Calculating WACC, Venture Capital Returns, Sustainable Growth Rate, and Understanding Cash Flow Fore

What is WACC and how is it calculated?

1.  Calculate the weighted average cost of capital (WACC) based on the following information:  the capital structure weights are 50% debt and 50% equity; the interest rate on debt is 10%; the required return to equity holders is 20%; and the tax rate is 30%.

                        a.  7%

                        b.  10%

                        c.  13.5%

                        d.  17.5%

                        e.  20%

2. Venture capital holding period returns (all stages) for the 10-year period ending in 2014, were approximately:

                        a.   20%

                        b.   15%

                        c.   10%

                        d.     5%

3.  If a venture has a return on assets (ROA) = 10%, an equity multiplier based on beginning equity = 3.5 times, and a retention rate = 50%, the sustainable growth rate would be:

                        a.  10%                                                           

                        b.  17.5%

                        c.  35%

                        d.  40%

                        e.  20.5%

4. When long-term financial planning efforts set cash as a percentage of sales or as a fixed dollar amount for planning purposes, the projected cash flow statement is said to be a ________ forecasting statement.

                        a.  dynamic

                        b.  passive

                        c.  conservative

                        d.  checking

5. Estimate a venture’s terminal value based on the following information:  current year’s net income = $20,000; next year’s expected cash flow = $26,000; constant future growth rate = 7%; and venture investors’ required rate of return = 20%.

                        a.   $156,846

b.   $285,714

c.   $200,000

d.   $150,000

e.   $428,571

6. An individual’s work-related, non-financially compensated, contribution to the enhancement of a venture’s value is referred to as:

a.   money equity

b.   sweat equity

c.   goodwill

d.   intangible work

7. Determine the future value of a target venture which has net income expected to be $40,000 at the end of four years from now.  A comparable firm currently has a stock price of $20.00 per shares; 100,000 shares outstanding; and net income of $50,000.

                        a.   $1.0 million

                        b.   $1.4 million  

                        c.   $1.6 million

                        d.   $2.0 million

8.  Personal credit cards have proven to be a source of financing for start-up firms for all of the following reasons except?

a.  credit card debt is not based on the firm’s  ability to repay, but rather the individual card holder’s ability to repay

                        b.  teaser rates afford initial low cost borrowing

                        c.  balance transfer at below-prime rates

            d.  credit card debt can create problems if the firm doesn’t generate cash flows to cover credit card payments once low introductory rates expire

Venture Capital Returns: Holding Period Returns

9. A venture is expected to have an exit value of $10,000,000 five years from now. If venture investors invest $1,000,000 now, and expect a 20% compounded rate of return on their investment, what portion of the exit value would they need?

                        a.   10.5%

                        b.   20.1%

                        c.   24.9%

                        d.   28.8%

                        e.   32.5%

10. Ventures that reach their survival stage of their life cycles and seek first-round financing are typically organized as:

                        a.   proprietorships or partnerships

                        b.   LLCs or corporations       

                        c.   corporations

                        d.   partnerships or LLCs

                        e.   proprietorships or corporations

Part B: Answer all of the four questions given below (15 marks each)

Questions 1.

The Mega One Software Corporation was organized to develop software products that would provide Internet-based firms with information about their customers.  As a result of initial success, the venture’s premier product allows firms with subscriber bases to predict customer profiles, retention, and satisfaction.

Arlene received an undergraduate degree in computer sciences and information systems from a major northeastern university four years ago.  The Omega Subscriber Software Product was developed, test marketed with the help of two of her classmates; Mega One Software Corporation was up and running within one year.  Venture capital was obtained to start up operations; a second round of venture financing helped Mega One to move through its survival stage.  Product success in the marketplace has allowed the venture to achieve such rapid sales growth that it now is able to get bank loans and issue long-term debt. 

The interest rate on the bank loan is 10 percent.  For long-term debt, the real interest rate is estimated to be 3 percent; the inflation premium is 4 percent; and Mega One’s default/liquidity risk premium over government bonds is estimated to be 7 percent.  The cost of common equity was estimated using the risk-free long-term government bond rate and a stock investment risk premium of 13 percent.

Arlene has now reached the point of being able to consider whether Mega One is adding economic value in terms of its net operating profit after taxes (NOPAT) and its weighted average cost of capital (WACC).  Following are the financial statements for 2016.

Mega One Software Corporation

Mega One Software Corporation

Balance Sheet                                                2016

B.     Calculate Mega One’s net operating profit after taxes (NOPAT).  Why does the NOPAT differ from the earnings after taxes?

C.     Estimate the effective before-tax cost of the long-term debt.

<span style="font-size: 12.0pt; font-family: 'Times New Roman','serif'; mso-fareast-font-family: 'Times New Roman'; mso-ansi-language: EN-US; mso-bidi-fo