It's Gonna Be Big (IGBB)
It's Gonna Be Big (IGBB) is seeking venture capital investment of $8 million. The founder and the venture capital fund agree the firm is worth $15 million today, and the venture capital investor asserts it requires a 35% (compounded annually) expected return. IGBB and the venture capital investor foresee an IPO in four years, at which time IGBB is expected to be valued at $90 million.
-Suppose the venture capital investor's share of the equity in IGBB is 25%,and that in four years at the IPO the firm is valued at $120 million.What annual (compounded)return did the venture capital investor earn?

Question

Quizplus · Accepted Answer

To calculate the annual compounded return, we first need to calculate the initial investment by the venture capital investor:
Initial investment = (25% of $15 million) = $3.75 million

Using the future value formula:
FV = PV*(1+r)^n
Where,
FV = future value
PV = present value
r = annual compounded return
n = number of years

$120 million = $3.75 million*(1+r)^4

Solving for r, we get:
r = 0.0903 or 9.03%

However, this is the annual compounded return on the overall investment, not the expected return of the venture capital investor. To calculate the expected return, we need to use the formula:
Expected return = (1 + annual compounded return)^(1/4) - 1

Expected return = (1 + 0.0903)^(1/4) - 1 = 0.0874 or 8.74%

Since the venture capital investor expected a 35% (compounded annually) return, but only earned an 8.74% (compounded annually) return, it means the investment did not meet the investor's expectations. Therefore, B is the best answer.