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Managerial Finance

Sam Jones is a pharmacist earning $90,000 per year and he is deciding whether to purchase a pharmacy and become the owner/manager of a business that generates revenue of $500,000 per year. The pharmacy has expenses of $200,000/yr. for supplies, $75,000/yr. for hired help, $50,000/yr. for rent, and $10,000 for utilities. You may consider these as perpetual revenue and expenses. Assume there are no taxes.

Sam does some checking and finds that the cost of equity for pharmacies is usually expected to be15% when the company is 80 percent equity financed. Suppose you can consider any debt to be risk-free because it will be backed by a Small Business Administration loan guarantee. The cost of such debt is 10%.

Sam has hired you as a consultant and wants you to advise him as to how much he should offer to pay to purchase this business. In coming up with your final purchase price, please provide information on the following:

1. What is the projected accounting profit in any year?
2. How should you handle a salary for the owner in calculating economic profit and cash flow?
3. Based on the information provided, what is the weighted average cost of capital one should use in valuing this company?
4. Using the free cash flow valuation method, what is the maximum amount you would be willing to pay for this company?
5. Knowing that you are bidding against your classmates for this company, what amount would you choose to bid? Explain

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Answer 1
The projected accounting profit in any year can be calculated as follows:
Revenues
Sales 500000

Expenses
Supplies 200000
Hired help 75000
Rent 50000
Utilities 10000
Total exp 335000

Profits Revenues - Expenses
500000-335000
165000
The projected accounting profit in a year is expected to be 165000 $.

Answer 2
While calculating the accounting profit, the opportunity cost ...

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