Case Solultion: Advanced Business Computers

Case solultion: Advanced Business Computers

1) Why has the bank refused to increase the line of credit?

Currently ABC: s debt to equity ratio is 3.95 (see exhibit 1)which indicates that the company is highly leveraged and thus is a high risk company for the bank to give loan to. In order to improve the debt to equity ratio, each of the directors have provided a personal guarantee of 100,000£ in addition to the floating charge over current assets. Taking this into account the debt to equity ratio is about 2, which is still quite high. Also the personal guarantees lack of credibility because the personal financial situation of the directors are not exactly good. One of the directors has a very expensive life-style and other has an already very high mortgage.

Exhibit 1 ABC debt to equity ratio (with and without personal guarantees)

2) £1 million equity investment for what percentage of the company?

There are several methods to valuate a company. Valuing a new start-up company can be especially difficult due to unlimited amount of historic performance data and thus the estimated future projections can be very subjective. Using not only one but multiple valuation methods can give us a good estimation of a company's current valuation.

Comparison: We compare ABC to similarly performing traded companies. By looking at companies traded in stock market or USM we see that there are 2 companies with similar yearly net profit: 0.65 and 0.46 £m which are close to ABC: s current performance. These companies have P/E values of 5.4 and 21.3. The average P/E value of these two companies is 13.35. Using this we can estimate the MCAP for ABC which is then 5.3 £m, required ownership thus is 19%. The average P/E ratio for related companies is 10.9. After shortlisting to most relevant companies (those that supply systems, or hardware and software) the average P/E ratio is 7.86. Using this P/E ratio we get a market cap for ABC of 3.11 £m. Which would indicate a 32% share for the 1 £m.

Discounting Terminal Value: We can estimate the terminal value of the company, which is the value of the company when the exit is planned to do. Typically Venture Capitalists exit in 3-5 years from initial investment. The terminal value can be calculated by multiplying company net income at the exit year with P/E ratio. In this case the terminal value would be 10.11 £m, present value 3.00 and thus the required ownership 33%. Typically due to very high risk the weighted average cost of capital used in determining net present value is very high, 30% - 70%, so we used a WACC of 50% in these calculations (see exhibit 2 and 3 for more detailed calculations).

Using these different methods to value ABC, 1 £m investment would require a 30%