Garrett Technologies (GT) has been in operation for one full year (2017). Financial statements follow. GTs management is interested in determining the value of the venture as of the end of 2017. Sales are expected to grow at a 40 percent annual rate for each of the next three years (2018, 2019, and 2020) before settling down to a long-run growth rate of 10 percent annually. The cost of goods sold is expected to vary with sales. Operating expenses are expected to grow at 70 percent of the sales growth rate (i.e., be semi-fixed) for the next three years before again growing at the same rate as sales beginning in 2021. Individual asset accounts are expected to grow at the same rate as sales. Depreciation can be forecasted either as a percentage of sales or as a percentage of net fixed assets (since net fixed assets are expected to grow at the same rate as sales growth). Accounts payable and accrued liabilities are also expected to grow with sales.

GTs management is interested in determining the equity value of the venture as of the end of 2017. Because GT is in its startup life cycle stage, management and venture investors believe that 50 percent is an appropriate discount rate until the firm reaches its long-run or perpetuity growth rate. At that time it will have survived and will become a more typical firm with an estimated cost of equity capital of 20 percent.

GARRETT TECHNOLOGIES CORPORATION

Income Statement for December 31, 2017

(Thousands of Dollars)

Sales $55,000

Cost of goods sold -27,500

Gross profit 27,500

Operating expenses -17,000

Depreciation -800

EBIT 9,700

Interest -250

EBT 9,450

Taxes (35%) -3307.5

Net income $6,142.5

Balance Sheet as of December 31, 2017

(Thousands of Dollars)

Cash $ 2,500 Accounts payable $ 3,000

Accounts receivable 2,500 Accrued liabilities 2,200

Inventories 3,000 Bank loan 1,800

Total current assets 8,000 Total current liabilities 7,000

Gross fixed assets 11,000 Common stock 9,100

Accumulated depreciation 800 Retained earnings 2,100

Net fixed assets 10,200 Total equity 11,200

Total assets $18,200 Total liabilities and equity $18,200

1. Project the financial statements for the next four years (2018-2021).

2. Calculate the valuation cash flow for each year.

3. What is the terminal value of this venture?

4. What is the reversion value?

5. Determine GTs equity value at the end of 2017.

6. What percent ownership interest should the present owners of GT be willing to give today for a $10 million investment?

7. If an investor wanted to own 20% of GT, how much should he or she be willing to pay?