Hi everybody. In this part of Capstone Project, I want to find value of the start up using multiple approach and discount cash flow approach. I hope you remember an example that I used in the first week of Course 2, where you want to buy a condominium in Seoul. To determine the price of a condominium, first, you should find the size of a condominium and its price per square foot. Then you can tell the price of the condominium by multiplying the size of a condominium in square feet by the price per square foot. The price per square foot is from comparable condominiums that are sold recently and the price per square foot is called the multiple. We can apply this same idea to estimate startup value by replacing square footage with some more appropriate measures of the font scale, such as earnings per share or book value per share. Let me describe the multiple approach for your recollection. PE ratio is price to earnings ratio and is equal to the share price divided by his earnings per share. As you may remember, there are very few startups making any profits. That is most of the startups have negative earnings. Then you can now apply PE ratio to estimate a value for startups. However, you can estimate value of startups using price to book equity or price to sales ratios. PB ratio is the ratio of Stock Price per share to book value per share. PS ratio is price to sales ratio, and it is equal to the Share Price, divide by sales per share. I must apply multiple approach to find terminal value of the startup where multiples are what you can find for companies in the same industry these days. Another evaluation approach is discount cash flow approach. In order to find terminal value you can apply present value of perpetuity formula. That you learned in the 2nd week of Course 1. Perpetuity means perpetual annuity or perpetual cash flows. We learned that the amount you have to save in the bank account to receive $1,000 every month when the interest rate is 0.5% per month is 1,000/0.5% = $200,000. In this example, $1,000 is perpetuity and $200,000 is present value of perpetuity. You can apply this formula to find the value of real estate as well as a company. If a company is mature, you assume that the company's cash flow is the same forever or grows at a constant rate. Then you can use the same formula to find this terminal value of a company in the mature stage. Next, you need to estimate free cash flows as you learned in the third week of Course 1. Free cash flow is FCF for short, and it is what the firm has available to pay all investors, including both equity holders and debt holders. Free cash flows is EBIT x (1- t)- Net Investment- Increase in net working capital. In this equation, EBIT is earning before interest and tax, and t is tax rate, so EBIT x (1-t) is earnings after tax. Capital expenditures are investments in fixed assets. And we can define the forms net investment as its capital expenditures in excess of depreciation. Net working capital, NWC, is the difference between current assets and current liabilities. That is cash plus inventory plus account receivables minus account payables. When sales increases, net working capital also increases as you can imagine that inventory and account receivables increase with the sales. How can you estimate a firm's enterprise value? To estimate a firm's enterprise value we compute the present value of these free cash flows as well as terminal value. After you find the value of a startup, let's consider the situation your startup finances, external financing needed using new investment from venture capitalists. How much ownership should a start up give to venture capitalist to persuade venture capitalist to invest in the start up? You can use the method discussed in the 2nd week of Course 2. You have to find the future value of the venture capitalist's investment in year 5 and the ratio of the future value to the terminal value of the startup to find the venture capital's ownership. You can also find how many shares should be issued to the venture capitalist using the formula that venture capitalist ownership is equal to new shares over shares outstanding plus new shares. In other word, new shares is venture capitalist's ownership x shares outstanding over 1- VC's ownership. Since we know the share price and shares outstanding before the venture capitalist's investment, the value of the startup is equal to shares outstanding times the share price. This is called the pre-money valuation of the startup. Post-money valuation of the startup is pre-money valuation + the new investment. This and the next pages are summaries of the third Capstone Project.
