Question

Milano Pizza Club owns three identical restaurants popular for their specialty pizzas. Each restaurant has a debt–equity ratio of 30 percent and makes interest payments of $47,000 at the end of each year. The cost of the firm’s levered equity is 22 percent. Each store estimates that annual sales will be $1.42 million; annual cost of goods sold will be $730,000; and annual general and administrative costs will be $465,000. These cash flows are expected to remain the same forever. The corporate tax rate is 34 percent.

  

a.	Use the flow to equity approach to determine the value of the company’s equity. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

  

Value of the company’s equity

$

  

b.	What is the total value of the company? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

  

Value of the company

$

Answer 1

a)

We need to discount cash flows available to equity holders at the cost of firm's levered equity. The cash flows to equity holders will be the firm’s net income which is calculated below:

Note: Firm has 3 stores, so we multiply each figure by 3

EBT = Sales - COGS - G & A costs - Interest

EBT = 4260000 - 2190000 - 1395000 - 141000 = 534000

Net Income = EBIT - EBIT( tax)

Net Income = 534000 - 534000 ( 0.34) =

Net Income = 534000 - 181560 = 352440

Since the cash flows will remain forever, the present value of cash flows available to the firm's equity holders is a perpetuity:

Present value of net income = 352440 / 0.22

Present value of net income = 1602000

b)

Total value of the company = Sum of market value of debt + sum of market value of equity

Value of equity = 1602000

The company has debt equity ratio of 30% which can be written as following:

D / E= 0.3

D = 0.3 * 1602000

D = 480600

Total value of the company = 1602000 + 480600

Total value of the company = 2082600

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