Jones is negotiating to buy Smith \' s business, which is privately owned and no

ID: 2335904 • Letter: J

Question

Jones is negotiating to buy Smith ' s business, which is privately owned and not publicly traded, and which does not have a history of systematically distributing dividends. It is assumed that the business will be a permanent one (not a short-term venture). They are both utilizing an EBITDA figure of $10,000 ,000 per year, and are using an EBITDA multiple to value the business. Jones views her required rate of return as 20.0%, while Smith sees 16.67 % as an appropriate cost of capital for this type of investment. Both are basing the ir respective valuations of the business on the basis of a multiple of EBITDA. At what amount does Jones value this business, based on $10M of EBITDA? What value does Smith place on her business, based on $10M of EBITDA?

If Jones actually believes she can improve EBITDA to $ l 2M per year, what purchase price might she willing to go up to, based on $12M of annual EBITDA and her 20% required rate of return (In other words, what price could she pay and still achieve her 20% desired rate of return if EBITDA turns out to be the $12M she expects it to be?)?