill distribution channels, and pay other start-up costs they have estimated a financing need of $250,000. They have presented their business plan to Glenn Smith and other angel investors at the Portland Venture Group. Considerable interest was shown at the meeting and Glenn must decide if this opportunity provides enough upside potential gain to risk his $250,000 of investment capital. Hisrule of thumb is to only invest if he has a reasonable shot at increasing the value of his initial investment by a factor of “ten X in five years” (i.e. he wants to get 10 times his original investment back in five years or less).Glenn is reviewing the pro forma financial statements Sally and Susan have presented and sees they expect to have sales of $4,000,000 five years after they receive the investment capital.Glenn is also familiar with another similar company called Moisture Up! that recently sold for $30,000,000 to a large pharmaceutical company. In the year the company was sold, it had sales of $10,000,000.a. If Glenn agrees to invest $250,000, and negotiates 25% ownership of the company for hisinvestment, what is the post-money (or after investment) implied value of the entire company?b. If the company is valued at a similar price to sales multiple (or ratio) as Moisture Up! in year five after the investment, what is the implied value of the company then?c. If Glenn’s ownership position is not diluted during this five year period, how much will his stake in the company be worth (again assuming the same price to sales multiple as Moisture Up!)?d. What is the lowest revenue amount in year five that would still make this a potentially attractive investment for Glenn (again assuming the same price to sales multiple as Moisture Up!)?e. Assuming year five revenues are as forecast, what is the lowest price to sales multiple that will still make this an attractive investment for Glenn?f. If Glenn does make this investment and ends up being able to liquidate his original investment of $250,000 for $1,000,000 after a five year period, what is his annual return on investment?Solution for Glenn Smith’s Investment Decision ProblemThe proposed investment is $250,000The goal is to grow this initial investment to 10 times the invested amount in five year, or:FV = $250,000 * 10 = $2.5 milliona. If $250,000 buys 25% of the company, we can determine the value of the entire company by setting up the following ratios:Investment Price / % of Company Owned = Total Price of Company / 100 %Total Price (or Value) of Company = $250,000 / .25 = $1,000,000b. Price of Company = Sales of Company times the Price to Sales Multipleor: Price = Sales * (P/S)Using Moisture Up! as a comparable:P / S = $30 million / $10 million = 3Therefore: Price (or value) = $4 million * 3 = $12 millionc. Investment Value = Company Value times the Percent of Company OwnedInvestment Value = $12 million * 25% = $3 milliond. From above we know Glenn requires that his $250,000 investment grow to $2.5 million.Therefore the company must be worth $10 million in order for his 25% ownership to be $2.5 million ($2.5 million / 25%).With a Price to Sales multiple of 3, this requires sales be at least $3,333,333 as shown:Sales = Price / (P/S) = $10 million / 3 = $3.333 millione. If Sales = $4 million and the Price is $10 million (the lowest acceptable value) then the minimum price to sales ratio is:P/S = $10 / $4 = 2.5f. This is an internal rate of return calculation where the present value is the investment of $250,000, the future value is the return of $1,000,000 and the period is 5 years; solve for i.Therefore the annual rate of return is
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