1334 Westwood Blvd. Suite 6 Los Angeles, Ca. 90024 Phone: (310) 943-7070 Fax: (310) 476-9520
Web site: www.CinemaShares.com E-mail:
Valuation Analysis and Tables
Purpose
This report is an analysis of the determination of fair market value of MediaShares.com, LLC.
Standard of Value
The term “fair market value” as used herein is defined by Revenue Ruling 59-60 as the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. The hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property.
Valuation Basis and Effective Date
This valuation is made on a minority interest, going concern basis as of December 31, 2008.
The interest being valued represents a controlling interest.
Overview
Valuation of a business ownership interest requires consideration of all pertinent factors bearing upon its investment quality. As listed in Revenue Ruling 59-60, these factors generally include:
· The nature of the business and the history of the enterprise from its inception.
· The economic outlook in general and the condition and outlook of the specific industry in particular.
· The book value of the stock and the financial condition of the business.
· The earning capacity of the company.
· The dividend-paying capacity of the company.
· Whether the enterprise has goodwill or other intangible value.
· Sales of the stock and the size of the block of stock to be valued.
The market price of stocks of corporations engaged in the same or similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter.
Valuation Approaches
In principle, the value of an investment is equal to the present value of expected future returns from the investment. Various methods may be used to estimate the value of a business ownership interest. These methods can be broadly categorized into three valuation approaches:
· Income Approach: In this approach, estimated future returns are discounted to present value at an appropriate rate of return for the investment.
· Market Approach: This approach utilizes valuation ratios derived from market transactions involving companies that are similar to the subject business. Past transactions involving the subject business, if any, are also considered.
· Asset-Based Approach: In this approach, the assets and liabilities of the business are restated from historical cost to fair market value.
The use of the income approach to value is appropriate in this instance. The market approach to value requires a level of current revenues or income from operations to use with an earnings multiple to arrive at a value conclusion and since the subject company is a start-up company and is not currently earning revenues this method cannot be utilized.
An asset-based approach is also not relevant as the value of a start-up company is in the form of anticipated earnings used to determine a level of intangible value. The asset based approach uses the book value of tangible assets, adjusts them to market value and does not consider intangible value.
When valuing a start-up business that does not have current income or cash flows, an estimate of future income and projections must be determined in order to arrive at a conclusion of value. The use of exceedingly conservative projections does not capture the real potential of a business or business opportunity. Conversely, the use of overly aggressive projections does not accurately demonstrate the earnings potential of the business. As such, management believes the five-year projections used in this analysis are based on the best efforts of management and its financial advisors and are considered the most likely results of operations.
Income Approach
In the Income Approach, expected future returns from an investment in the form of cash flows are discounted to present value at an appropriate rate of return for the investment. The selected discount rate or rate of return should reflect the degree of uncertainty or risk associated with the future returns and returns available from alternative investments. Higher uncertainty or risk leads to a higher expected rate of return, which produces a lower value for the investment.
Income Approach valuation methods include Discounted Cash Flow and Capitalization of Cash Flow analyses. In the Discounted Cash Flow analysis, future cash flows are discounted to present value using an appropriate discount rate or rate of return. Cash flows are forecasted for a discrete period of years and then projected to grow at a constant rate in perpetuity. The Capitalization of Cash Flow analysis uses forecasted cash flow for the next period, which is converted to present value using an appropriate capitalization rate, equal to the discount rate, less the expected growth rate in perpetuity. As cash flows for the next period are not representative of future levels, this method is not appropriate.
A Discounted Cash Flow Analysis was applied in this valuation.
Discounted Cash Flow Analysis
In the Discounted Cash Flow Analysis, future cash flows are estimated and then converted to present value at an appropriate equity discount rate, indicating the value of stockholders’ equity. These cash flows represent potential cash flows available to equity holders.
Cash flow is defined as:
Pretax earnings (EBT)- / Income Taxes on EBT
+ / Non-Cash Expenses
+/- / Adjusted Working Capital Changes
- / Capital Expenditures
+ / Long-term Debt Additions
= / Cash Flow
Cash flows are estimated over a five-year forecast period beginning on the valuation date. Beyond the five-year period, a terminal or residual value is calculated using an appropriate capitalization rate. The cash flows and residual value are converted to present value using an appropriate discount rate to indicate an equity value for the Company. In the present value computation, the assumption is that future cash flows will be received midway through each year of the forecast period rather than assuming they are all received at the end of the year.
