Blakey’s Enterprises Ltd. is a Canadian-controlled private corporation that has operated a small retail men’s clothing store in rural Ontario for 70 years. Like his father before him, Charlie Blakey is a conservative businessman who believes that personal service and a choice of inventory is the key to success. In fact, he is so concerned with attempting to keep customers happy that he seldom holds after-season sales for fear of offending those customers in a small town who have paid the full retail price.

His banker often says, “Charlie, you’ve got to get that inventory down. You turn that stock only three times a year, which is much less than the norm for your industry.” Blakey knows this to be true but always says he would rather keep unsold stock after the end of season than unload it at a discount. His interest costs are understandably high, and during the last economic crisis, when interest rates reached an all-time high, he had some concern for the store’s survival.

Blakey’s daughter Kimberleigh also works in the business but has little interest in it. Most of her time is spent on a few administrative matters and outside business interests. There are four staff members on the payroll—Blakey, his daughter Kimberleigh, George (near retirement), and Fred. Their salaries are given below.

Blakey ................................................................ $24,000
Kimberleigh, Blakey’s daughter ....................... 16,000
George ................................................................ 16,000
Fred ..................................................................... 20,000

Fred is the most enthusiastic of the group and is constantly coming up with new ideas, only to see them put aside by Blakey. As Blakey reaches retirement age, Fred approaches him with the idea of purchasing the business. After discussing the matter with his daughter, Blakey decides to sell the store to Fred provided that a reasonable price can be established and that Fred can raise the necessary cash to meet the full purchase price.

Blakey has provided Fred with the most recent financial statements (see Exhibits 1, 2, and 3) as well as the following information:

1. Profits during the recent recession were nominal, according to the past financial statements. However, the most recent year was profitable, and in order to avoid an excessive tax burden, Blakey undervalued the closing inventory by $20,000. Blakey’s tax rate is 13%.

2. Blakey is satisfied that the current level of profits reflects future expectations and that the past year’s results, during the recession, should be ignored.

3. The outstanding shareholder’s loan is non–interest-bearing and is payable on demand.

4. For years, Blakey has obtained his personal clothes from the store without cost. The amount has varied from year to year; in the previous year the cost value of clothing taken was $4,000.

5. In addition, certain expenses have always been paid by the store. Blakey’s car is leased by the store at a cost of $380 per month and is used primarily to get him to and from work. From time to time, Blakey drives to Toronto on buying trips. The store also owns a four-wheel-drive Jeep used exclusively by Kimberleigh.

6. Travel expenses include a $1,200 trip to Ithaca, New York, for Blakey and his wife to attend a bowling tournament. Blakey’s great love is bowling, and his store annually gives away a fine suit as a prize for a bowling tournament, which is usually held in the United States.

7. Blakey’s daughter Kimberleigh will obtain another job before the sale. Fred does not intend to hire a replacement for her. Fred asks Blakey to remain on the staff after the sale for a salary of $24,000 per year. Fred will manage the store. (A friend of his, the local manager of a department-store men’s wear department, earns a salary of $30,000.)

8. The building and land had been acquired years ago for $47,000. The building has been depreciated to $15,000 since acquisition. A recent appraisal indicated that the property is now worth $90,000. The building has an area of 1,500 square feet. Space of similar quality is usually leased at $6 per square foot net of all building expenses and property taxes.

9. Published statistics indicate that stores of this nature are currently valued based on a normal after-tax return of 20%.

10. Fred is anxious to proceed because a national men’s wear chain has also approached Blakey to discuss a buy-out.

Required:

Assist Blakey and Fred in establishing a value for the business. Also, consider how this value may be affected if the purchaser is the clothing store chain, rather than Fred.