Question

The Ties & Tux Shop is a family owned business located in Leadville. It is one of two formal wear outlets Leadville. The family is ready to go south to warmer climates and the business is up for sale. Financial data for the business (which is an S corp.) is detailed below:

                                                                                       BOOK                     MARKET

                        Current assets                                      $ 158,000                    $ 150,000

                        Prop., Plant, & Equip                          $  45,000                     $ 225,000

                        Current liabilities                                 $(125,000)                  $(125,000)      

                        Mtge. Payable                                     $( 23,000)                   $( 23,000)

                                                                                    -------------                   -------------

                                                                                    $  55,000                     $227,000

                                      2017                2016                2015                2014  

Revenues                     $218,000         $254,000         $242,000         $245,000

Expenses                     (182,000)        (221,000)        (212,000)        (204,000)

                                    ---------            ---        ------------        ---------            ---        -------------

Net Income                  $ 36,000          $ 33,000          $ 30,000          $ 41,000

Other (interesting?) information:

The property plant and equipment includes a building at the corner of 6th and Harrison (location of the only stop light in town).

All family members will sign a 10-year non-compete agreement if the buyer so desires.

The normal cost of capital in this industry is 8%. The average rate of return in the industry is 10%.

Expenses include salary paid to owner/employee.

Additional information is available upon request.

ISSUES

Your client desires to escape the hustle and bustle of the Front Range and live in the clean rarefied air of Leadville. Your client tells you he once wore formal wear and has a friend in the business in Grand Junction. All and all, he feels qualified to successfully run the business. The big question - what to offer as a purchase price.

He asks you to help him determine what to offer for the business.

REQUIRED:

Prepare your analysis including the amount you think he should offer with supporting reasoning and computations.

What is the best way to start this assignment???

Answer 1

1. Calculation of Goodwill according to Capitalisation of Average Profit method -

Average Profits for 4 years = 36000+33000+30000+41000 / 4 years

= 140000 / 4

= 35000

Normal Capital employed = Average Future profits * 100 / Normal rate of return

= 35000*100 / 10

= 350000

Actual Capital employed = Sundry Assets - Sundry Liabilities

= 55000

Goodwill = Normal Capital employed - Actual Capital employed

= 350000 - 55000

= 295000

Valuation of business, i.e. The best price for assignment should be = Fair Market Value of Assets + Goodwill = 227000+295000 = 522000