10.13 An investor is interested in making a minority equity investment in a smal

Question

10.13 An investor is interested in making a minority equity investment in a smallprivately held firm. Because of the nature of the business, she concludes that itwould be difficult to sell her interest in the business quickly. She believes that the discount for the lack of marketability to be 25%. She also estimates that if she wereto acquire a controlling interest in the business, the control premium would be 15%.Based on this information, what should be the discount rate for making a minorityinvestment in this firm? What should she pay for 20% of the business if she believesthe value of the entire business to be $1 million? Answer : Discount rate = 9.78% and purchase price for a 20% interest = $180,440.

Explanation / Answer

Discount rate = premium x (1+ liquidity premium)/ (1+ premium)

                                = 0.15 x (1 + (-0.25)) / (1+0.15)

                                = 0.1125/ 1.15

                                = 9.78%

Value of stake = total value x % of stake

                                = 1,000,000 x 20%

                                = 200,000

Amount to be paid for the stake = value of stake x (1-discount rate)

                                                                = 200,000 x (1- 0.0978)

                                                                = 180,440

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