Joe Ogden, the Chairman and CEO of Ogdenergy, Inc., a promising venture in the natural gas industry, is negotiating with Summer Street Capital Partners, a Buffalo, NY-based venture capital firm (VC), for funding of $15 mn., which will be used for building PP&E.Summer Street is impressed with the venture, and is considering providing the funding in exchange for equity shares.However, Summer Street is concerned that if they demand an equity ownership percentage that is too high, Ogdenergy's entrepreneurs may be less inclined to work hard to ensure the venture's success.They determine that if they demand a 40% equity percentage, the firm will be worth $44 mn., but if they demand a 60% ownership percentage, the firm's value will be only $26 mn.Which equity ownership percentage should Summer Street take? (i.e., which maximizes Summer Street's NPV?)

Question

Quizplus · Accepted Answer

At a 40% equity stake, the firm's value is projected to be $44 million, making Summer Street's share worth $17.6 million (40% of $44 million). At a 60% equity stake, the firm's value drops to $26 million, making Summer Street's share worth $15.6 million (60% of $26 million). Therefore, a 40% equity stake maximizes Summer Street's NPV.