1. Ms. Emma originally approached the company, Peterson Accounting, when she discovered problems with her faulty title to the vacant land. She hired the company to value the hotel
property so she could provide lenders an independent appraisal of the collateral value of the
property.
Peterson Accounting researched valuation approaches used to determine most banks’ collateral
value of bed and breakfast Inns in the Laguna area and discovered that most bank appraisers
calculate the collateral value using the expected value approach. They place weights on
appraisals that result from two methods. First, many bed and breakfast operations are valued at
four times the past two years’ average gross margin. Appraisers assume that this appraisal is
correct about 40% of the time, and accordingly place a 40% weight on the number derived from
this method. Second, many properties are valued by taking the present value of the average of
the past three years’ cash flows discounted at an 8% discount rate for 10 years. (Appraisers
assume that the past cash flows are a good estimate of future cash flows and those cash flows
should continue for 10 years in the future.) Appraisers place a weight of 60% on the number
derived from this method.
Using the income statement and footnotes for XYZ’s Inn for the past three years provided by the
existing owner’s accountant to help in the appraisal process, verify the value of the hotel
determined by Peterson Accounting by using:
a. Four times the past two years’ average gross margin
b. The present value of the average of the past three years’ cash flows discounted at 8% for
the next 10 years. In order to do this, first prepare an estimate of cash flow from
operations for the three years. Then discount the average of this amount at 8% for 10
years to determine the hotel’s implied value.
c. Combine the values calculated in a) and b) using the weights provided. What is the
appraised value of the Bed and Breakfast? Assume the appraised value is the total
amount that the bank will loan Ms. Emma unless she either pays 25% of the purchase in
cash or pledges to the bank a first priority lien on the vacant land as collateral. If Ms.
Emma has $500,000 available as a down payment, could she have borrowed enough
money based on this appraisal without pledging the vacant land as collateral?
d. Should Peterson Accounting have relied on the income statement and footnote information
provided by Ms. Rachel’s accountant? Why or why not?
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