Question

Milano 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 $53,000 at the end of each year. The cost of the firm’s levered equity is 20 percent. Each store estimates that annual sales will be $1.54 million; annual cost of goods sold will be $790,000; and annual general and administrative costs will be $525,000. These cash flows are expected to remain the same forever. The corporate tax rate is 40 percent. Use the flow to equity approach to determine the value of the company’s equity. What is the total value of the company?

Answer 1

1. Flow to equity approach to determine the value of the Company's equity-

Particulars	Amount (in $)
Sales	1,540,000
Less: Cost of goods sold	790,000
Less: General and administrative costs	525,000
Less: Interest expenses	53,000
Income before corporate tax	172,000
Less: Corporate tax @ 40%	68,800
Net income	103,200

Value of Milano Pizza Club’s equity

= Net income/ cost of the firm’s levered equity

= $103,200/0.20

= $516,000

2. Calculation of total value of Company-

Debt equity Ratio = 0.35

Debt/Equity = 0.35

Debt/ $516,000 = 0.35

Debt = $516,000 * 0.35

Debt =$180,600

Company’s value = Equity + Debt

Company’s value = $516,000 + $180,600

Company’s value = $696,600