An investor believes that she can improve the operating income of a bakery by 30

Question

An investor believes that she can improve the operating income of a bakery by 30 percent by introducing modern management and marketing techniques. A review of the target’s financial statements reveals that its operating profit in the current year is $150,000. Recent transactions, resulting in a controlling interest in similar businesses, were valued at six times operating income. The investor also believes that the liquidity discount for businesses similar to the target firm is 20 percent. What is the most she should be willing to pay for a 50.1 percent stake in the bakery?

Explanation / Answer

The most that can be paid for the 50.1% stake =

150000*1.3*6*0.501*(1-0.2) = $468,936

Expected profit = 150000*1.36 = 195000

6 times value = 195000*6 = 1170000

50.1% = 1170000*0.501 = 586170

Value after adjusting liquidity discount = 586170*0.8 = $468,936.

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