Sick and tired of the investment banking grind, you decide to quit and buy a franchise for a fast-growing bagel chain in your town. You have been able to get information on what another franchise for the same chain is generating in revenues in the neighboring town.
a. The franchise has revenues of $1 million and earnings before interest and taxes of $150,000 last year but the owner did not assess a salary for himself. He does the accounting and oversees the bagel shop and you believe that hiring someone else to do what he does will cost you $50,000 annually.
b. The revenues and operating income are expected to grow 3% a year in perpetuity.
c. You expect to pay 35% of your income in taxes and use all of your investment savings to buy the shop. The unlevered beta for franchise food chains is 0.80.
d. The owner has a bank loan outstanding of $300,000 and the book value of equity in the business is $700,000. However, the average market debt to capital ratio of publicly traded restaurants is 20% and the average pre-tax cost of debt for restaurants is 8%.
e. The riskless rate is 5% and the market risk premium is 4%. Estimate the value of the bagel shop to you.