Reference no: EM133015757

Question - Maria is thinking about starting a bike rental business. She plans to buy four bikes now and to then add a fifth bike at the end of the second year. Each bike will cost $20,000. Maria has carefully evaluated the local market for rental bikes and believes that each bike will generate $5,000 of net operating cash flow each year. At the end of five years, she believes the bikes can be sold for $30,000 in total.

Additional information:

Maria will put $80,000 cash into the business. This amount represents beginning equity.

The company will pay out all excess cash as dividends each year. The cash needed to buy the bike in Year 2 will come from operating cash flows that year. No new investment will be required.

Bike depreciation is $3,043.48 per bike per year, which results in the bikes having a book value of $30,000, the expected salvage value, at the end of Year 5.

The appropriate discount rate is 10%.

How much is the business worth? Use the abnormal earnings approach to valuation.

Calculate the value for different scenarios:

a) The company makes an impairment write-off of $20,000 in Year 2.

b) The company makes an impairment write-off of $20,000 in Year 3.

Make required adjustments for subsequent depreciation.