Question

Pompeii Pizza Club owns three identical restaurants popular for their specialty pizzas. Each restaurant has a debt-equity ratio of 35 percent and makes interest payments of $61,000 at the end of each year. The cost of the firm’s levered equity is 18 percent. Each store estimates that annual sales will be $1.56 million; annual cost of goods sold will be $840,000; and annual general and administrative costs will be $500,000. These cash flows are expected to remain the same forever. The corporate tax rate is 24 percent.

  

a.	Use the flow to equity approach to determine the value of the company’s equity. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)
b.	What is the total value of the company? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)

Answer 1

Solution:

a.

Particulars	Amount in $
Sales	15,60,000
Less: cost of goods sold	8,40,000
Less: general and administrative cost	5,00,000
EBIT	2,20,000
Less: interest	61,000
EBT	1,59,000
Less: taxes @24%	38,160
EAT	1,20,840

Value of company's equity = annual cash flow / cost of capital

Value of company's equity = 120840/0.18= $6,71,333

b. Value of equity = $6,71,333.33

Debt equity ratio = 35%

Debt/ 6,71,333.33= 35%

Debt = 6,71,333.33*35%

Debt = $2,34,966.67

Total value of the company = Debt + equity

Total value of the company = $2,34,966.67 + $6,71,333.33= $9,06,300