Palm Beach Case

Economics Case – 3

a. Would you pay $900,000 for the company? Yes, or no and why?

• To determine the value that we should pay for the business we made a few assumptions and based on that we came to a conclusion.

• After detailed research, we came up with following assumptions listed below:

• Required rate of return should be between 33% and 25%. So while discounting the cash flows we used an average of 33% and 25% (i.e. 29%).

• Ideal payback period should be between 3 years and 4 years. So we assumed the ideal payback to be 3.5 based on average of 3 years and 4 years.

• If we take a business loan of $900,000 to pay the acquisition cost, we take the interest rate to be between 4.44% and 3.78% (so we take the average again i.e. 4.11%).

• To project future net income, we use the Compounded annual growth rate (CAGR) method from 2009 to mid 2011.

• Total Net income for 2011 is calculated by doubling the net income from half year (i.e. 189,180 * 2 = 378,360)

Case 1:

Projections of net income from years 2012 to 2016.

[pic 1]

We take 3.5 years as the time (ideal payback period based on assumptions) to calculate the future value of the projected net incomes i.e. future values of income for years 2012, 2013, 2014 and mid 2015.

So based on calculations, we project the future values of net incomes after 3.5 years to be $ 2652,720.

We also find out the future value of loan after 3.5 years by compounding method @ 4.11% which results to be $1,036,253.

So when we compare the future value of projected net incomes ($2,652,720) with future value of loan taken ($1,036,253), we come up to the conclusion that we should buy the business for $900,000 as we are creating value for the firm.

Case 2:

To make sure that our decision to pay 90000 is worth or not, we take another scenario where we assume that the net income for next 5 years (2012-2016) remains the same as year 2011 (378360). This means that even if the restaurant is not growing and earning the same revenue as previous years, how good our decision would be.

We again do a similar calculation to find out the future value of net incomes for 3.5 years (ideal payback period), which turns out to be $1393701. Comparing this value with future value of the loan ($1036253), we still are creating value for the firm. So our decision to buy it for $900,000 is still convincing.