This task is based on the Capstone Case 2: Spatial Technology, Inc. (refer Leach, JC, and Melicger, RW 2018, Entrepeneurial Finance, 6th edn, Cengage Learning, Boston, MA. pp. 649-674). You need to carefully read the material presented in this case.
Your task is as follows:
Prepare a report for Dick Sowar that outlines why you believe that the latest (1996) and the previous (1992) IPO’s failed to garner sufficient interest from investors.
In support of your answer relating to the 1996 initial IPO process you should prepare various valuations of the business based on the valuation techniques that you have learned about in this course – use 5 years (1997 to 2001) plus a terminal year (2002) in preparing the valuations.
Valuation A: Manipulate the 1996 full year revenue in order to obtain the estimated $1.7M net earnings after tax and the estimated $5.4M earnings after tax for 1997 as outlined in Exhibit 9 and then select the necessary growth rate for 1998, 1999, 2000, and 2001 to achieve a pre-money valuation of $60M. This reflects a share price of approximately $10.
Valuation B: Adjust your assumptions about growth for the 5 year growth period to reflect a $30M pre-money valuation. This reflects a share price of approximately $5.
Valuation C: Adjust the various forecasts that you have made for 1996 and 1997 as well as the other years in the forecast to reflect what you would consider a more realistic growth trend. What is the 1996 valuation of the business based on your assumptions?
In each of the three valuations use these simplifying assumptions:
1. Use a growth rate of 6% for the Terminal year.
2. In preparing the valuations you will need to make assumptions about the various expense, asset, and liability items as a percentage of sales. In making these assumptions you should use historical ratios based on preceding years financial statements.
3. The tax rate is 25%.
4. Use 2% as the ratio for required cash.
5. If any funds need to be borrowed the interest rate on those funds will be 15%.
6. The WACC is 20% – what is the cost of equity?
7. The interest rate that can be earned on any excess cash is 5%.
8. Use 5,937,223 pre-money shares as the basis for calculating price per share.
9. If you need to make any other assumptions include them under a separate heading in your report and provide a rationale for each assumption made,
Issues that you should consider in your report might include:
• The success or otherwise of Spatial’s strategy to penetrate the market;
• The impact that Spatial’s management team has on the IPO process;
• At what valuation share price would you recommend to potential investors as a fair price.
• Would you invest in this business? Why or why not?
• Summarise for Dick Sower the impact of your analysis and how it affects Sower.
Include in your report a reflective assessment of what you have learned from preparing the report. This reflection should cover the process of analysing the Spatial business as well as what insights you have gained that will help you with your own entrepreneurial plans or career in the finance industry.
It is likely that you will make use of the internet to complete this task as there will have been much written about the rise and fall of this business. You should make sure that you don’t fixate on a single source – as then you will be only reflecting the views of the author of that source. You also should make sure that you are completely aware of the University’s position of plagiarism – this needs to be your own work and not that of someone else. Also ensure that where you do use ideas gained from another source that you adhere to the standards of academic referencing.
NB: a key to successfully completing this task is the creation of a well-designed spreadsheet for carrying out the valuations.
Task length: 3,500 words excluding tables, spreadsheets, and references.
additional information for you:
1. In simplifying the case requirements I decided not to include a requirement to have a set level of long-term debt in the business in the forecast years. The removal of this requirement makes if difficult for you to determine the required return on equity which you need for doing the present value calculations. Therefore you should use 23.5% as the required return on equity.
2. The other issue that was raised with me is that of Depreciation and Amortisation. This expense is not shown explicitly in the Balance Sheets or in the Profit and Loss Statements (Income Statements). However, the annual expense number is provided in the Cash Flow Statements.
3. In order to avoid any confusion, I would draw your attention to the Pro-Forma Balance Sheet for June 30, 1996 in Exhibit 5b. You will note that you have been provided with balances of the various equity accounts as at June 30, 1996 – as part of your projections you will need to complete the rest of this Pro Forma Balance Sheet.