Chapter 10: Venture Capital Valuation Methods

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CHAPTER 10
VENTURE CAPITAL VALUATION METHODS
TrueFalse Questions
F.

1. The venture capital valuation method estimates the ventures value by

projecting both intermediate and terminal/exit flows to investors.

T.

2. Venture investors returns depend on the ventures ability to generate cash

flows or to find an acquirer for the venture.

F.

3. The value of the ventures equity is equal to the value the financing
contributed in the first venture capital round.

F.

4. A direct application of the earnings-per-share ratio to venture earnings is

known as the direct comparison valuation method.

T.

5. The venture capital valuation method which capitalizes earnings using a cap
rate implied by a comparable ratio is known as direct capitalization.

T.

6. Failure to account for any additional rounds of financing and its

accompanying dilution in order to meet projected earnings will result in the
investors not receiving an adequate number of shares to ensure the required
percent ownership at the time of exit.

T.

7. Almost without exception, professional venture investors demand that

some equity or deferred equity compensation be structured into any
valuation.

F.

8. If a venture issues debt prior to the exit period, the initial equity investors
will still receive first claims on the ventures net worth at exit time.

F.

9. The utopia discount process allows the venture investors to value their
investment using only the business plans explicit forecasts, discounting it at a
bank loan interest factor.

F.

10. The internal rate of return is the simple (non-compounded) interest rate
that equates the present value of the cash inflows received with the initial
investment.

T.

11. The basic venture capital method estimates a ventures value using only
terminal/exit flows to all the ventures owners.

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Chapter 10: Venture Capital Valuation Methods

F.

12. The basic venture capital method estimates a ventures value using only
terminal/exit flows to founders.

T.

13. Post-money valuation of a venture is the pre-money valuation plus money

injected by new investors.

T.

14. Staged financing is financing provided in sequences of rounds rather than

all at one time.

F.

15. In staged financing, the expected effect of future dilution is borne by both
founders and the investors currently seeking to invest.

F.

16. The capitalization rate is the sum of the discount rate and the growth
rate of the cash flow in the terminal value period.

T.

17. The internal rate of return (IRR) is the compound rate of return that
equates the present value of the cash inflows received with the initial
investment.

T.

18. The discount rate that one applies in a multiple scenario valuation will
usually be lower than the discount rate that would be applied to the business
plan cash flows.

F.

19. All of the scenarios in a multiple scenario analysis must have exit cash
flows in the same year.

T.

20. The discount rate applied in an Expected PV approach should be the same
rate across scenarios.

T.

21. The expected present value method incorporates the present values of
different scenarios, as well as their probabilities, into the valuation
process.

For the Chapter 10 Learning Supplements:

T.

22. The Venture Capital ShortCut (VCSC) method is a post-money version of

the Delayed Dividend Approximation (DDA).

F.

23. The VSCS and DDA methods are just-in-time capital methods which do
not assess capital charges for idle cash.

T.

24. A price-earnings ratio is related to the level and growth of earnings.

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T.

25. For the typical business plan having current and early cash outflows and
later-stage cash inflows, the VCSC and DDA methods will typically give lower
valuations than the MDM and PDM.

T.

26. The VSCS is like a post-money version of the DDA.

F.

27. For the typical business plan having current and early cash outflows and
later-stage cash inflows, the VSCS will give a higher valuation than the DDA.

T.

28. The DDA and VCSC methods give the same valuation.

Multiple-Choice Questions
d.

1. The return to venture investors directly depends on which of the following?

a. ventures ability to generate cash flows
b. ability to convince an acquirer to buy the firm
c. the amount of its short-term liabilities
d. both a and b
e. all of the above

b.

2. To obtain the percent ownership to be sold in order to expect to provide the

venture investors target return, one must consider the:
a. cash investment today and the cash return at exit multiplied by the
venture investors target return, then divide todays cash investment by
the ventures NPV
b. cash investment today and the cash return at exit discounted by the
venture investors target return, then divide todays cash investment by
the ventures NPV
c. cash investment today and the cash return at exit multiplied by the
venture investors target return, then divide todays cash investment by
the ventures NPV
d. cash investment today and the cash return at exit discounted by the
venture investors target return, then multiply todays cash investment
by the ventures NPV

a.

3. The value of the existing venture without the proceeds from the potential
new equity issue is known as?
a. pre-money valuation
b. post money valuation
c. staged financing
d. the capitalization rate

b.

4. The value of the existing venture plus the proceeds from the potential new
equity issue is known as?

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a.
b.
c.
d.
c.

pre-money valuation
post money valuation
staged financing
the capitalization rate

5. Financing provided in sequences of rounds rather than all at one time is

known as?
a. pre-money valuation
b. post money valuation
c. staged financing
d. the capitalization rate
Use the following information for the next six (6 through 11) problems.
A potential investor is seeking to invest $500,000 in a venture, which currently
has 1,000,000 million shares held by its founders, and is targeting a 50% return
five years from now. The venture is expected to produce half a million dollars
in income per year at year 5. It is known that a similar venture recently
produced $1,000,000 in income and sold shares to the public for $10,000,000.

b.

