4. Tom is thinking of purchasing Pizza Hot Inc., a pizza restaurant in New Lynn.

Question

4. Tom is thinking of purchasing Pizza Hot Inc., a pizza restaurant in New Lynn. After conducting a due diligence review of the company, Tom finds out that cash flows of the company during the next five years are to be expected as follows: Year 1-$100,000, Year 2--$5,000, Year 3= $100,000, Year 4-S2,000,000, Year 5= $2.5 million. Cash inflows in year 6 are expected to be $3.5 million and will grow at a 5 percent annual rate thereafter. Pizza Hot Inc. is currently in the survival stage. As an experienced investor, Tom knows that the typical return for a seed financing is 60 percent, a first round financing is 40 percent, a startup financing is 50 percent, a second round financing is 30 percent and a seasoned financing is 20 percent. What is the maximum price Tom is willing to buy Pizza Hot Inc.? (2 marks) Use the discount rate in the current stage for the whole period. a. $2,807,260.37 b. $2,510,079.98 c. $2,602,354.04 $2,434,136.84 $1,035,460.04 2. 1.5 2.500, 00 C 2000o ?·? f $2,771,546.08 + 3,500 0oo (OC-Oo) 5 1.5

Explanation / Answer

Since Pizza Hot Inc. is in its survival stage and expected to generate positive cash-flows from Year 3, it needs a first round financing. So, the applicable discount rate would be 40% here.

In order to determine the maximum price that can be paid, we need to calculate the Net Present Value of all future expected cash-flows.

Year

Discount Rate

Cash Flow

Present Value

1

40%

-$100,000.00

-$71,428.57

2

-$5,000.00

-$2,551.02

3

$100,000.00

$36,443.15

4

$2,000,000.00

$520,616.41

5

$2,500,000.00

$464,836.08

6

$3,500,000.00

$464,836.08

Terminal Value

$10,500,000.00

$1,394,508.24

Net Present Value

$2,807,260.37

Workings:

Present Value = Cash-flow in the year / (1+r)n (Where, r is discount rate and n is number of year)

Terminal Value = [Cash-flow in Year 6 * (1+ Perpetual Growth Rate)] / (Discount rate - Perpetual Growth Rate)]
=> ($3,500,000*1.05) / (0.40 – 0.05) = $464,836.08

Hence Option A is correct.

Year

Discount Rate

Cash Flow

Present Value

1

40%

-$100,000.00

-$71,428.57

2

-$5,000.00

-$2,551.02

3

$100,000.00

$36,443.15

4

$2,000,000.00

$520,616.41

5

$2,500,000.00

$464,836.08

6

$3,500,000.00

$464,836.08

Terminal Value

$10,500,000.00

$1,394,508.24

Net Present Value

$2,807,260.37

Related Questions

Navigate

• Browse (All)
• Browse 4
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.