You are valuing a bed-and-breakfast in Vermont with the following informa-

tion:

The business had pretax operating income of $100,000 in the most recent

year. This income has grown 5% a year for the past three years, and is ex-

pected to continue growing at that rate for the foreseeable future.

About 40% of this operating income can be attributed to the fact that

the owner is a master chef. He does not plan to stay on if the business is

sold.

The business is financed equally with debt and equity. The pretax cost of bor-

rowing is 8%. The beta for publicly traded firms in the hospitality business is

1.10. The Treasury bond rate is 7%, the market risk premium is 5.5%, and

the tax rate is 40%.

The capital maintenance expenditure, net of depreciation, was $10,000 in

the most recent year, and it is expected to grow at the same rate as operat-

ing income.

The business is expected to have an operating life of 10 years, after which the

building will be sold for $500,000, net of capital gains taxes.

a. Value the business for sale.

b. How much would the value change if the owner offered to stay on for the

next three years?