A potential investor is willing to provide $500,000 in first-round financing with the expectation of a 50% annual compound rate of return over the next five years. Founders currently hold 1,000,000 million shares of stock. The venture is expected to produce $500,000 in net income in year 5. A similar firm with annual net income of $1,000,000 sold shares to the public for $10,000,000. What is the number of shares that must be issued to the new investor in order for the investor to earn his target return?

Question

Quizplus · Accepted Answer

To achieve a 50% annual compound return over five years, the investor's $500,000 must grow to $3,805,078. The similar firm's P/E ratio is 10 ($10,000,000/$1,000,000). Applying this to the venture's expected net income of $500,000 gives a valuation of $5,000,000. To achieve the target return, the investor needs a 76.1% ownership ($3,805,078/$5,000,000). Therefore, the investor should receive approximately 3,156,276 shares, calculated as 76.1% of the total shares (1,000,000 existing + new shares).

A Potential Investor Is Willing to Provide $500,000 in First-Round