The Greens are looking to sell Aquarius Ales, their pub located in Austin Texas as they are looking to fully retire and take up golfing and quilt making. Recently they have received their first offer to buy the business which was $450,000 from Marc Johnston and John Sheridan, two University of Texas graduates who miss the college scene. The Greens are seriously considering the offer but feel that it may be a bit low as they estimated the value of Aquarius Ales to be closer to $700,000. Marc and John were having similar thoughts, their interest in purchasing the pub was sincere, but they were still unsure that $450,000 was the appropriate valuation and selling price. Advantages of Paying Managers a Percentage of Profits
There are a couple of advantages to paying managers a percentage of profits. The most obvious reason is that Aquarius will have incentivized management’s performance effectively connecting it to the performance of the bar in general. With this pay scheme management will be more invested in the success of the bar in general and with that they will likely adjust their actions towards reaching that goal. For example they will work harder to increase sales, sell items with higher profit margins, and keep customers drinking longer. At the same time they might be more attentive to catching theft and other losses such as spoilage. In contrast if they have only a regular salary, the only motivation to do these things would be internal motivation driven by their own values. Competitive Advantages
Over the years the law governing partnership and the payments to be allocated to the partners either for the services offered or for the property was being treated like a transaction. This aspect of partnership laws includes but not limited to payments received as interests of profit made in the partnership as payments for services rendered and this could either be viewed either as a capital or ...
Currently Aquarius Ales has two main competitive advantages, their location and their lack of competition. Aquarius Ales is located in the main bar area, which is conveniently located close to a large university, the University of Texas, Austin. With this they have a large pool of customers mostly consisting of the 25-45 year old range. In addition to this the city in which Aquarius is located recently rezoned commercial areas forcing many of Aquarius Ales competition out of business. These competitive advantages are likely to be sustainable in the short-term but there is always the possibility that the city will rezone again after a few years, which will open up the area to increased competition. Also even if that doesn’t happen, going forward more pubs might open up in the areas that are still zoned to sell alcohol, also increasing competition. There is also the possibility that the younger portion of Aquarius Ales’ customer base (university students) taste’s will change from frequenting bars to going other places such as house parties, clubs, etc. This would lead to a decreased customer base and decreased sales. One way to counter this would be to differentiate the bar to pull in more customers from different demographics not previously served.
Appropriate Discount Rate
The most appropriate discount rate for to use in valuing Aquarius Ales would be their weighted average cost of capital (WACC), the average of the costs of their sources of financing, an appropriate discount rate to use for cash flows in the free cash flow method. WACC is extremely useful in the case of Aquarius Ales as they are a non-issuer, a private company, with no previous out independent valuation analysis. In calculating Aquarius Ales’ WACC certain judgment was used in decided their beta and size premium. Their beta was derived using two proxies, Buffalo Wild Wings and BJ’s, two pubs located in similar regions offering similar selections of food and drinks.
The average of these two firms Beta’s, 3.6, was used in the calculation of Aquarius’ WACC. In addition to the beta, a size premium (the return in excess of CAPM) of 9.83% was used. To get this, the rate was taken from firms with the smallest market capitalization on Ibbotson Associates Risk Premiums over Time chart. While this is the most appropriate rate to use from the chart, is quite possible that it should actually be higher as Aquarius has sales nowhere near $10 billion dollars annually and thus would likely be riskier. Using these rates, a WACC of 18.3% (Exhibit 2) was derived. Aquarius Estimated Selling Price
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Based off of the free cash flow analysis conducted on Aquarius Ales, their current value taking into consideration cash flows from 2006 to 2014, is $268,376 (Exhibit 3).
While using the free cash flow valuation method for Aquarius, the interest expense was not included in the calculations because interest is based on long-term debt which is already included in the WACC calculation. Not including the interest expense in the free cash flow model, removes the possibility of double counting it in the valuation. Sensitivity Analysis and Valuation Assumption Consideration
In using the FCF method to determine the selling price for Aquarius Ale certain judgment was used in deciding the beta and size premium. To account for this, it is pertinent to conduct sensitivity analysis to derive a range of possible selling prices using a worst case scenario, best case scenario, and a most-likely scenario. In doing this, certain inputs such as the growth rate and WACC can be manipulated. For the worst case scenario, the growth rate was lowered to 1% while the WACC was increased by 2%, which created a total value of approximately $217,000 (Exhibit 4).
For the best case scenario, the growth rate was increased to 4% and the WACC was lowered by 2%, which gave a total value of approximately $326,000 (Exhibit 5).
Using the original conditions, the most-likely scenario gave a total value of approximately $268,000 Green’s asking Price – Their Method (?) vs FCF using WACC Based off of the FCF valuation conducted on Aquarius, Green’s original asking price of $700,000 is not an appropriate selling price. Green’s estimate was based off of the original book value of the assets purchased, believing they would get on average a 15% return, plus taking into consideration the inherent value of the pub, they arrived at the $700,000. Using a FCF method it was determined the most likely total value, and selling price of Aquarius Ales should be around $268,000.
The price elasticity of demand measures the responsiveness of quantity demanded to a change in price. In other words, it measures by how much the quantity demanded will vary if there is a change in price. If a small decrease in the price of the product causes a huge increase in the quantity demanded, then the product is said to be price elastic. When the demand is price elastic, a fall in price ...