ILLUSTRATION 9-9: Amount to Offer Investors Hannah projects cash distribution to her equity investors to be $60,000 per year. She plans to hold her hotel for 7 years, then sell the property. She estimates that a sale at the end of Year 7 will bring in $1.2 million. She knows her investors are expecting at least a 12% annual return on their investment. To meet, but not exceed, the financial goals of her investors (their hurdle rate) and raise $500,000 in equity, how much ownership should Hannah offer her equity investors in return for their investment of $500,000? Step 1: PV of the investment opportunity Alternative or Option: use the NPV with a zero initial outflow, 60000 per year cash flow for 7 years, & Resale value of 1.2 Million at the end of year 7; Investor Hurdle Rate 12% 12.00% HURDLER 12.00% Cash Flows Year 1 60000 Year 2 60000 Year 3 60000 Year 4 60000 Year 5 60000 Year 6 Year 7 60000 1260000 PV = Year 5 Alternativeor Option 2 = PV of an 7 year annuity @ $60,000 + PV of a single lump sum of 1.2 Million in Year 7 Cash Flow: Year 1 Year 2 Year 3 Year 4 Year 6 Year 7 Annuity 60000 60000 60000 60000 60000 60000 60000 Lump Sum 0 0 0 0 0 0 1200000 Rate = 12.00% Periods 7 Annuity 60000 Y7 Resale 1200000 PV of 7 year annuity of 60,000/year = PV of Single Lump Sum of Resale= PV of the investment opportunit $0.00 Step 2 The Amount of Ownership to Offer How much ownership does Hannah need to give up if the Investors give 500000 at 12% for 7 years, Resale 1.2 million? Cost = 500000 Total PV of projected cash distributions = $0.00 $ Amount of Ownership Cost/PV = /= (The % ownership Hannah should offer for $500,000 of equity). Optimistic projected 0.15 Cash Flows Year 1 69000 Year 2 69000 Year 3 69000 Year 4 69000 Year 5 69000 Year 6 Year 7 69000 1449000 PV = Step 2 The Amount of Ownership to Offer How much ownership does Hannah need to give up if the Investors give 500000 at 12% for 7 years, Resale 1.2 million? Cost = = 500000 Total PV of projected cash distributions = $0.00 Amount of Ownership Cost/PV = (The % ownership Hannah should offer for $500,000 of equity)