Value of Four Ideas:
Please see Exhibit-1 for just option prior to Lance Bernard meeting his friends. If the company is successful, he would get an end value of $68.5K for an investment of $90K with a net loss of ($21.5K). Please see the Exhibit-2 for application of Real Options in this scenario, there are at least 4 other ways this can evaluated as profitable opportunity. 1. Viewer is Functional and Website is a success: This is highly profitable if this is accomplished. The return will be $500K. Discounting it at 20%, it will be $456K. Net Gain will be = $456 - $90K = $366K 2. Viewer is Functional but Website is failure: If the website is a failure, exploring further the option of abandoning the website and sell the software. It takes $25K to shrink-wrap the software and develop a sell version. The software can be sold for $450K. Lance Bernard’s share will be $125K, discounting at 20% it will be $114K. The net gain will be $114K - $90K = $24K 3. Viewer is Non-Functional but Website is a Winner: In this case, the business could switch to a license of an alternate viewer. Assuming the website can be sold to the owner of other viewer, the business could get $300K for the sale. Lance Bernard’s share will be $100K. Discounting it at 20% it will be $91K. The net gain will be $91K - $90K = $1K. 4. Expanding the website with additional capabilities: Expanding the website with additional capabilities to composers, website can earn free copies of other works or royalties. This additional capability could take additional 6 months, and $450K in investment. Lance Bernard will put one third of this amount. This will turn the company into profitability and will be valued much higher. Just considering the first three options above and calculating their net additional value, it will be $27.5K. Comparing with the original opportunity and Lance Bernard’s initial loss of $21.5K, the above three ideas have increased the value of the opportunity by $49K.
Other Contingent Opportunities:
Here are a few other contingent opportunities that would add value to this business - * Expanding the business by adding additional capabilities will add significant value to the business as mentioned above. * Buying a controlling share of the business will add additional value. Control of a viable company is worth around $100,000 in and of itself. * Even if the viewer is not functional and website is a failure, it will not be completely worthless. I believe the software developed, viewer ideas could be sold for a certain price. This will also bring other intangible benefits.
I strongly Bernard invest in this business after evaluating his friends suggestions and their potential value. The additional options increased the net value of the investment by $49K into the positive territory. There is a great possibility of one of them or both those – functional view and successful website – could be a success which will result positive cash net present value. There are other contingent opportunities and intangible benefits that this will bring to Lance Bernard. Also, the discount rate of 20% is pretty high in general and accomplishing positive net present value of this investment is great indication that it is an attractive and viable investment opportunity. Also Assuming doing nothing or status quo will keep the situation unchanged is incorrect. Not investing in anything could potentially be worse than status quo or doing nothing.
Perhaps not all the uncertainty is considered in the base model of Exhibit 2. Adding more uncertainty or wider probability distributions will add volatility or higher fluctuations to the monthly projected views there by increasing the fluctuation on EBITDA numbers. This will negatively impact the valuation as sustainability of growth will be questioned. I believe Lance Bernard’s cutoff level for investment of net value of the investment to be greater than zero. This model certainly...
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