You have been approached by valuation advice by the owner of CalMex Inc, a private restaurant chain that is planning on going public in the near future. You are provided with the following information on the firm:

CalMex is expected to generate $5 million in after-tax operating income on revenues of $100 million next year. The book value of capital invested in the firm is $50 million and after-tax operating income is expected to grow 4% a year in perpetuity.

There are significant inefficiencies in the way the restaurant is run, entirely attributable to the owners management style. If these inefficiencies are removed CalMex could generate $ 6.5 million in after-tax operating income next year on the same revenues, though expected growth is unlikely to be affected.

The unlevered beta of publicly traded restaurants is 1.25, but the average correlation of the sector with the market is only 0.40. The treasury bond rate is 5% and the market risk premium is 4%.

The firm will be all equity financed.

A. Calculate the Cost of equity of CalMex at the IPO

B. Estimate the value of the firm with existing management for a public offering.