Answer to Question #159293 in Finance for iqra

Question

: As an analyst in the valuation team your job is to perform significant financial modeling and analysis. Your company is seeing a new sales strategy that require your input. The strategy will be effective for the upcoming 4 Years. If the company adopts the new strategy, sales will grow at the rate of 15% per year for three years. Other ratios such as: Asset turnover, gross margin, the capital structure and income tax will remain unchanged. However, depreciation would be applicable at 8% of net fixed assets at the starting of the year. Moreover, the target rate of return for the company is 12%. Additional financial information for current year is mentioned below:

 

Income Statement

Sales

50,000

Gross Margin (15%)

7,500

Admin., selling and Distribution expenses (7%)

3,500

Profit before tax

10,000

Tax (35%)

3,500

Profit After Taxes

6,500

Balance Sheet

Fixed Assets

17,000

Current Assets

12,000

Equity

25,000

  

A)   Determine value of business before adoption of new strategy?                          

What will be the incremental value and value of business after adoption of this new strategy?

Answer 1

Answer:

Introduction

Business valuation refers to the process of determining the fair value of the business in order to assess the worth of actual business or a company as a unit.

Value of Business

Computation of value of business before adoption of new strategy

Value of business =  Profit after tax / Target rate of return 

  =$6,500 \over 0.12$

  =54,166.67

Therefore, the value of business before adoption of new strategy is 54,166.67.

Workings

Note: Capital expenditure is calculated by using the formula, Net increase in fixed assets + Depreciation.

Value of Business After Adoption of New Strategy and Incremental Value

Computation of value of business after adoption of new strategy

Value of business = $Free cash flow \over (1 + Target rate of return)^{Number of year}$

 

= [ $3,125 \over (1+0.12)^1$] + [ $3,594 \over (1+0.12)^2$] + [ $4,133 \over (1+0.12)^3$]+ {[ $1 \over (1+0.12)^3$]×($4,753 \over 0.12$)}

= 2,790.18 + 2,865.11 + 2,941.78 + 28,192.43

= 36,789.50

Computation of incremental value of business

Incremental value = Value of business after new strategy − Value of business under old  strategy

  =36,789.50 − 54,166.67

= −17,377.17