You have been approached by the owner of a successful restaurant in Dallas who is raising $275,000 of new equity to fund the investments necessary to support anticipated growth over the next few years.

The restaurant owner tells you his restaurant will generate (in yr. 1) $1,000,000 in revenues and incur operating cash expenses of $650,000. He expects revenue and expenses to grow 2% in perpetuity. He also expects capital expenditures and depreciation each to be equal to 5% of sales. Working capital is 2% of sales.

You believe that the target capital structure is debt-free. The average tax rate is 25%. A review of comparable publicly-traded companies indicate a levered beta of 2.0 with average debt/(debt+equity) of 50%. The risk-free rate is 3.0% and market risk premium is 6.0%.

1. What is the expected rate of return on equity? [10 points]

2. What percentage of the equity in the restaurant would you expect if you were to provide the entire $275,000? [10 points]