The IRR measures an annual percentage return on investment
The IRR calculation is reliable over long periods of time
The IRR-hurdle rate comparison helps assess an investment’s viability
Discounting future net earnings at the IRR makes the net present value of an investment, i.e. money in minus money out, equal to zero
A well-known piano manufacturer wishes to expand in China. It decides that 80% of the $32 million it needs will come from debt, and the remaining 20% from selling equity. The cost of debt is 7% and the corporate tax is 35%. To estimate the cost of equity, the firm uses the CAPM with these parameters:
What is the WACC, or hurdle rate, of the investment?
If the IRR of the investment is estimated at 7 %, should it proceed?
Founders are issued common stock but investors get preferred stock, and have priority recovering the investment when the business is sold. VC investor Fred Wilson believes that entrepreneurs can get a shot at a fair deal if they understand where investors are coming from. He discusses preferred stocks, investors’ need for a liquidation preference, and gives us a model for liquidation analysis; see FW1, FW2, FW3, and FW4.Here is the last question in this week’s assignment. Are investors any different to ordinary buyers of stocks and bonds in seeking some assurance of liquidity? Give at least two reasons why they are and two reasons why they are not.
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