Use the following information to answer questions 1-5.

John Tiemann is considering the purchase of Bluejay Lawn Care, a successful, lawn care business in Omaha, NE. Tiemann gathers the following information on Bluejay for the most recent year:

Exhibit 1 Bluejay Lawn Care

Tiemann begins by calculating normalized net income for Bluejay. The current owner of Bluejay takes an annual salary of $150,000 (representing half of operating expenses). Also, the current owner simply stores the companys equipment at his own home every night (thus avoiding storage costs). Tiemanns market research shows that an annual salary for a CEO of a business the size of Bluejay is $90,000. Furthermore, Tiemann estimates the cost of a rental facility to store the equipment to be $5,000 per year. Lastly, Tiemann believes that the optimal debt level for the company would imply annual interest expense of $35,000. Tiemann believes that all other data items it Exhibit 1 fairly represent normalized business activity.

Tiemann next estimates free cash flow for Bluejay for next year, based on the following assumptions:

• Revenues and operating expenses (excl. depr.) will grow by 5%

• Gross profit margin will remain at 60% and tax rate will remain at 40%

• Depreciation will be equal to 3% of revenues

• Interest expense of $35,350 on debt financing of $505,000 (7% interest rate)

• Working capital costs will be equal to 15% of incremental revenues (IR)

• Capital expenditures will be equal to depreciation expense + 5% of IR

  Tiemann estimates a cost of equity using a build-up approach of 16%. Tiemann estimates a weighted average cost of capital (WACC) of 9.5% based upon his view of the companys optimal capital structure.

  Finally, Tiemann estimates the intrinsic value of Bluejay using four approaches.

Revenues	$750,000
Gross profit margin	60%
Operating expenses, excluding depreciation	$300,000
Depreciation (as % of revenues)	$15,000
Interest expense	$20,000
Tax rate	40%

Approach 1: Approach 2:

Approach3:

Approach 4:

Value Bluejay using the capitalized cash flow method. Under Approach 1, a capitalization rate of 6.5% is applied to next years FCFF estimate (from Question 1 below).

Value Bluejay using the free cash flow method. Under Approach 2, next years FCFF estimate (from Question 1 below) is expected to grow by 7% for four years starting in year 2, before slowing to a growth rate of 4% starting in year 6 into perpetuity.

Value Bluejay using the guideline public company method. Tiemann calculates a peer group median MVIC/EBITDA multiple of 9x. However, due to differences in risk/growth characteristics relative to the peer group, Tiemann concludes a 20% downward adjustment to the multiple is warranted. Furthermore, Tiemann believes a firm control premium of 10% should be applied to the adjusted multiple. This final adjusted multiple is then applied to next years estimated EBITDA.

Value Bluejay using an industry valuation rule of thumb. Tiemann learns that the industry rule of thumb for valuing lawn care businesses is typically a range of 13 times annual revenues. Under Approach 4, Tiemann applies a multiple of 2x to next years revenue estimate.

Note: Before you answer the following questions, you will need to create a two-column income statement for Bluejay; one column showing the calculation of current net income, and the second column showing the calculation of normalized net income using Tiemanns estimates of rental cost, market-based CEO salary, and interest expense. Be careful here; all of your answers will likely be wrong if this first step is not done correctly. Example 1 in the private company valuation reading can guide you through building an income statement. Please remember that gross margin is not the same as operating margin there should be a deduction for COGS to get to gross margin, and a deduction of all other expenses to get to EBIT.

Also, just a reminder, the value of equity is firm value less the value of debt keep this in mind as you answer these questions.

1. 1.) What is next years total FCFF based upon Tiemanns assumptions?

2. 2.) What is the estimated total equity value of Bluejay under Approach 1?

3. 3.) What is the estimated total equity value of Bluejay under Approach 2?

4. 4.) What is the estimated total equity value of Bluejay under Approach 3? (Hint: The control premium should only be applied to the equity value. See the footnote to the table outlining the solution to Question #2 in Example 5 within the private company valuation reading for an example.)

5. 5.) What is the estimated total equity value of Bluejay under Approach 4?