Misty: I would like you to do your first draft of the valuation using a weighted average capitalization rate of 12%. Once you have prepared the valuation, you will need to check it for reasonableness. One of the simplest ways to check the reasonableness of the valuation is to compare the value determined in the capitalized cash flow approach to the adjusted net asset value. The adjusted net asset value will provide the "floor value" of the company in other words, the lowest value Wutang should accept in a transaction. The difference between the two is typically the amount assigned to goodwill. I also put together a memo for you with some information on non-recurring or unusual items incurred by OTE. I will email it to you. (Exhibit II) Since FCI is public, it would not be able to claim a small business deduction for OTE. I would say that FCI could expect to pay corporate tax at the rate of 30%.

Required:

Part 1 In Excel, prepare a capitalized cash flow valuation for OTE, using the information provided in the exhibits.

Part 2 In Excel, prepare an adjusted net asset valuation for OTE using the financial statements and information attached.

Part 3 In Word, prepare a memo comparing the two valuation approaches. Summarize your results from the calculations and explain why there is a difference in the two valuations.

Exhibit I

Over The Edge Inc.

Balance sheet

As at December 31

Current year | Prior year

Cash $ 4,560 |$ 12,720

Investments | 29,850

Accounts receivable 1,370,150 | 1,112,457

Income taxes receivable 36,160 |

Inventory 1,196,190 | 938,945

Prepaids 4,920 | 4,920

TOTAL CURRENT ASSETS 2,611,980 | 2,098,892

Property, plant, and equipment 4,244,413 | 2,998,749

Intangible assets 13,883 |

Due from shareholder 21,500 | 21,500

Total Assets $ 6,891,776 | $ 5,119,141

Demand bank loan $ 375,422 | $ 96,800

Accounts payable and accruals 1,409,932 | 1,175,915

Warranty accrual 315,231 | 259,412

Deferred revenue 156,500 |

Current portion of term loan 141,000 | 141,000

Income taxes payable | 11,700

2,398,085 | 1,684,827

Term loan 572,000 | 713,000

Other long-term liabilities 1,128,570 |

Share capital 150,100 | 150,100

Retained earnings 2,643,021 | 2,571,214

TOTAL Liabilities and shareholder's equity $ 6,891,776 | $ 5,119,141

Over The Edge Inc. Statement of income and retained earnings For the year ended December 31

Current Year | Prior Year Sales

$ 8,959,800 | $ 8,834,000

Cost of sales 5,949,648 | 6,129,709

Gross profit 3,010,152 | 2,704,291

Expenses:

Advertising and promotion 357,900 | 266,500

Amortization 219,163 | 166,584

Automobile 140,800 | 102,600

Bad debts 17,250 | 19,110

Donations 1,200 | 1,000

Dues and fees 7,500 |

Insurance 69,600 | 57,200

Interest and bank charges 119,203 | 46,600

Office 101,200 | 108,700

Professional fees 67,700 | 34,800

Property taxes 44,700 | 40,900

Rent expense 84,654 |

Repairs and maintenance 207,100 | 155,100

Salaries and wages 1,160,460 | 1,175,600

Travel 117,666 | 103,900

Utilities 67,600 | 60,200

Warranty 72,059 | 69,482

Income before taxes 154,397 | 296,015

Income taxes 33,840 | 76,754

Net income 120,557 | 219,261

Retained earnings, opening 2,571,214 | 2,360,953

Dividends 48,750 | 9,000

Retained earnings, closing $ 2,643,021 | $ 2,571,214