Ms. Warren originally approached the company, Desert Mirage 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.

Desert Mirage Accounting researched valuation approaches used to determine most banks’ collateral value of bed and breakfast Inns in the Palm Desert 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 Hotel California 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 Desert Mirage Accounting by using:

Should Desert Mirage Accounting have relied on the income statement and footnote information provided by Ms. Ramirez’s accountant? Why or why not?

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