This is my first post and probably won’t be my last. Finance is proving a challenge to understand, and the ends to which one can go in finance are as far as the eye can see.
My question is about NPV and Shareholder Equity Split.
Say you found an investor and you told her:
“Ok, give me 1 million dollars of investment for 1/3rd of the company.”
Therefore, we can say that the valuation of the company is 3 million dollars.
Moreover, when we want to calculate the NPV, we want to get NPV = 3 million dollars to stick to our claims.
We show our investor all the WACC assumptions and Cash Flow assumptions and when we calculated the NPV over the next 5 years we got 3 million dollars NPV. She was happy. She put her money in.
So here’s my question:
NPV = Discounted Cash Flows (Years 1-5) - Initial Investment (Yr 0)
If the NPV is 3 million, and the Initial Investment is 1 million, shouldn’t then the Discounted Cash Flows of Years 1 through 5 be 4 million in order to obtain the NPV value we promised, the NPV promise that put the entire deal together? Is this the correct way to think about NPV and equity splits?
If I’m not wrong, u mistook the NPV in DCF valuation for Equity Value. NPV is the valuation of the company, aka Enterprise Value (EV). From the 4 million NPV (EV) that you were saying, you will need to deduct Cash & Cash Equivalent/Marketable Securities and add back any debt (Zero debt as i assumed this is a pure equity company) to get to the Equity Value (Valuation of the investment). In the end, you will get this following.
EV = Interest-bearing Debt - Cash & Cash Equivalent + Market Cap
Net Debt = Interest-bearing debt (we assumed 0 debt) - Cash & Cash Equivalent (1mn from the initial investment) = 1
EV (4mn NPV from DCF) = 1 + 3 ( 3/3 investment of the company )
The par value of the company remains 3 Mn. because it is inclusive of the 1 Mn. of the initial investment. There are no stake dilution just that the paid up capital ( base value, par value, NPV whatever you want to call it) was split between two parties. One owing 1/3 and the other 2/3.
The other way of looking at the same problem is when the venture was marketed at 3 Mn and somebody invested 1 Mn. for a 33% stake it simply means that the original promoter(s) sold their stake and pocketed the cash. That cash was never invested in the company. Because if it were not so then the paid up capital immediately becomes 4 Mn(1 Mn premium in cash account). Again depending upon which is the origination(formation) time of the company the stakes are said to have been or been not diluted.