XY Decorations, Inc. (“XY”) is an early-stage business which has forecasted a need for $1,250,000 in external funds to support the expansion of its physical plant, purchase equipment and hire essential staff. Before pursuing funding, XY must develop a credible/defensible estimate of its current value. The company just finished its first six (6) months of operations during which it experienced negative cash flow and a substantial operating loss. The management team, with the assistance of financial and accounting advisors, has prepared pro forma financial statements and cash flow projections which are based on a financial model using what the team believes are reasonable operating, new CAPEX, and Net Working Capital (NWC) requirement assumptions. After the next year (Year 1), the XY team projects   VERY SUBSTANTIAL increases in Sales. The founding team wants to retain a 60% ownership interest in the firm AFTER the $1,250,000 anticipated capital infusion. XY’s financial Model projects the following Annual (Discreet) and Terminal Cash Flows:

Year 1 = -450,000; Year 2 = 175,000; Year 3 = 1,300,000. Beginning with Year 4, the team projects a steady, perpetual Cash Flow growth rate of 3%. Cash flows in the 3 year Discreet period are considered to have a risk factor of 45%; Cash Flows in the Terminal period are considered much less risky and the team believes they should be discounted at a risk factor of 20%.

XY operates in a relatively mature industry with several trade and industry-wide associations and organizations which gather and publish operating, financial and transactional information for member companies of various sizes and maturities. XY’s financials project $ 395,000 (Net Profit) and $705,000 (EBITDA) for Year 3. Industry data indicates that risky companies currently sell for approximately 20 times Net Profit and 12 times EBITDA. As indicated above, XY’s management believes that a 45% return is necessary to attract investors.  

1. What should XY’s management present as the firm’s approximate PRESENT value if it uses the Discounted Cash Flow (DCF) valuation methodology? DCF calculation

2. What should XY’s management present as the firm’s approximate PRESENT value if it uses a COMPARABLES valuation methodology?  

Net Profit Comp Calculation:  

EBITDA Comp Calculation:

Which Valuation method should XY use and why?

3. Based on the estimated valuations you calculated above, comment on how likely you think it is that XY will be able to raise the required capital on terms acceptable to its management? Explain your answer.

4. Explain the difference between pre-money and post-money valuation; which value is preferred by investors and explain why.