Small Manufacturer Valuation in .NET framework

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Small Manufacturer Valuation
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Excess Earnings Method
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(This method considers cash ow and values in hard assets, estimates intangible values, and superimposes tax considerations and nancing structures to prove the most-likely equation)
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Weighted/Reconstructed Net Income Less: Comparable Salary Less: Contingency Reserve Net Cash Stream to Be Valued Cost of Money Market Value of Tangible Assets Times: Applied Lending Rate Annual Cost of Money Excess of Cost of Earnings Return Net Cash Stream to Be Valued Less: Annual Cost of Money Excess of Cost of Earnings Intangible Business Value Excess of Cost of Earnings Times: Intangible Net Multiplier Assigned Intangible Business Value Add: Market Value of Tangible Assets TOTAL BUSINESS VALUE (Prior to Proof) Financing Rationale Total Investment Less: Down Payment (25%) Balance to Be Financed $ 203,412 50,000 10,000 $ 143,412 $ 568,943 10% $ 56,894 $ 143,412 56,894 $ 86,518 $ 86,518 50
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$ 432,590 568,943 $1,001,533 (Say $1,000,000) $1,000,000 250,000 $ 750,000
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At this point, we know that we have a serious problem with nancing because total assets less liabilities equal $568,943, and we know that banks want collateral to make loans We also know that $250,000 cash is a lot of money to expect from buyers in general, and as it is, this cash requirement already puts us into a category of nding perhaps no more than 3% to 5% of all buyers that will qualify to purchase this business It s important to use a good deal of logic at this stage of valuation or you will waste a lot of time coming up with reliable estimates One can set up the nancing scenario any way appropriate to their local conditions, but my guess is that the following would be pretty close (So as not to be confusing, equipment is listed on the balance sheet as $280,407 plus $5,405 or $285,812 When added to leasehold improvements of $87,895, we have fair market value of plant and equipment of $373,707 The reason
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The Valuation Exercise
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I ve broken these down in this stage is that banks nance each item differently, if at all)
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Equipment ($285,812) at 70% of Appraised Value Inventory ($52,252) at 60% of Book Value Leasehold Improvements ($87,895 and long-term lease conditions) at 40% of 2001 (new) Value Receivables Minus Payables ($120,107) at 70% Estimated Bank Financing Bank (10% 15 years) Amount Annual Principal/Interest Payment Testing Estimated Business Value Return: Net Cash Stream to Be Valued Less: Annual Bank Debt Service (P&I) Pretax Cash Flow Add: Principal Reduction Pretax Equity Income Less: Est Dep & Amortization (Let s Assume) Less: Estimated Income Taxes (Let s Assume) Net Operating Income (NOI) $200,068 31,351 35,158 84,075 $350,652* (Say $350,000)
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$350,000 45,133 $143,412 45,133 $ 98,279 13,078* $111,357 41,027 12,100 $ 58,230
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*Debt service includes an average $13,078 annual principal payment that is traditionally recorded on the balance sheet as a reduction in debt owed This feature recognizes that the owned equity in the business increases by this average amount each year Return on Equity: Pretax Equity Income Down Payment $111,357 $250,000 445%
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Return on Total Investment: Net Operating Income Total Investment $ 58,230 $1,000,000 58%
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Although return on total investment is abysmally low in relationship to conventionally expected investment returns, the return on equity is attractively high and cash ow is strong
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Basic Salary Net Operating Income Gain of Principal Tax-Sheltered Income (Dep) Effective Income $ 50,000 58,230 13,078 41,027 $162,335*
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*There is also the matter of $10,000 annually into the contingency and replacement reserve that would be at the discretion of the owner, if not required for emergencies or asset replacements
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Small Manufacturer Valuation
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At this time we have estimated business value but have we estimated the estimated value $250,000 cash down payment plus $350,000, or $600,000, leaves us with a $400,000 shortfall of the all-cash target speci ed by the seller If we leave the price at $1,000,000, either the buyer has to make up the difference outside this business ($250,000 plus $400,000 equals $650,000 cash down payment), or the seller must become exible toward providing $400,000 of seller nancing, or nd another buyer with more cash, or the estimated price must be squeezed to t the conditions of this buyer We need not muddy the eld, but since this is a real case history, I can say unequivocally that the bank would not provide more than the $350,000 stated The buyer had a net worth of well over $15 million, had more cash, but was adamant in not giving up more than $250,000 toward purchase The seller wanted his million dollar price and was adamant in not providing partial nancing but still wanted to sell to this buyer We had a dilemma or so it would seem Key in this speci c transaction was that both buyer and seller were bent on doing this deal How then might we resolve the discrepancy
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1 We know that we are $400,000 short of nancing 2 We know that we have an effective income stream of $149,257 ($162,335 minus noncash equity buildup $13,078) a powerful stream in light of cash outlay at purchase 3 We know that the seller is anxious to receive cash as quickly as possible 4 Thus, one possible solution might be answered by the question: What effect would a ve-year payout of $400,000 bring to bear on the buyer
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In attempting to solve for this question, we return to the point in the equation for Financing Rationale
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Financing Rationale Total Investment Less: Down Payment (25%) Balance to Be Financed Bank (10% 15 years) Amount Annual Principal/Interest Payment
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$1,000,000 250,000 $ 750,000 $350,000 45,133
The Valuation Exercise Seller (10% 5 years) Amount Annual Principal/Interest Payment Total Annual Principal/Interest Payment Testing Estimated Business Value Return: Net Cash Stream to Be Valued Less: Annual Debt Service (P&I) Pretax Cash Flow Add: Principal Reduction Pretax Equity Income Less: Est Dep & Amortization (Let s Assume) Less: Estimated Income Taxes (Let s Assume) Net Operating Income (NOI)
$400,000 101,986 $ 147,119 $ 143,412 147,119 $ 3,707 93,078* $ 89,371 41,027 2,000* $ 46,344
*Debt service includes an average $93,078 annual principal payment that is traditionally recorded on the balance sheet as a reduction in debt owed This feature recognizes that the owned equity in the business increases by this average amount each year Tax obligations are reduced since interest expense is deductible from business cash ow Return on Equity: Pretax Equity Income Down Payment $ 89,371 $250,000 357%
Return on Total Investment: Net Operating Income Total Investment $ 46,344 $1,000,000 46%
Note that returns decrease somewhat but are still quite reasonable under our new scenario This is because the average annual principal being returned to the balance sheet in the way of debt reduction has grown by $76,293 from $13,078 to $89,371 However, let s look at how the buyer might view this posture
Buyer s Potential Cash Bene t Forecast Annual Salary Pretax Cash Flow (contingency not considered) Income Sheltered by Depreciation Less: Provision for Taxes Discretionary Cash Add: Equity Buildup Discretionary and Nondiscretionary Cash
$ 50,000 3,707 41,027 2,000 $ 85,320 93,078 $178,398
Although the business s cash ow would be highly leveraged during the rst ve years, at the end of this period the buyer could have amassed ownership equity of $650,000 (down payment of $250,000 plus