6. What is the percent ownership of our venture that must be sold in order to
provide the venture investors target return?
a. 33.33%
b. 75.94%
c. 12.76%
d. 15.00%

a.

7. What is the number of shares that must be issued to the new investor in
order for the investor to earn his target return?
a. 3,156,276
b. 1,578,138
c. 4,156,276
d. 2,578,138

d.

8. What is the issue price per share?

a. $0.1939
b. $0.1203
c. $0.3168
d. $0.1584

c.

9. What is the pre-money valuation?

a. $120,300
b. $316,800

Chapter 10: Venture Capital Valuation Methods

c. $158,400
d. $193,900

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Chapter 10: Venture Capital Valuation Methods

a.

10. What is the post-money valuation?

a. $658,354
b. $499,954
c. $408,377
d. $249,977

b.

11. What is the value of the venture in year five using direct capitalization?
a. $500,000
b. $5,000,000
c. $1,000,000
d. $100,000

d.

12. For early stage ventures, which of the following is a strong reason for
having an equity component in employee compensation?
a. the expected deferred and tax-preferred compensation allows the
venture to pay a lower current compensation to employees
b. as a way to motivate employees to strive for the same goal of high
equity value
c. because any dividends received as part of the equity compensation
reduces taxable income
d. both a and b
e. all of the above

c.

13. During the exit period, which of the following will have last crack at the
ventures wealth?
a. banks giving loans to the venture
b. convertible debt holders of the venture
c. initial equity investors of the venture
d. participating preferred equity holders

d.

14. Suppose your ventures expected mean cash flows are $(85,000) initially,
followed by expected mean cash flows at the end of the first, second, and third
years of $40,000, $40,000, and $35,000. What is the internal rate of return?
a. 13.9%
b. 14.7%
c. 16.2%
d. 17.2%
e. 19.2%

b.

15. A P/E multiple refers to:

a. price/expectations multiple
b. price/earnings multiple
c. profit/EBIT multiple
d. profit/earnings multiple
e. price/EBITDA multiple

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c.

16. Estimate the value of a privately-held firm based on the following

information: stock price of a comparable firm = $20.00; net income of a
comparable firm = $20,000; number of shares outstanding for the comparable
firm = 10,000; and earnings per share for the target firm = $3.00.
a. $10.00
b. $20.00
c. $30.00
d. $40.00
e. $50.00

b.

17. Estimate the value of a privately-held firm based on the following

information: total market value (or capitalization value) of a comparable firm
= $200,000; net income of a comparable firm = $40,000; number of shares
outstanding for the comparable firm = 20,000; net income for the target firm =
$15,000; and number of shares outstanding for the target firm = 10,000.
a. $5.00
b. $7.50
c. $10.00
d. $12.50
e. $15.00

c.

18. Determine the market value of a comparable firm based on the

following information: value of target firm = $4,000,000; net income of target
firm = $200,000; and net income of comparable firm = $500,000.
a. $4 million
b. $7.5 million
c. $10 million
d. $12.5 million
e. $15 million

a.

19. Determine the net income of a comparable firm based on the following
information: value of target firm = $4,000,000; net income of target firm =
$200,000; stock price of comparable firm = $30.00; and 300,000 shares of
stock outstanding for the comparable firm.
a. $450,000
b. $500,000
c. $550,000
d. $600,000
e. $700,000

c.

20. Determine the future value of a target venture which has net income
expected to be $40,000 at the end of four years from now. A comparable firm
currently has a stock price of $20.00 per shares; 100,000 shares outstanding;
and net income of $50,000.

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a.
b.
c.
d.

$1.0 million
$1.4 million
$1.6 million
$2.0 million

e.

21. Which of the following financing rounds dilutes the ownership founders?
a. first-round
b. second-round
c. incentive ownership round
d. a and b
e. a, b, and c

c.

22. The utopian approach to valuation ignores which of the following venture
scenarios:
a. black hole scenarios
b. living dead scenarios
c. both a and b
d. neither a or b

d.

23. Which of the following is not a variation of the venture capital valuation
method?
a. venture capital method
b. expected present value
c. utopian discount process
d. none of the above

For the Chapter 10 Learning Supplements:

d.

24. The two just-in-time capital methods are:

a. DDA and VCSC
b. DDA and PDM
c. VSCS and MDM
d. MDM and PDM

a.

25. When a firm has growth that only meets, rather than exceeds, the cost of
capital, we would expect its price-earnings multiple to be approximately equal
to:
a. the reciprocal of its required return on equity
b. its earnings per share
c. its book-to-market ratio
d. its debt-to-value ratio

Chapter 10: Venture Capital Valuation Methods

b.

26. For the typical venture investing project, the valuation will be highest
under:
a. DDA
b. PDM and MDM
c. VCSC
d. initial book value of equity

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