Question 1

Original
Exit Hold IRR Marks
No of Shares % Realn Invstmnt Period Expect
Owners 1,000,000 54.0% 323.97
Round I 314,432 17.0% 101.87 10 5 59.1% 1+1
Round II 296,448 16.0% 96.04 25 4 40.0% 1+1
Round III 241,150 13.0% 78.13 50 2 25.0% 1+1
1,852,030

Revised
Owners 1,000,000 19.0% 47.62
Round I 500,000 9.5% 23.81 10 6 15.6% 1+1
Round II 1,250,000 23.8% 59.52 25 5 18.9% 1+1
Round III 2,500,000 47.6% 119.05 50 3 33.5% 1+1
5,250,000

IRR Haircut
Round I 74%
Round II 53%
Round III -34%

Revised arrangement
Owners 1,000,000 42.7%
Round I 292,740 12.5% 31.25 10 6 20.9% 1
Round II 451,991 19.3% 48.25 25 5 14.1% 1
Round III 597,190 25.5% 63.75 50 3 8.4% 1

IRR Haircut-Revised
Round I 65%
Round II 65%
Round III 66%

To establish the reason for the lack of interest of Round I investor one needs to see f she is losing out
vis a vis (i) her originally expected return and (ii) she is losing out more vis a vis her expected returns
than the other investors are losing out vis a vis their expected returns.

The table above calculates (i) the originally expected returns of each of the investors and (ii) their
hair-cuts vis a vis their originally expected returns. That table establishes the reason for Round I
investor losing interest in the transaction.

Any arrangement that would get back the Round I investor back into the deal would need to ensure at
the minimum that the Round I investor does not suffer a higher haircut than the other investors. This

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assumes that all the investors are willing to accept the same haircut no matter what risk they faced
while making the investment. That is usually considered a fair position around which further
negotiations might take place.

Grading Scheme – See table above

3 marks each for getting cash original and revised realizations

3 marks each for getting original and revised IRR

3 marks for getting the haircuts right

3 marks for proposing an arrangement as above

3 marks for working out the exact formulation This has been awarded the minimal marks although it
is the core of the solution because of the difficulty in getting the right solution in a limited time.

Anyone who gets the original and revised IRRs right gets two thirds of the credit because it indicates
that s/he has got the drift of the solution right.

Error in steps – No marks for the step

Flow through error – Flow throughs from one error not penalized

Flow through from two errors – half the allotted marks

Flow through from more than two errors – no credit

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Question # 2

Year 1 2 3 4 Marks
EBIT 10 24 42 54
Tax @ 40% 4 9.6 16.8 21.6 1
EBIT x (1-tax rate) 6 14.4 25.2 32.4 1
Add Depreciation 8 8 9 12 1
Total 14 22.4 34.2 44.4
Less Capex 0 8 20 0 1
Less Incre NWC 12 12 6 6 1
FCF 2 2.4 8.2 38.4 1
PV FCF 1.74 1.81 5.39 21.96 1
Horizon Value at t=4 207.58 1
PV Horizon Value at t=0 118.68 1
Tax Shields
Startup Exp Written off 5 5 1
Tax Shield 2 2 1
PV Tax Shield –Amortisation 1.32 1.14 1

Term Loan Balance 90 90 60 30

Interest 9 9 6 3 1
Tax Shield on Interest 3.6 3.6 2.4 1.2 1
PV TS - Interest 3.27 2.98 1.80 0.82 1

APV of RCATS
PV FCF 30.90
PV Horizon Value 118.68
PV TS - Start up Expenses 2.46
PV TS – Interest 8.87
Total APV 160.91 1

Cost of capital for FCF – ra = WACC = 15%

Cost of Capital for Interest Tax Shield – Pre tax Cost of debt

Cost of Capital for Tax Shield from write off Start up expenses = WACC, because it is subject to
availability of taxable profits

Treatment of errors and Flow through errors – refer to the notes to question # 1 above

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 Question -3

EV Sales EV/Sales Marks

Jugaad Multimedia 16 0 #DIV/0!
Panther Online 27 8 3.38
Oriental Transmedia 28 14 2.00
Media Telnet 13.5 5 2.70
Hind Telemedia 18 11 1.64
New Millenium Media 16 3 5.33
Average ex Jugaad 3.01
Average ex Jugaad trim 2.43 3
Av ex
Jugaad Trim
Exit Value 812.41 655.52 1+2

Exit Realisations required Amt Years RoR Cash

Round I 10 7 50% 170.86
Round II 15 6 40% 112.94
Round III 40 4 25% 97.66

Av ex
Exit holding % Jugaad Trim
Round I 21.03% 26.06% 1
Round II 13.90% 17.23% 1
Round III 12.02% 14.90% 1

Entry holding %
Round I 28.39% 38.40% 1
Round II 15.80% 20.25% 1
Round III 12.02% 14.90% 1

Given the nascent nature of the industry and the lack of profitability the only multiple that seems to
make sense is EV / Sales. One firm, New Millenium Media seems to skew the average. It is possible
that the firm is mispriced or is a non-comparable business. That makes a case for trimming the
average by removing New Millenium from the sample. Jugaad does not give a quotient.

EV/ Employee would be a valid multiple for a firm / industry at this level of evolution. However it
results in an extremely low multiple which suggests that it might undervalue firms.

The rest of the solution is evident from the table above.

Grading – see table above for marks break-up.

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Both average ex Jugaad as well as trimmed average have been given full mark for that step as well as
the % equity calculations following from the same. So also an average of EV/ Employee and EV /
Sales has been accepted as a solution although I am afraid the reservation about EV/ Employee
continue to be a source of worry.

For measures using EV/EBIDTA or EV/PBT 1 or 2 points have been docked to reflect the importance
of choosing the right multiple. The main purpose of the question is to test that aspect of valuation.
Points have not been docked for explaining the basis of selection of multiples in spite of the fact that it
is the main testing point in this problem.

Errors and flow-through errors - See comments in relation to Question -1

Question – 4

Drop in valuation defined: If the price per share in a subsequent round (2nd or third round) times the
number of shares allotted to the first round investor is less than the cash paid by the investor in Round
1. This will arise when the pre money valuation in any round (t+1) is less than the post money
valuation in any round ‘t’. The condition to be stipulated therefore is that Upstart will not raise capital
in any round at a pre money valuation lower than the post money valuation in the previous round.

The problem intentionally provides some additional (but incomplete) data which are not necessary to
arrive at this answer.

Illustration

Cash raised in round 1 Rs 10 mn

Post money valuation Rs 50 mn
% equity at entry 20%
Premoney valuation Rs 40 mn
No of shares allotted to investor 200,000 (assuming firm starts with 800,000 shares of Re 1 each
allotted to the owners)
Price per share Rs 50 (Valuation = Rs 50 x 200, 000 = Rs 10 mn)
Cash raised in Round 2 Rs 20 mn
Minimum condition Pre money valuation = Rs 50 mn
Post money valuation in Rnd 2 Rs 70 mn
% equity at entry in Rnd 2 28.57%
Shares allotted to Rnd 2 investor 399972
Price / share in Rnd 2 Rs 50
Valuation of Rnd 1 shares based on Rnd 2 price remains Rs 10 mn.

Note: This is the same condition we use in our discussion on dividends and irrelevance of capital
structure in the Core course to ensure there is no transfer of wealth between incoming and incumbent
shareholders.

Grading: Full marks for answer as above, 1 mark for an attempt with some complete numerical, 0.50
mark for an attempt with no numerical.