After gaining experience performing a business valuation in the practice assessment, you will now apply what you learned to a unique scenario, in which you will determine the value of a business that is for sale, and offer recommendations to buyer and seller.
Jane Winfield would like to buy Ted Garner’s company. She has conducted a detailed financial analysis of Ted’s firm and has determined the following:
Estimated earnings over the next five years:
Year 1 |
$200,000 |
Year 2 |
$300,000 |
Year 3 |
$400,000 |
Year 4 |
$500,000 |
Year 5 |
$600,000 |
Jane also believes that it is best to use a conservative discount rate. She has settled on 24% percent. Using the discounted earnings method, what is Ted’s business worth? Please show your calculations.
NPV = $200,000 / (1 + .24)1 = $161,290
NPV = $300,000 / (1 + .24)2 = $195,109
NPV = $400,000 / (1 + .24)3 = $209,707
NPV = $500,000 / (1 + .24)4 = $211,488
NPV = $600,000 / (1 + .24)5 = $204,666
What is the worth of Garner Industries based on the discounted future earnings method?
Total NPV of projected earnings = sum of years 1 - 5 = $982,260
Ted decides an alternative valuation should be given using the excess earnings method.Ted has collected the following information to help him with this learning method:
Adjusted Assets |
Book Value |
Fair Market Value |
Inventory |
$200,000 |
$300,000 |
Plant and Equipment |
$800,000 |
$1,200,000 |
Other intangibles |
N/A |
($100,000) |
Totals |
1,000,000 |
$1,400,000 |
What is the adjustable tangible book value of assets for Garner Industries?
ATBV of assets = $1,400,000 - $1,000,000 = $400,000
Ted determined that his total value of all assets, including those not adjusted for is $1,200,000 and his total liabilities is $800,000. Calculate adjusted tangible net worth.
ATNW = $1,200,000 + $400,000 - $800,000 = $800,000
Calculate the opportunity cost of investing in the business, assuming a 24% discount rate and a $60,000 salary opportunity.
OC = $800,000 x 24% = $192,000 + $60,000 = $252,000
Calculate the extra earnings power of Garner Industries over a period of 5 years,using Jane Winfield’s discounted earnings valuation.
EEP = $982,260 - $252,000 = $730,260
EEP over 5 years = $730,260 x 5 = $3,651,300
Determine the value of Garner Industries, according to the excess earnings method.
$3,651,300 + $800,000 = $4,451,300
Recommendations for Exit Strategies:
Apart from selling to Jane, Ted is considering a whole range of other exit strategies open to an entrepreneur. Describe one pro and one con of three possible exit strategies available to Ted and make a recommendation of the most suitable. Make sure to reference the financials above to ascertain the current legal status of Ted’s business.
Answers will vary.