I need help with Part 2 A & B.

Part 1:

John Thompson, CEO of NewVenture, Inc., seeks to raise $5 million in a private placement of equity in his early stage venture. Thompson conservatively projects net income of $5 million in year five and knows that comparable companies trade at a price earnings ratio of 20X.

a. What share of the company will a venture capitalist require today if her required rate of return is 50%per annum?

Fv = $5m (1 + 0.5)^5

Fv = $37.97m

Value = $5m * 20

Value = $100m

Required Return = $37.97m / $100m

Required Return = 37.97%

The company will require a rate of 37.97%.

b. If the company has 1,000,000 shares outstanding before the private placement, how many shares should the venture capitalist purchase? What price per share should she agree to pay if her required rate of return is 50%? (Note: Assume investment is in standard preferred stock with no dividends and no conversion rate to common 1:1)

Shares to purchase = (1,000,000 * 37.97%) / (1 - .3797)

Shares to purchase = 612,091

Price = $5m / 612,091

Price = $8.17

She should agree to pay $8.17 per share for 612,091 shares.

c. John feels that he may need as much as $12 million in total outside financing to launch his new product. If he seeks to raise the full amount in this round, how much of his company will he have to give up? What prices per share will the venture capitalist agree to pay if her required rate of return is 50%?

For 50%: FV = $12m (1 + 0.5)^5

FV = 91.13

Shares = $91.13m / $100m = 91.13%

Shares to Purchase = (1,000,000 * 91.13%) / (1 + .9113)

Shares to Purchase = 476,796

Price = $12m / 476,796

Price = $25.17

John will have to give up 91.13% of the company and the VC will have to agree to

pay $25.168 per share.

e. Samantha Jones of Gorsuch Capital likes Thompson's plan, but thinks it nave in one respect: to recruit a senior management team, she believes Thompson will have to grant generous stock options in addition to the salaries projected in his business plan. From past experience, she thinks management should have the ability to own at least 15% share of the company by the end of year 5. Given her beliefs, what share of the company should Samantha insist on today if her required rate of return is 50%?

15% held by management, meaning $85m will go to other shareholders

Fv = $5m (1 + 0.5)^5

Fv = $37.97m

Required share = $37.97m / $85m

Required share = 44.67%

Samantha should insist on owning 44.67% of the company.

Part 2:

During negotiations between Samantha Jones and John Thompson, Jones proposes using a hybrid security called participating in preferred stock. A participating preferred security enables the holder to convert the security to common stock at the previously agreed conversion rateand to have the principal amount repaid. In standard convertible preferred stock, the holder gets the maximum of the liquidation valueor the value if converted into common stock.

a. What share of the company will Samantha Jones require today if her required rate of return is 50% and she uses participating preferred stock instead of a standard convertible preferred security?

b. If the company has 1,000,000 shares outstanding before the private placement, how many shares should Samantha purchase? What price per share should she agree to pay if her required rate of return is 50%?

c. How does utilizing participating versus standard preferred change John and Samantha's perceptions of the risk and reward profile of this deal?

Since Samantha will have her principal paid first, she'll need less share to offset her

risk while still getting a high rate of return with lower risk. It shifts some of the risk

from Samantha to John since John is responsible for that preferred stock.