You want to estimate the value of a privately-owned restaurant that is financed

Question

You want to estimate the value of a privately-owned restaurant that is financed entirely with equity. Its most recent income statement is as follows:

You note that the profitability of this restaurant is significantly lower than that of comparable restaurants, primarily due to high salary and wage expenses. Further investigation reveals that the annual salaries for the owner and his wife, the firm’s accountant, are $900,000 and $300,000 respectively. These salaries are much higher than the industry median salaries for these two positions of $100,000 and $50,000, respectively. Compensation for other employees ($200,000 in total) appears to be consistent with the market rates. The median P/E ratio of comparable restaurants with no debt is 10. What is the total value of this restaurant?

Category Value Revenue $3,000,000 Cost of goods sold 600,000 Gross profit $2,400,000 Salaries and wages 1,400,000 Selling expenses 100,000 Operating profit (EBIT) $900,000 Taxes 315,000 Net Income $585,000

Explanation / Answer

Note : In order to dermine the true value of the restaurant we must eliminate the salaries drawn by owner and his wife which is above the market standards & adjust maket rate of the salaries for the position held by the owner and his wife otherwise the valation will remain undervalued.

Correct EBIT = EBIT (given )+ Wrongly charged Salaries & wages + Correct Salaries & wages as per market rate.

= $900,000 + $1,400,000 - $350,000 = $1950,000

Correct Net Income = Correct EBIT - Tax rate @35 % (same tax rate as given in question)

= $1950,000 * (1- .35)= $1,267,500

Total value of this restaurant = Correct Net Income * P/E ratio  = $1,267,500 * 10 = $12,675,000

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