The discounted cash flow analysis presents the forecasted cash flow. The assumptions used in the analysis are shown in the discounted cash flow exhibit. Revenue sources and expenses allocations are described in the MediaShares.com, LLC Financial Pro-forma Assumptions report.
Discount Rate
The discount rate is a market-driven rate, representing the rate of return necessary to induce investors to commit funds to an investment given its level of risk. The discount rate is applied to cash flows to estimate an equity value.
The discount rate used is the cost of equity capital, based on the Build-up Model. Computation of the discount rate is described in below.
The small stock premium represents the additional return required by investors for “micro-capitalization” stocks (average market capitalization approximately $100 million) over the S&P 500 stocks. Since the subject Company is much smaller than these “micro-capitalization” stocks, an additional premium is required to account for size and is included in the subject company adjustment.
The subject Company risk premium is based on a consideration of the Company’s operating and financial risks. A company in the start-up phase faces considerable uncertainty of the realization of anticipated cash flows. Recognizing this fact, venture capitalists require considerable return premiums for their investment in such circumstances. It has been determined that an appropriate required return for this investment may be in the range of 40 to 60 percent. An upward adjustment of 30 percent has been included to account for this risk.
The computation of the discount rate is presented in the Cost of Equity exhibit (see page 5). Based on this analysis, it is our opinion that a discount rate of 51.7 percent is appropriate.
Residual Capitalization Rate
Beyond the five-year forecast period, residual cash flows are estimated to grow at a constant rate into perpetuity. These cash flows are converted to a residual value using an appropriate residual capitalization rate.
The residual capitalization rate is equal to the discount rate minus the expected long-term growth rate of cash flows. We estimated a long-term growth rate of 3.0 percent. The residual capitalization rate computation is presented in the Cost of Equity exhibit. Based on this analysis, it is our opinion that a residual capitalization rate of 48.7 percent is appropriate.
Summary
This Discounted Cash Flow Summary exhibit summarizes the results of our discounted cash flow analysis:
MEDIASHARES.COM DISCOUNTED CASH FLOW SUMMARY
/ 23-Feb-04MEDIASHARES.COM, LLC
INCOME APPROACH - DISCOUNTED CASH FLOW ANALYSIS ($000)
Projected / Projected / Projected / Projected / Projected
Forecast: Year ending December 31 / Year 1 / Year 2 / Year3 / Year4 / Year5 / Residual
Cash Flow to Equity / ($2,305) / $5,734 / $28,031 / $40,734 / $64,935 / $69,150
Residual Capitalization Rate / 48.7%
Future Value of Cash Flows / ($2,305) / $5,734 / $28,031 / $40,734 / $64,935 / $141,992
Number of Periods Deferred / 0.5 / 1.5 / 2.5 / 3.5 / 4.5 / 4.5
Present Value Factor / 0.8119 / 0.5352 / 0.3528 / 0.2326 / 0.1533 / 0.1533
Present Value of Cash Flows / ($1,872) / $3,069 / $9,889 / $9,475 / $9,954 / $21,767
Present Value of Cash Flows / $30,515
Present Value of Residual / 21,767
Indicated Equity Value / 52,282
Concluded Income Approach Value (Majority Interest) / $52,000
Below is the formula for computation of the Residual Capitalization Rate:
MEDIASHARES.COM, LLC / 23-Feb-04MEDIASHARES.COM, LLC
INCOME APPROACH - DISCOUNTED CASH FLOW ANALYSIS ($000)
Projected / Projected / Projected / Projected / Projected
Forecast for the year ending December 31, / Year 1 / Year 2 / Year 3 / Year 4 / Year 5 / Residual
