You are an entrepreneur starting a biotechnology firm. If your research is succe

Question

You are an entrepreneur starting a biotechnology firm. If your research is successful, the technology can be sold for $34 million. If your research is unsuccessful, it will be worth nothing. To fund your research, you need to raise $3.3 million. Investors are willing to provide you with $3.3 million in initial capital in exchange for 35% of the unlevered equity in the firm. What is the total market value of the firm without leverage? Suppose you borrow $0.7 million. According to MM, what fraction of the firm's equity will you need to sell to raise the additional $2.6 million you need? What is the value of your share of the firm's equity in cases (a) and (b)? What is the total market value of the firm without leverage? The market value without leverage is

Explanation / Answer

1) Total value of equity = capital raised/share of unlevered equity = 3.3/0.35 = 9.428 ~9.4m

2) MM says total value of firm is still $9.4 million. $.7 million of debt implies total value of equity is $(9.4-0.7) = 8.7 million. Therefore, 29.88% of equity must be sold to raise $2.6 million.

3)

In a) 65% of equity = 9.4*.65 = 6.11m

in b) (100-29.88)% of 8.7 = 6.08m

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