# A realistic problem

I’ve got a realistic problem that I could use some help with. I started out knowing exactly what to do, but I seem to have confused myself on the way and now I’m stuck in circular logic and can’t figure out the right answer here. Let’s say I am valuing a startup hydroelectric company that currently owns licenses to several hydro sites, and can begin building power generation plants at each site after it raises \$100m in capital. I am trying to value the company and determine the price of equity when raising the capital; and to determine the current value of the current owners shares. The business plans on raising capital using a 70/30 debt/equity capital structure (\$30m equity and \$70m debt need to be raised). The company is privately held and there are currently 15,000 shares outstanding. I have valued the company using a discounted cash flow model and decided that the equity is worth \$145m (\$215m FCFF - \$70m debt). Here is where my confusion begins. I have valued the company using projections that are assuming that the \$100m capital is raised successfully. Without raising the \$30m equity and \$70m debt the company will not be able to build generation units and will not produce cash flow. Are the current 15,000 shares worth \$145m total (\$9,666 per share) as per my valuation model? Or should it not be valued that way due to the fact that the projections are post capital raising projections? What is the value of the shares right now, and after the money is raised? How many new shares should the company issue to raise \$30m in equity, and how much should they be sold for? I realize there can be many answers because the price depends on the number of shares issued, but if someone can explain the methodology they use I would be eternally grateful. I’ll be glad to clarify further if anyone needs some more info, but this has me stumped and I would appreciate any help.

Here’s my guess. B4 raising money , the share value depends on cost of license . When raising money, the share value of original owner=145m-30m(new capital).

That is exactly how I approached the problem. However, I’m having a hard time seeing how someone could invest a few million dollars in a license and then have it suddenly be worth 100+ million. It doesn’t make sense to me.

Interesting, I would see it as a venture capital problem. I have worked for project investment for some years and have not come accross with such case, FCFF approach, price per share, etc. Ok, let’s assume your valuation is correct. \$145 is the value of equity after financing. Thus 145 is the post money valuation, you need 30 equity investment, i.e. INV, POST=PRE+INV 145 = PRE + 30, PRE = 115 Your 15000 shares does not worth 145m, as you need additional equity in order to build the power to achieve 145m. As 15000 shares worth 115m, each share is \$7667. For 30m, 3913 new shares will be issued. Thus, existing shareholder owns 79% and the new investor own 21%. This is the CFA thing. However, if you look at the deal. When someone invest 30m to the company and your wealth will suddenly increase by 115m. That is beautiful. Something must be wrong. First VC is financed basically by equity. It is doubt that 70% debt financing is possible. Secondly, new investor will calculate the future cash flow and discount by their own discount rate. If so, the INV may be less than 30m and existing management may need to finance the balance. Normally, shareholders will share the 30m initial investment according to their shareholding. If a shareholder holds some valuation asset such as license or land, these can be regarded as a kind of value, but need to quantify. Furthermore, I am doubt whether the FCFF approach can be applied to capital budgeting. Inclusion of debt in NPV analysis (although many companies do it this way) is incorrect, according to all the corporate finance textbook. Can somebody from VC or investment bank provide some input?

I appreciate the help, jogging. While the first method seems correct to me, you brought up exactly what I have an issue with. Suddenly their 3m investment + time invested explodes into 115m. How can this be realistic? I suppose one way to look at it is that the time and costs of acquiring the licenses and setting up the projects is worth 115m in the end. Obviously this is a terrific return on investment if true. You mention that you have not come across a case such as this yourself before where projections are discounted at FCFF. That was my addition to the project and my personal way to determine a valuation. The reasoning for such is that there are several different projects being developed and the business is hoping to sell the projects off to a larger company that can fund the operation, but if they can not get an acquisition they are going to attempt to raise equity privately or publicly. I am attempting to value the projects if they are consolidated into one business and the business raises money privately to fund their projects. Does this make sense to you? Does using the FCFF discount model make sense to you under these circumstances or not really?

The FCFF things make sense to me, but probably not to your director, the investor or the buyer. FCFF is reasonable to me as it is the cash flow before any financing. If you like to sell several projects in one goal, it seems make sense to combine the net cash flow from different projects and calculate the NPV, IRR. But if I am the potential investor, I would disintegrate your spread sheet, using my own conservative assumption and calculate the each project value. And negotiate with you the pricing based on my own calculations. I guess there would be some synergy among the projects, e.g. management, technology, purchasing, etc. Build them into the model to make they are sold altoghther. Otherwise, investor (like me) will just pick the high return and give up the low return ones.