Peterson Accounting researched valuation approaches used to determine most banks collateral value of bed and breakfast Inns in the Springfield area and discovered that most bank appraisers calculate the collateral value using the expected value approach. They place weights on appraisals that result from two methods. First, many bed and breakfast operations are valued at four times the past two years' average gross margin. Appraisers assume that this appraisal is correct about 40% of the time, and accordingly place a 40% weight on the number derived from this method. Second, many properties are valued by taking the present value of the average of the past three years' cash flows discounted at an 8% discount rate for 10 years. (Appraisers assume that the past cash flows are a good estimate of future cash flows and those cash flows should continue for 10 years in the future.) Appraisers place a weight of 60% on the number derived from this method.

Four times the past two years' average gross margin.

The present value of the average of the past three years' cash flows discounted at 8% for the next 10 years. In order to do this, first prepare an estimate of cash flow from operations for the three years. Then discount the average of this amount at 8% for 10 years to determine the hotel's implied value.

Combine the values calculated in a) and b) using the weights provided. What is the appraised value of the Bed and Breakfast? Assume the appraised value is the total amount that the bank will loan Ms. Ahmad unless Ms. Ahmad either pays 25% of the purchase in cash or pledges to the bank a first priority lien on the vacant land as collateral. If Ms. Ahmad has $500,000 available as a down payment, could she have borrowed enough money based on this appraisal without pledging the vacant land as collateral?

Should Peterson Accounting have relied on the income statement and footnote information provided by Ms. Amsteds accountant? Why or why not?

Lt ttttt For the years ended December 31, 2004 2003 2002 Rental Revenue Other Revenues (note 1) 2 Total Revenuese $892,513 212,432 $1,104,945 $796,500 183,195 $979,695 $ 759,656 171,923 $931,579 Cost of Revenue (note 2) Gross Profite Marketing General and Administrative (note 3) Operating Income 441,978 $662,967 110,495 287,286 $265,187 411,472 $568,223 97,970 254,721 $215,533 419,211 $512,368 e 93,158 242,211 e $177,000 e Notes to Income Statemente Note 1: Other Revenuese e Other revenues consist of charges to guests for charges for other goods and services. Note 2: Cost of Revenue Cost of revenue includes all payroll related costs of employees; depreciation on the property, improvements, and furniture; linen service charges; utilities; and bed taxes. Depreciation in cost of revenue Building (40 year life, Straight line) Property Improvements (various) Furniture (5 year life, Straight line) 2004 $50,000 72,000 88,000 2003 $50,000 68,500 82,000 2002 e $50,000 e 65,000 82,000 Note 3: General and Administrative Expenses- General and administrative expenses do not include a salary for S. Amsted, the ownere of the hotel, since this is a sole proprietorship and not a corporation. Ms. Amsted took drawings of $75,000 in 2004; $72,000 in 2003; and $70,000 in 2002 in addition to the expenses listed above. These amounts approximate what a manager would be paid. General and administrative expenses also include depreciation on equipment 2 of $22,000 in 2004; $23,000 in 2003, and $27,000 in 2002. Itt Lt ttttt For the years ended December 31, 2004 2003 2002 Rental Revenue Other Revenues (note 1) 2 Total Revenuese $892,513 212,432 $1,104,945 $796,500 183,195 $979,695 $ 759,656 171,923 $931,579 Cost of Revenue (note 2) Gross Profite Marketing General and Administrative (note 3) Operating Income 441,978 $662,967 110,495 287,286 $265,187 411,472 $568,223 97,970 254,721 $215,533 419,211 $512,368 e 93,158 242,211 e $177,000 e Notes to Income Statemente Note 1: Other Revenuese e Other revenues consist of charges to guests for charges for other goods and services. Note 2: Cost of Revenue Cost of revenue includes all payroll related costs of employees; depreciation on the property, improvements, and furniture; linen service charges; utilities; and bed taxes. Depreciation in cost of revenue Building (40 year life, Straight line) Property Improvements (various) Furniture (5 year life, Straight line) 2004 $50,000 72,000 88,000 2003 $50,000 68,500 82,000 2002 e $50,000 e 65,000 82,000 Note 3: General and Administrative Expenses- General and administrative expenses do not include a salary for S. Amsted, the ownere of the hotel, since this is a sole proprietorship and not a corporation. Ms. Amsted took drawings of $75,000 in 2004; $72,000 in 2003; and $70,000 in 2002 in addition to the expenses listed above. These amounts approximate what a manager would be paid. General and administrative expenses also include depreciation on equipment 2 of $22,000 in 2004; $23,000 in 2003, and $27,000 in 2002. Itt