Revenues / $1,500 / $14,265 / $54,109 / $75,990 / $120,159 / $123,764
Operating Expenses:
Operating Exp. - Excluding Dep. / 3,114 / 3,637 / 4,063 / 6,268 / 8,244 / 8,492
Depreciation Expense / 50 / 50 / 50 / 50 / 50 / 30
Operating Income / (1,664) / 10,578 / 49,996 / 69,671 / 111,865 / 115,242
Other Income (Expense) / 0 / 0 / 0 / 0 / 0 / 0
Earnings Before Interest & Taxes / (1,664) / 10,578 / 49,996 / 69,671 / 111,865 / 115,242
Interest Expense / 23 / 0 / 0 / 0 / 0 / 0
Pretax Earnings / (1,686) / 10,578 / 49,996 / 69,671 / 111,865 / 115,242
Income Taxes on Pretax Earnings / 0 / 4,231 / 19,999 / 27,868 / 44,746 / 46,097
Net Income / (1,686) / 6,347 / 29,998 / 41,803 / 67,119 / 69,145
Depreciation / 50 / 50 / 50 / 50 / 50 / 30
Cash Flow / (1,636) / 6,397 / 30,048 / 41,853 / 67,169 / 69,175
Working Capital Changes / (75) / (638) / (1,992) / (1,094) / (2,209)
Capital Expenditures / (594) / (25) / (25) / (25) / (25) / (25)
Long-Term Debt Additions / 0 / 0 / 0 / 0 / 0 / 0
Cash Flow to Equity / ($2,305) / $5,734 / $28,031 / $40,734 / $64,935 / $69,150
Assumptions:
Sales Growth Rate / NA / 851.0% / 279.3% / 40.4% / 58.1% / 3.0%
Operating Expenses:
Promotion and Marketing / 45.3% / 5.5% / 2.0% / 1.5% / 1.0% / 1.0%
Web Site Development / 20.8% / 2.3% / 0.6% / 0.5% / 0.3% / 0.3%
General and Administrative / 144.8% / 18.0% / 5.0% / 6.3% / 5.6% / 5.6%
Operating Exp. - Excluding Dep. / 207.6% / 25.5% / 7.5% / 8.2% / 6.9% / 6.9%
Depreciation Expense / 3.3% / 0.4% / 0.1% / 0.1% / 0.0% / 0.0%
Other LLC (Exp.) - Excluding
Interest / 1.5% / 0.0% / 0.0% / 0.0% / 0.0% / 0.0%
Earnings Before Interest & Taxes / 1.9% / 74.2% / 92.4% / 91.7% / 93.1% / 93.1%
Interest Expense / 0.2% / 0.0% / 0.0% / 0.0% / 0.0% / 0.0%
Effective Tax Rate / 40.0% / 40.0% / 40.0% / 40.0% / 40.0% / 40.0%
Required Net Working Capital / (5.0%) / (5.0%) / (5.0%) / (5.0%) / (5.0%) / (5.0%)
Required Net Working Capital / ($75) / ($713) / ($2,705) / ($3,799) / ($6,008) / ($6,188)
Capital Expenditures / 594 / 25 / 25 / 25 / 25 / 25
Long-Term Debt Additions
- as % Capital Expenditures / 0.0% / 0.0% / 0.0% / 0.0% / 0.0% / 0.0%
Discount Rate / 51.7%
Residual Capitalization Rate / 48.7%
MEDIASHARES.COM, LLC -
COST OF EQUITY
MEDIASHARES.COM, LLC
DISCOUNT RATE AND CAPITALIZATION RATE ANALYSIS
Discount Rate - Build-up Method - All Equity Financing
Ke = / Rf / + / Re / + / Rs / + / Rc
Ke = / 5.1% / + / 7.4% / + / 9.2% / + / 30.0% / = / 51.7%
where:
Ke = discount rate – un-levered cost of equity capital
Rf = risk free rate / 5.1% / a
Re = equity risk premium / 7.4% / b
Rs = small stock risk premium / 9.2% / c
Rc = subject company risk premium / 30.0% / d
Residual Capitalization Rate - Free Cash Flow to Equity
C = ( / Ke / - / G / )
C = ( / 51.7% / - / 3.0% / ) = / 48.7%
where:
C = residual capitalization rate
Ke = discount rate - levered cost of equity capital / 51.7% / See above
G = growth rate into perpetuity / 3.0% / e
a. / Estimated 20-year Treasury Bond yield as of valuation date, as published in the Federal Reserve Statistical Release.
b. / This represents the premium demanded by investors in equity securities over and above the risk free rate as published by Ibbotson Associates in Stocks, Bonds, Bills & Inflation (SBBI) 2003 Yearbook
c. / This represents the premium demanded by investors in small capitalization stocks over and above the premium demanded by equity investors, as published by Ibbotson Associates in SBBI 20032 Yearbook.
d. / Estimated additional risk premium that would be demanded by investors in subject Company.
e. / Estimated growth rate of free cash flows into perpetuity for subject Company.
Summary Budget and Cash Flow Projections follow below: