David found a company and goes through the investment rounds shown below: Round Source Price Number of Shares
Series A Self $0.50 375,000
Series B Angel $1.00 400,000
Series C Venture Capital $1.50 250,000
Series D Venture Capital $2.25 400,000
He decides to take the company public through an IPO, issuing 2 million new shares. Assuming that he successfully completes the IPO, the net income for the next year is estimated to be $9 million. His banker informs him that the price of shares should be set using average price-earnings ratios for similar businesses, which is 14. What will be the IPO price per share?

Question

Quizplus · Accepted Answer

To calculate the IPO price per share, we first need to calculate the earnings per share (EPS). The net income is $9 million and the total number of shares after the IPO will be 2,000,000 + 375,000 + 400,000 + 250,000 + 400,000 = 3,425,000. Therefore, the EPS will be:

EPS = Net income ÷ Total number of shares
EPS = $9,000,000 ÷ 3,425,000
EPS = $2.63

Next, we use the average price-earnings ratio (P/E) of 14 to calculate the IPO price per share. The P/E ratio is the share price divided by the EPS. We rearrange this formula to get the share price:

Share price = P/E ratio x EPS
Share price = 14 x $2.63
Share price = $36.82

However, we need to consider the fact that David's company has gone through several investment rounds, which means that the company's actual share value may be higher or lower than the IPO price calculated above. To account for this, we can calculate the average price per share of all the investment rounds:

Average price per share = Total amount invested ÷ Total number of shares
Series A: $0.50 x 375,000 = $187,500
Series B: $1.00 x 400,000 = $400,000
Series C: $1.50 x 250,000 = $375,000
Series D: $2.25 x 400,000 = $900,000
Total amount invested = $1,862,500
Total number of shares = 375,000 + 400,000 + 250,000 + 400,000 = 1,425,000
Average price per share = $1,862,500 ÷ 1,425,000 = $1.31

Comparing the two values, the IPO price is higher than the average share price of all the investment rounds, which makes sense since the company is going public for the first time and investors would be willing to pay a premium for the opportunity to invest. Therefore, the best choice is C, $36.79.

David Found a Company and Goes Through the Investment Rounds