In 2014, Dub Tarun founded a firm using $ 200,000 of his own money, $ 200,000 in senior (bank) debt, and an additional $ 100,000 in subordinated debt borrowed from a family friend. The senior debt pays 10% interest, while the subordinated debt pays 12% interest and is convertible into 10% of the firm€™s equity ownership at the option of the investor, J Martin Capital. Both debt issues have ten-year maturities. In March 2015, the firm€™s financial structure appeared as follows:

Dub has determined that he needs an additional $ 250,000 if he is going to continue to grow his business. To raise the necessary funds, he intends to use an 8% convertible preferred stock issue. Dub projects that the firm€™s EBITDA will be $ 650,000 in five years. Although Dub isn€™t interested in selling his firm, his banker recently told him that businesses like his typically sell for five to seven times their EBITDA. Moreover, by March 2020, Dub expects that the firm will have $ 300,000 in cash and that the firm€™s pro forma debt and equity will be as follows:

a. What would you estimate the enterprise value of Dub Tarun Inc. to be on March 2020

b. If the estimated enterprise value of the firm equals your estimate in Problem 10-8(a), what rate of return does the subordinated debt holder realize if he converts in 2020? Would you expect the subordinated debt holder to convert to common stock?

c. If the new investor were to require a 45% rate of return on his $ 250,000 purchase of convertible preferred stock, what share of the company would he need, based on your estimate of the value of the firm€™s equity in 2020? What is your estimate of the ownership distribution of Dub Tarun€™s equity in 2020, assuming that the new investor gets what he requires (to earn his 45% required rate of return) and the subordinated debt holder converts to common? What rates of return do each of the equity holders in the firm expect to realize by 2020, based on your estimate of equity value? Does the plan seem reasonable from the perspective of each of the investors?

d. What would be Dub Tarun€™s expected rate of return if the EBITDA multiple were five or seven?

e. What was the post-investment and pre-investment value of Dub Tarun€™s equity in 2015, based on the investment of the new investor?

Dub Tarun Inc., March 2015 $100,000 Accounts payable Short-term notes 150,000 $250,000 Total short-term debt 200,000 Senior debt (10% interest rate) Subordinated debt (12% interest rate, convertible into 10% stock) 100,000 Equity (Dub Tarun) 200,000 Total debt and equity $750,000