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# Kendall Trotter

Celso Lopez
Esmeralda Torres Sanchez
Maria Garcia
25 February 2020
Case 3: L.A. Café Valuation
1. The real value of D1 in the formula they use Po=D1/i-g, is profits after interest not the earning

before taxes as proposed in the text. The formula doesn’t calculate risk as well as discount of

future cash flows. Growth is uncertain in a competitive business such as the restaurant business

and optimistically, they usually only last 15-20 years. They also don’t count their salaries which

## is also a huge factor to not include.

2. The current liquidation value is \$54,375. To get the value you must assume cash at 100%

value which is \$46,500, while the rest of the assets are assumed to be @ 75% so to get that value

you must add accounts receivable, inventory, and building and equipment multiply by .75 to get

\$178,875. For the liabilities, they are assumed to be %100 @ \$171,000. In the end what you get

is the (46500+178875)-171000=\$54,375

4. The pessimistic outlook of L.A. Café values the company at \$88,312.50, the moderate
outlook has a value of \$127,999.03, and the optimistic has a value of \$166,625.49. The annual
cash flows were adjusted for a tax rate of 35% and a competitive wage rate, 50% increase in
salary, for an experienced manager. The liquidation value, \$40,000 cost of remodeling, and
discount rate of 20% was considered when calculating the net present value of the company.
Pessimistic
Discount Rate Year Cash Flow
20% 0 -\$40,000
1 \$32,500
2 \$32,500
3 \$32,500
4 \$32,500
5 \$32,500
6 \$32,500
7 \$72,500
NPV \$88,312.50

Moderate
Discount Rate Year Cash Flow
20% 0 -\$40,000
1 \$37,375
2 \$37,375
3 \$37,375
4 \$37,375
5 \$37,375
6 \$37,375
7 \$37,375
8 \$37,375
9 \$37,375
10 \$107,375
NPV \$127,999.03

Optimistic
Discount Rate Year Cash Flow
20% 0 -\$40,000
1 \$42,250
2 \$42,250
3 \$42,250
4 \$42,250
5 \$42,250
6 \$42,250
7 \$42,250
8 \$42,250
9 \$42,250
10 \$42,250
11 \$42,250
12 \$42,250
13 \$42,250
14 \$42,250
15 \$182,250
NPV \$166,625.49
5. L.A. Café is valued at \$253,500 using the business broker’ rule of thumb estimation model.
The model estimates the value of a company by subtracting the amount of interest-bearing debt
from the fair market value (FMV) of all assets plus 20% as a goodwill factor. In the case of
L.A. Café, the interest-bearing debt, which are the bonds issued by the company, amounting to
\$88,500 is subtracted from the FMV of all assets plus 20% or \$342,000; this leaves a value of
\$253,500 for the restaurant.
8. If the net present value of cash flows for the optimistic scenario is calculated, the result is an

NPV of \$166,625.49. This value is calculated by calculating the present value for each cash

period, while also adjusting for the remodel cost and liquidation value. The CF0 was -\$40,000 to

account for the remodel cost. From there our cash flow was \$42,250 for each period. The

\$42,250 was calculated by taking the optimistic EBT of \$90,000 and deducting the additional

wage cost of a new manager of \$25,000 to get \$65,000. Then the \$65,000 was multiplied by 1

minus the after-tax discount rate of 35%, to account for taxes, leaving a cash flow of \$42,250.

This was used as the cash flow for periods one through fourteen. For cash flow fifteen, the

liquidation value of \$140,000 was added to \$42,250, resulting in \$182,250 for this cash flow. .

Based on this NPV of \$166,625.49, Thompson should not buy the restaurant. This is the

cash flows NPV for the best-case scenario, meaning it is highly unlikely that the restaurant will

realistically generate enough to meet this NPV throughout its next 15 year, which is how long

the optimistic scenario is guessing it will last. They are more likely to be closer to their moderate

## scenario NPV of \$127,999.03, so Thompson would be overpaying for the restaurant. If

Thompson has the ability to purchase an identical restaurant for \$150,000, he should just start the

new restaurant rather than buying the current restaurant from Moore because it would cost him

less.

9. The purpose of the Market to Book ratio is to compare a business’s net assets to the sales price

of its stock. Since L.A. Café is not selling any stock, it’s market value is the total value of the
company as a whole, and it’s book value is the equity of the company. A good market to book

ratio is any value under 1, this indicates that the stock is undervalued or that the company is

earning a poor return on its assets. The market to book ratio for the other companies are:

restaurant 1= 1, restaurant 2= 0.85, restaurant 3= 0.75. These ratios tell us that this is the average

worth of restaurants in this area, any number greater than this would tell us that the company is

being overvalued. In order to see if L.A. Café is overvalued or undervalued, we calculated the

Market to Book ratio for the pessimist, moderate, optimistic scenarios. The market value that

was used for each equation is the EBT of each scenario and the book value is 114,000.

## Scenario Equation Ratio

Pessimistic 75000 0.6579
114000
Moderate 82500 0.7237
114000
Optimistic 90000 0.7895
114000

Based on the Market to Book ratios of the 3 other restaurants Rogers’ found and L.A. Café, we

can predict the possible problems this can cause for the negotiations between Pat Thompson and

Craig Moore. Seeing as the three ratios are all under 1, we can assume that all three scenarios are

a good asking price for the company. However seeing as the pessimistic and moderate ratios are

very low Craig Moore would be reluctant to sell his share of his company for that low and lean

more towards the optimistic scenario. As well as not accept anything less than that. While Pat

Thompson would lean more towards the moderate ratio, seeing as it very close to the optimistic