Sophie Zincmann Company has purchased an auto repair business in Tucson, Arizona, at the beginning of Year 1. One of the assets of the acquired company is a business license issued by the city of Tucson. These licenses are valuable, but they trade infrequently, and the last separate sale of a similar license was 10 years ago. Accordingly, Sophie Zincmann has determined that an income approach is necessary to determine the fair value of the acquired business license. Because similar licenses are sometimes sublicensed, or rented, in exchange for a royalty fee based on total repair shop revenue, Sophie Zincmann can use a “relief-from-royalty” method to estimate the fair value of the license. Sophie Zincmann has determined that the prevailing market royalty rate for such an arrangement is 2.0%. Using this approach, the fair value of the license is the present value of the after-tax royalties that Sophie Zincmann is avoiding by owning the license. Sophie Zincmann has generated the following inputs for use with the “relief-from-royalty” method:
Royalty rate: 2.0% of total repair shop revenue (before subtracting any expenses)
Discount rate: 15.0%
Expected repair shop revenue in Year 1: $300,000
Expected growth rate in repair shop revenue each year for Years 2 through 5: 10.0%. Sophie Zincmann expects rapid revenue growth for the next five years, but then the growth will slow to a sustainable long-term level.
Expected growth rate in repair shop revenue each year after five years (Year 6 and beyond): 3.0%
Income tax rate: 30%
Using these data, estimate the fair value of the business license.