You are interested in purchasing a construction company that is primarily involv

Question

You are interested in purchasing a construction company that is primarily involved in the rehabilitation of homes. The business is 10 years old and has seen steady growth in revenues and profits each year since its founding, except during periods of economic recession. Assume that net income has been the following for the past 4 years: 2014 - $7,000,000 2013 - $5,000,000 2012 - $3,000,000 2011 - $1,000,000 The owner has given you the following balance sheet for your review. ASSETS Current Assets Cash $12,000,000 Accounts Receivable $ 8,000,000 Inventory $ 4,000,000 Total Current Assets: $24,000,000 Fixed Assets Equipment $ 10,500,000 Less accumulated depreciation ($ 3,000,000) Total Fixed Assets: $ 7,500,000 TOTAL ASSETS $31,500,000 LIABILITIES Current Liabilities Accounts Payable $ 6,000,000 Other Liabilities $ 3,000,000 Accrued Taxes $ 2,500,000 Total Current Liabilities: $ 11,500,000 Long-term Liabilities Long-term Debt $ 4,000,000 Total Long-term Liabilities: $ 4,000,000 TOTAL LIABILITIES $15,500,000 OWNER’S EQUITY $16,000,000 TOTAL LIABILITIES AND OWNER’S EQUITY $31,500.000 Valuation Methods It is now your task to establish a valuation for the business using the following: 1. BASIC BALANCE SHEET METHOD 2. ADJUSTED BALANCE SHEET TECHNIQUE 3. EARNINGS APPROACH o EXCESS EARNINGS METHOD 4. MARKET APPROACH Use the following assumptions: 1. 10 percent of the accounts receivable are over 120 days old. 2. 5 percent of the remaining accounts receivable are 90 days old. 3. 10 percent of the remaining accounts receivable are likely to be paid on the basis of 3 net 30. 4. 5 percent of the inventory is outdated and essentially useless 5. An appraisal of the firm’s equipment reveals that it is worth 5 percent less than the stated value on the balance sheet. 6. A vendor has informed you that your bill has been over estimated by $50,000 due to a billing error. 7. Assume an 8 percent rate of return. 8. Assume an additional opportunity cost of $125,000 for salary forgone if you purchase the business. 9. We are now emerging from a recession and sales are expected to increase by 3% in the coming year. 10. Assume a years-of-profit figure of 4 for this business. 11. Assume that the four publicly traded firms that are in the same business trade at P/E ratios of 3, 5, 6, and 7, respectively.

Explanation / Answer

Assets $ Liabilities $ Cash 12000000 Accountas payable 6000000 Accounts Receivable 8000000 Othere Liabilities 3000000 Inventory 4000000 Accured Taxes 2500000 Total current assets 24000000 Current Liabilities 11500000 Fixed Assets 10500000 Long Term Liabiities Accumulated Depreciation 3000000 Long term Debt 4000000 Total Fixed Assets 7500000 Total Liabilities 15500000 Owners equity 16000000 Total Assets 31500000 Total Liabilities & Owners Equity 31500000 Ans 1 $16,000,000 Basic Balance Sheet Method is Book value method it is value of shareholder equity stated in the balance sheet which is difference between total assets and total outside liabilities Ans 2 Adjusted Blalance Sheet- It is valued after the adjustments of assets and liabilities with their market value and net worth is obtained. Assets $ Liabilities $ Cash 12000000 Accountas payable 5950000 Accounts Receivable 8000000 Othere Liabilities 3000000 Inventory 3800000 Accured Taxes 2500000 Total current assets 23800000 Current Liabilities 11450000 Fixed Assets 10500000 Long Term Liabiities Accumulated Depreciation 3000000 Long term Debt 4000000 Total Fixed Assets 7500000 Total Liabilities 15450000 Owners equity 15850000 Total Assets 31300000 Total Liabilities & Owners Equity 31300000 Answer $15,850,000 ans 3 Equity value$ 160000000 160000000 8% is Rate of Return 3% is Sales growth constant Accounts receivable taken as accounts receivable Ans 4 2014 Net Income $7,000,000 P/E ratio will br avearge of four other companies 5.25 (3+5+6+7)/4 equity Value (market Method) $36,750,000 equity Value= P/E ratio*Net income

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