You Have Been Asked by An Investor To Value A

The assistant has been asked to value a local restaurant for an investor. The restaurant earned $300,000 in pretax operating income last year and income has grown 4% annually for the past 5 years. With modern management methods, income growth can be increased to 6% beyond the second year. The investor is willing to pay a 10% premium for control. Factors like debt ratios, borrowing costs, taxes, and growth projections are given. The assistant must calculate the business's worth.

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You Have Been Asked by An Investor To Value A

Uploaded by

Amit Pandey

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Solved: You have been asked by an investor to value a

You have been asked by an investor to value a local restaurant. In the most recent year, the
restaurant earned pretax operating income of $300,000. Income has grown an average of 4%
annually during the last five years, and it is expected to continue growing at that rate into the
foreseeable future. By introducing modern management methods, you believe the pretax
operating-income growth rate can be increased to 6% beyond the second year and sustained at
that rate through the foreseeable future. The investor is willing to pay a 10% premium to reflect
the value of control. The beta and debt-to-equity ratio for publicly traded firms in the restaurant
industry are 2 and 1.5, respectively. The business’s target debt-to-equity ratio is 1, and its
pretax cost of borrowing, based on its recent borrowing activities, is 7%. The business specific
risk for firms of this size is estimated to be 6%. The investor concludes that the specific risk of
this business is less than other firms in this industry due to its sustained profit growth, low
leverage, and high return on assets compared to similar restaurants in this geographic area.
Moreover, per capita income in this region is expected to grow more rapidly than elsewhere in
the country, adding to the growth prospects of the restaurant business. At an estimated 15%,
the liquidity risk premium is believed to be relatively low due to the excellent reputation of the
restaurant. Since the current chef and the staff are expected to remain if the business is sold,
the quality of the restaurant is expected to be maintained. The ten-year Treasury bond rate is
5%, the equity risk premium is 5.5%, and the federal, state, and local tax rate is 40%. The
annual change in working capital is $20,000, and capital spending for maintenance exceeded
depreciation in the prior year by $15,000. Both working capital and the excess of capital
spending over depreciation are projected to grow at the same rate as operating income. What is
the business worth?