In: Finance
Bella's Bone World, Inc. is a thriving bone production business! As the chief bone examiner, Bella is performing simple valuations as a starting point to determining the overall value of her bone production business. Bells uses a 9% required rate of return for operations. She used her 2019 financial statements to calculated her residual operating income as $25 million and net operating assets were $82 million at the end of 2019. Her residual operating income is expected to stay the same level for 2020 because even during the pandemic, dogs eat bones. While Bella does not expect growth, she expects to maintain her financial position in 2020.
For this question, you need to do two calculations. First, forecast Bella's operating income for 2020. Then calculate the value of operations for Bella's Bone World.
Select the answer below that most closely matches your calculations.
The format of the answer is: 2020 operating income, Value of operations
$36.2 million, $402.22 million
$32.92 million, $299.27 million
$74.02 million, $672.91 million
None of the above
$32.38 million, $359.78 million
Residual operating income is the income above the required return for the given rate of return. This is also called the net operating income.
Since the required rate of return is 9% and the value of operating assets is 82 million (investment on which return is calculated). The value of required return is 9% of 82 million = $ 7.38 million
Total return or the total operating income = residual operating income (2020 figure same as 2019 figure at 25 million) + value of required return calculated above = 7.38 +25.00 = $ 32.38 million Answer 1
For calculating the value of the business, since the residual income is not going to change over time, the value of perpetutity income received from this business is 32.38 million.
So Value = 32.38 mn/ 9% = $ 359.78 million Answer 2
$32.38 million, $359.78 million Final Answer