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 $44,000 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 $1.36 million; annual cost of goods sold will be $700,000; and annual general and administrative costs will be $435,000. 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.

b.	What is the total value of the company?

Answer 1

Sales	1,360,000
COGS	700,000
SGA	435,000
Interest	44,000
EBT	181,000
Tax (34%)	-61,540
Profits	119,460
Value	543,000

Value = Profits / cost of equity

Company has 3 restaurants, value of equity = 543,000 x 3 = 1,629,000

Value of company = Equity + Debt = (1 + D/E) x Equity = 1.3 x 1,629,000 = 2,117,700