1. The formula given considers the value of D1 as EBIT but actual formula has value of D1 as the profits after interest and Taxes.
2. The model does not consider the riskiness of the business.
3. The model does not discount the value of future cash flows.
4. The business is volatile and growth is uncertain.
5. The model does not consider the actual receipt, it actually considers EBIT.
6. Considering risks decision tree should be used.
7. First PAT should be determined based on growth (risk consideration) than its present value.
8. The formula is not perpetual as the year is not considered.
Salary given to the two is not considered, it may be possible that two managers are not required. Opportunity cost is not considered in the formula
2. calculate the current liquidation value of business…..
As it is mentioned and clear from the exhibit 1. Given at the end of the case:
Assumption 1. The cash amount will not be discounted to 75%, as it is money, not the asset whose resale value gets lesser.
After that all other assets are discounted to 75% of their book value.
This brings the total value of asset= $ 46500 + ($28000 + $24000 + $186000)*75/100
Which comes $224875
In the case of liability side:
Assumption 2. As it is mentioned that firm has only two partners, the value of equity will not be taken with other liability, as it is owner’s share.
Now, rest of the items in liability side of business,
The total liability= $22500 + $34500 + $25500 + $88500
Which is equal to $171000.
Now the total value of firm = value of asset- liability
= $224875- $171000
The current liquidation value, (which is equal; to the value one will get by selling the enterprise in today’s date), will be equal to current value of the firm, which is equal to
Daugherty and Rogers believe that there should be competitive managerial wages. Yes on the facet of the statement the statement seems very right because of the opportunity cost principal of the business. The amount of the money that the owner of the business would earn if he is not involved in the business this is the minimum amount that he owner should earn. So considering the above statement of opportunity cost the competitive managerial wages should be given but there is one very critical point to be considered before reaching any kind of conclusion that do this business requires two managers or One manger, if two mangers are required then the extra amount of $25000 should be paid and should be deducted from the Earning before Interest and Tax But if there is a need of only one manager then the amount paid is more than required.
Amount paid to 1 person is $25000; increasing it by 50% it comes out to be $37500 so the amount actually paid is $12500 more than required and this amount should be added back to Earnings before Interest and Tax.
So finally the competitive wages must be given based on Opportunity cost principal but the undisguised labour has to be taken care off.
Answer- 4. As per given cases in exhibit2.
If we consider the EBT, we need to take care of tax which is 35%, as per given in the case,
Now for the pessimistic case:
The earning after paying tax will be $75000*(1-0.35) = $48750
Now as per the assumption, which is that, ( the cash flow will continue with same amount, as no increase in working capital is mentioned in case, and might be, the case has already taken care of these things),
This implies that the value of $48750 will continue to flow for 7 years.
Now for the simplicity of calculations, we are amortizing debt in one go at the end of 7 years. As the interest is already being paid, the principle will have to be paid.
Now in case of last year calculation, the total inflow will be equal to $48750 + $40,000
Now the total debt to be paid = $88500
So, the total amount left after paying debt = $250
Now for the 6 years the regular flow of $48750 + $250(total inflow from 7th year), will contribute to net present value of restaurant.
Which will be equal to ($48750) ∑1/(1.2)^I, where i=1 to 6, + $250*1/(1.2) ^7
In the same way:
For the moderate case, the value of enterprise will be = $226926.92
For optimistic case, the value of enterprise = $280759.5
As per the broker’s rule of thumb, the price of a restaurant is equal to the fair market value of its assets plus 20% goodwill factor minus the interest bearing debts.
Case 1: When fair market value of assets is 75% of the book value:
Fair market value of assets is= 46500+ (28500+24000+186000)*.75=$224875
20% of goodwill factor=224875*.20=$44975
Interest bearing Debt (bonds) = $88500
Value of business =224875+44975-88500=$181350
Case 2: when fair market is equal to book value:
Fair market value of assets is= $285000
20% of goodwill factor=28500*.20=$57000
Interest bearing Debt (bonds) = $88500
Value of business =285000+57000-88500=$253500
In this question,
Moore is talking of dividing the cash and securities,
But a few things are not clear:
1. what is the ratio of division?
2. what is the way of division, whether it is at the level of company or at the level of personal level.
As it is mentioned in the case, one partner is thinking of coming out of this business, so,
it might be like doing the partition of assets and liabilities at the personal level, so that one will have clear and smooth exit with a clarity of state of business.
In this case, the overall impact on the operation of company and it’s estimations according to question 4, will not change.
But, in the case, both partners are taking the cash and liability in their personal account and are making enterprise free of all debt; it will change the calculations,
As in this case enterprise will not need to pay interest in future, and with it, the debt, which we have amortizes in last year will not be needed to amortized in this case.
So, on case specific way, it will be decide what changes will occur in question 4. Solution.
If in the exhibit 2 the liquidation value would not have been given than it would have a deep impact on the analysis, first thing would have been that the present value of the liquidation value would not have been considered and then the value of the business would have been less, the second thing is that the liquidation value gives the future prospects of the business. The less the Liquidation value the less would be the goodwill value of the business because it somehow indicates the future profitability of the business and less liquidation value actually means less future profitability leading to less goodwill.
Under optimistic conditions assumptions are:
Life of business=15 yrs
Given Tax rate= 35%
1Thus, EAT =90,000(1-0.35) =90000*0.65=$58500
Present value of EAT at discount rate of 20 % = 58500/ (1+0.20) ^ 15=58500*4.675=$273487.5
Present liquidation value=140000/ (1+0.20) ^15=140000*0.065=$9100
Thus total value of Business =273487.5+9100=$282587.5
As per given data, the new restaurant can be established at $150000 and if goodwill of 20% is considered total value would be $ 180000. Therefore from above data we can see that he will be profitable and should buy the restaurant.
Business negotiations are based a lot in the market scenario. There are sentiments prevailing in the market at a given time that affect the whole business transactions. Taking the present day’s scenario these days there is a negative sentiment in the market so therefore no bank is lending money. So considering this case also the market sentiment for the restaurant business is not too good as clearly shown in the in the given three examples that there has not been any goodwill involved in any of the sale of the restaurant. Before we reach to any inference based on these examples we need to consider a few other things as well like the brand image of these restaurants past financial performance, location and some other marketing parameters as well. Now considering that the image of La Café is not extra ordinarily good or better than those sold earlier there should not be any kind of good will given for the LA Café, but in case the business of LA Café is very good and it fares well on other evaluation criteria also than there can be some goodwill involved but in any case the goodwill can’t be significantly high based on the market sentiments valuation of business.
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