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The candidate should then proceed to costs. There are two components: fixed costs and variable costs. Have the candidate brainstorm possible fixed costs and variable costs. Under fixed costs the candidate might consider rent, general maintenance, management, insurance, liquor license, and possibly employees. The only real variable cost is the cost of goods sold. Allow the candidate to brainstorm costs before revealing the following data: Variable costs are 20% of total revenues, and fixed costs are $120,000. ! 35
Case 6: Scotch Bar Valuation
After the candidate has subtracted costs from revenues, he/she should have an income of $334,400. Do not forget that we need the after-tax cash flow number (approximately $334,000 * (1-40%)) = $200,400 (or $200,000 for ease of calculation in next prompt). You now have the annual cash flows generated by the bar. At this point a great candidate will drive the process forward and recognize that they need to figure out a stream of cash flows going forward. The interviewer may have to nudge less-savvy candidates toward the next step (discounted cash flow analysis). How does one perform a valuation of the business? To perform a valuation in this case, the candidate must estimate the cash flows from the business and discount them back using a perpetuity formula. The discount rate typically used for bars of this genre LV:KHQWKHFDQGLGDWHLQTXLUHVDERXWJURZWKUDWHVVD\WKHEDU¶VFDVKIORZLVJURZLQJDW-the rate of inflation. Thus, whatever numerator the candidate arrives at should be divided by .13 - .03 = .10, an easy calculation. Use the CF / (r ± g) formula for a perpetuity. In this case, the answer is around $200,000 / .10, or $2 million.
Expected: - Accurate arithmetic
Good: - Drive the process forward, accurate arithmetic. Excellent: - A great candidate will drive the process forward and recognize that they need to figure out a stream of cash flows going forward. Accurate valuation given assumptions. 36