You have recently been appointed as the finance manager for James Investments Ltd a Venture Capital organisations which specializes in investing in start-up organisations.
The board of Directors is considering purchasing one of three new potential start up- organisations. In order to assist with their decision, they have asked you to prepare a financial analysis of the potential acquisitions and recommend an appropriate funding for the purchase.
You have been given the following information relating to free cash flows provided by the companies and the estimated sale price expected as a trade sale at the end of year 4.
|Company Name||Initial investment
(price to acquire)
Fee cash flows
Free cash flows
|Year 3 free cash flows||Year 4
Free Cash flows
|Exit sale price|
|Jessica On line Dance||2,000,000||500,000||500,000||500,000||1,000,000||2,500,000|
|Luke Logistics Pty||2,500,000||750,000||1,250,000||1,500,000||1,000,000||3,500,000|
The directors of James Investments have provided overall guidance for the financial analysis and selection of new investments.
- No investments will be undertaken in companies which have a payback period of greater than three (3) years
- The Financial analysis should be undertaken using a discounted cash flow approach based on information supplied.
- The discount rate to be used is the Weighted average cost of Capital of James Investments plus a 2% risk component
You note that the weighted average cost of capital (WACC) has not been calculated for a long period, you decide to calculate it and include it in your report
On your research you acquire the following information.
|Balance sheet item||Average balance sheet Amount||Average cost|
|Capital and shareholders’ funds||$ 7,200,000||6.5%|
No other forms of financing are relevant for the calculation of WACC. Note the company tax rate is 30%
You are required to produce a properly formatted board report that provides the following information.
- Initial selection process based on payback period (6 marks)
- Your Weighted average cost of Capital calculation (8 marks)
- Your recommendation selection and analysis of the appropriate investment based on financial data provided. (15 marks)
- The preferred funding of the acquisition if issuing company bonds at a coupon of 6% paid annually. Advise the directors of the approximate issue price of the bond if similar bonds with three years to maturity are trading at a yield to maturity of 4.5%. (10 marks)
- As a venture capitalist also raise other areas that need to be considered by the Board of Directors in relation to the acquisition target, in addition to your financial analysis. (6 marks)