San Jose State University DCF and Exits Investing Discussion

1. Your three roommates have decided to start a company that makes motorized, solar-powered surfboards for rich older surfers who aren’t in good shape for paddling out. They have assigned themselves the titles of CEO, CFO, and VP Sales, and want you to do the fundraising for them since you are the only one who took a Fiance major.

You ask them what they think the exit strategy of the company is, so you can do a DCF valuation. But, the three of them can’t agree: the CEO thinks the exit will be an IPO ten years from now, valued at 20x their tenth-year earnings, which are forecasted to be $50mm; when you ask him why 20x, he says it’s because that equals $1b. The CFO thinks the exit is more likely to be a sale of the company five years from now to O’Neill, a sporting goods company which is run by SJSU graduates, for about $500mm, which is what O’Neill recently paid to purchase a maker of solar-heated wetsuits; however, that company had $250mm in sales at the time O’Neill bought it. The VP Sales thinks that they should just have fun running the company for as long as they want and then shut it down when they’re tired of it.

Using the knowledge you’ve gleaned from your major, evaluate which of the proposals seem reasonable or unreasonable for creating a current valuation to pitch to equity investors. Additionally, using a 20% discount rate, calculate the differences in current valuation that their three different strategies would result in. (Note: for simplicity, assume all earnings are being reinvested in the company’s growth, so investors would expect no cash flows before the Exit.) What do you believe is the best valuation approach to use in the current fundraising, and why?

2. Explains what Snappy Gifts do and why it’s a compelling investment opportunity? (HINT: Focus on why it’s attractive as an investment)