Chapter 11 Questions and Problems

Chapter 11 Questions and Problems - ENTREPRENEURIAL...

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E NTREPRENEURIAL F INANCE : Strategy, Valuation, and Deal Structure Chapter 11. The Entrepreneur’s Perspective on Value Questions and Problems 1. A venture that requires an investment of $5 million is expected to return a total of $20 million in four years. Assume that the venture has a standard deviation of (four-year) holding-period returns of 120 percent and that its correlation with the market is 0.3. Suppose the risk-free rate is 4 percent per year and the market risk premium is 7 percent per year. The one-year standard deviation of market returns is estimated to be 14 percent. a. What is the beta of the venture? b. What is its required holding period rate of return to a well-diversified investor? c. What is its required holding period rate of return to an entrepreneur who will invest all of her wealth in the venture? d. How much is the venture worth to the diversified investor? e. How much is it worth to the entrepreneur? 2. Suppose a two-year venture will cost $1.5 million and yield an expected cash flow of $3.2 million. The standard deviation of the expected cash flow is $2 million. Suppose further that the expected market is 13.5 percent per year, the risk-free rate is 7 percent per year, the market variance is 4 percent per year, and the correlation between the venture and the market is 0.2. a. Use the CEQ form of the CAPM to find the NPV of the venture to a diversified investor. b. Use your answer in part (a) to find the equilibrium standard deviation of holding period returns and then us the RADR form of the CAPM to find the NPV to a diversified investor. c. Use the CEQ form of the CAPM-based model (Eq. 10.6) to find the NPV of the venture as a full commitment. d. Use your answer in part (c) to find the equilibrium standard deviation of holding period returns and then use the RADR form of the CAPM-based model to find the NPV of the venture as a full commitment. 3. SIM Consider the simulation model in Table 11.2. Suppose sales revenue in year 1 is the greater of zero or a normal distribution with a mean of $400,000 and a standard deviation of $250,000. If the forecast of year-1 sales is positive, then the expected growth rate of sales from year 1 to year 2 is 50 percent. After year-2, sales growth rate assumptions are the same as in Figure 10-4, except that if sales in the prior year are zero, then the forecast is for sales of zero. Expected profitability is 55 percent of sales, less a fixed cost of $1000 per year. However, if the venture fails to generate positive sales in year-1, there will be no fixed cost in the subsequent years. Other assumptions in the model are unchanged. a. Simulate performance of the venture over the six-year period. What is the expected cash amount that will go to the investor/entrepreneur in year 6, and what is the
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standard deviation of that cash receipt? How often does the venture fail to generate sales in year 1? how often does it run out of cash by year 6 b. Using the same model and assumptions, what are the expected sales and standard
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Chapter 11 Questions and Problems - ENTREPRENEURIAL...

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