You are the potential buyer of a business, a shoe store.

You are the potential buyer of a business, a shoe store. You are negotiating with the seller: The seller is offering a selling price of $500,000. The seller calculated the NVP (business value) of $500,000, by forecasting future cash flows and applying a discount rate of 12%. In your negotiations, you agree with the future cash flow projections, but you want to pay a lower price.

What different discount rate will you suggest be used?
Are you sure about that discount rate? Try doing a quick NPV model (using your existing template) and see what happens!
The seller applied a 12% discount rate. With what logical reasoning will you try to convince the seller of a different discount rate?
Which Principle of Finance does your logical reasoning rest on?

Solutions

Expert Solution

The value of the business is arrived based on various valuation techniques, and in the current scenario the business is valued based on the Net Present Value ('NPV') of future cash inflows and outflows. Thus, in simple terms, 100$ received today has a greater value than received after 5 years. Though the numerical value of money remains the same, the time value of money makes them different.

Thus, discount rates are used to determine the value of cashflows at any point in time during a particular investment.

There are straight jacket formulas to arrive at dicount rates (among the many includes weighted average cost of capital).

In the given question, the discount rate used to discount the cashflows to arrive at the value of business is '12%'.

From the perspetive of the buyer, since the potential investment is in a shoe store, there are various risks which include inflation, business risks , market risks etc. Thus, the buyer could suggest a 'risk adjusted discount rate model' wherein the discount rate will be the risk free rate + risk premium.

The average industry beta for apparels or in specific the shoe industry could be used to arrive at the risk premium for the business and market risks.

Thus, a risk adjusted discount rate would be higher than the discount rate suggested by the seller. A higher discount rate would lower the value of business by less than $5,00,000, thus making it a profitable investment for the buyer.

jeff jeffy answered 2 years ago

Next > < Previous

Related Solutions

To increase business, the owner of a shoe store is running a promotion in which a...

To increase business, the owner of a shoe store is running a promotion in which a customer's bill can be selected at random to receive a discount. When a customer's bill is printed, a program in the cash register determines randomly whether the customer will receive a discount on the bill. The program was written to generate a discount with a probability of 0.15; that is, 15% of the bills get a discount in the long run. However, the owner...

Al Bundy wants to start a shoe store. It will cost $150,000 to get the business...

Al Bundy wants to start a shoe store. It will cost $150,000 to get the business started. Al can borrow the money from a bank at 5.5% interest rate. The estimated net cash flows from the business for the first 6 years are: -$50,000; -$20,000; $100,000; $180,000; $300,000; $360,000. Al will be happy to earn at least 12% so use a 12% discount rate. Answers questions 21-23. 21. The net present value of this business opportunity is: a. $327,600 ...

Globo opened its first store in 1992 and it is Canada's largest family shoe store with...

Globo opened its first store in 1992 and it is Canada's largest family shoe store with the widest selection of fashion-right footwear. The company has recently launched an online store. Sales via the internet have been sluggish compared to their brick and mortar stores, and management suspects that its regular customers have concerns regarding the security of online transactions. To determine if this is the case, they plan to survey a random sample of their regular customers. Under consideration are...

Tom is a store detective at a shoe store. One day at 9 am, he observed...

Tom is a store detective at a shoe store. One day at 9 am, he observed Jill leaving the store wearing a pair of shoes she had been trying on, without paying for them. He raced after her and escorted her back to the store where he locked her up in the office at the back. "That will teach her", he thought. When Jill pleaded to leave, he shouted "You can rot in hell, for all I care! I am...

A potential buyer of a sportscar is interested in the costs of a vehicle per mile...

A potential buyer of a sportscar is interested in the costs of a vehicle per mile travelled at net present value. The buyer is planning to sell the car after three years of operation at residual value. The car costs £35000.00 to purchase and the buyer incurs costs for insurance, fuel and mantenance of £1400.00 per year. The car is expected to depreciate in value by £4000.00 per year (straight line depreciation). The buyer is planning to travel 17000 miles...

If I worked as the manager of the Shoe Department at the local Sears store, how...

If I worked as the manager of the Shoe Department at the local Sears store, how should my financial success be measured, in your opinion?

A program was created to randomly choose customers at a shoe store to receive a discount....

A program was created to randomly choose customers at a shoe store to receive a discount. The program claims 15% of the receipts will get a discount in the long run. The manager of the shoe store is skeptical and believes the program's calculations are incorrect. She selects a random sample and finds that 12% received the discount. The confidence interval is 0.12 ± 0.05 with all conditions for inference met. Part A: Using the given confidence interval, is it...

There is single object to be sold to one of the n potential buyers. Each buyer...

There is single object to be sold to one of the n potential buyers. Each buyer has a valuation of vi for the object. Consider the auction rule where the winner is the highest bidder, and pays the minimum of all the bids, i.e. min{bi : i ∈ N}. In this game, truthtelling is a dominant strategy equilibrium. Is it true or false ?

Dean made a statistical estimation of the cost-output relationship for a shoe store. The data for...

Dean made a statistical estimation of the cost-output relationship for a shoe store. The data for the firm is given in the following table. x 4.5 7 9 10 15 20 33 50 y 3 3.3 3.4 3.5 4.5 5.5 7.5 12 Here x is the output in thousands of pairs of shoes, and y is the cost in thousands of dollars. A. Determine the best-fitting line (using least squares). S1(x) = Incorrect: Your answer is incorrect. r2 = B....

Suppose the manager of a shoe store wants to determine the current percentage of customers who...

Suppose the manager of a shoe store wants to determine the current percentage of customers who are males. How many customers should the manager survey in order to be 99% confident that the estimated (sample) proportion is within 10 percentage points of the true population proportion of customers who are males? z0.10 z0.05 z0.04 z0.025 z0.01 z0.005 1.282 1.645 1.751 1.960 2.326 2.576

Subjects