Mini-Case – Finance

In order to decide on an IPO price, we must look at the current financial position of the company, as well as make projections for possible future scenarios. From the data given, we know that Prairie Home Stores (PHS) has a current book value of $80,000,000. With 400,000 outstanding shares, the book equity per share is $200. There are two possible paths for future performance to consider. The first, a constant growth scenario, assumes that PHS will continue on its current trajectory of paying out 2/3 of its earnings as dividends, and retaining the other 2/3 to grow the business.In this scenario, we will continue the company’s growth rate of 5%, with no change in plowback or dividends. In this scenario, price per share is determined by the current dividends, divided by (r-g) The value of the company will be equal to the present value of all future cash flows ( i. e. dividend payments) that investors expect to receive. Constant growth scenario: EPS 2013 = $ 12,000,000 / 400,000 shares = $ 30. 00 Book equity per share in 2013 = $80,000,000 / 400,000 shares = $200. 00 per share Dividends paid out per share in 2013 = $ 8,000,000 / 400,000 shares = $ 20. 00 per share Payout ratio in 2013 = $ 20. 0 (DIV2013) / $ 30 (EPS 2013) = 0. 67 Plowback ratio 2013 = $10. 00 (RE per share 2013) / $ 30. 00 (EPS 2013) = 0. 33 Sustainable growth rate = 0. 15 (rate of return) x 0. 33 (plowback ratio) = 5 % Price per share 2012 = DIV2013/(r-g) = $20/(11%-5% ) = $ 333. 33 $ 333. 33 price per share x 400,000 shares = $ 133,333,333 – value of the company in 2012 P/E ratio = $ 333. 33( price per share) / 30 (EPS) = 11. 11 Rapid Growth Scenario: Since Price = DIV / r-g, and there are no dividends paid in the years 2013 – 2016, we can calculate the value of the company in 2016 and discount it to obtain the Present value in 2012.EPS 2017 = $21,000,000 / 400,000 shares = $52. 50 Book equity per share 2017 = $139,900,000 / 400,000 shares = $349. 75 Dividends paid out per s hare 2017 = $14,000,000 / 400,000 shares = $35. 00 Payout ratio in 2017 = $ 35. 00 (DIV per share 2017) / $ 52. 50 (EPS 2017) = 0. 67 Plowback ratio in 2017 = $ 17. 50 (RE in 2017) / 52. 50 (EPS in 2017) = 0. 33 Sustainable growth rate = 0. 15 (rate of return) x 0. 33 (plowback ratio) = 5 % Price per share in 2016= $35. 00 (DIV 2017) / 0. 06 (r – g)= $583. 33 Let’s discount it to 2012 value: Financial calculator: FV = 583. 33 N = 4, I/Yr = 11% PV = 384. 5 – price per share in 2012 384. 25 x 400,000 shares = 153,700,000 – value of the company in 2012 under rapid growth Conclusion: Rapid growth scenario promises higher stock price, so it should be chosen. PVGO between the previous example and this one: 153,700,000 – 133,333,333 = 20,366,667 Under both scenarios, current price per share is more than $200. Now here’s my calculations: Constant growth scenario: Assuming a 15% required return: P0 = DIV1 / (r-g) = $20 / (. 15 – . 05) = $20/. 1 = $200 Assuming an 11% required return, we’ll have: P0 = DIV1 / (r-g) = $20 / (. 11 – . 05) = $20/. 06 = $333. 33In the constant growth scenario, the stock is valued at $200 if we assume a 15% expected return, and $333. 33 if we assume 11% expected return. Now, in the rapid growth scenario, things get even more exciting. I think that 2017/2020 is the horizon year, because it’s AFTER that point when the growth goes down to 5%. In paragraph 6, the problem states â€Å"†¦ would require reinvestment of all of Prairie Home’s earnings from 2016 to 2019. After that the company could resume its normal dividend payout and growth. † your book’s years:20122013201420152016201720182019 my book’s years:20152016201720182019202020212022 year #01234567 arnings growth from previous year—4. 6%15%15%15%15%5%5% dividend0000$35$36. 75$38. 59 todayH NB: neither book shows 2019 or 2022, but we know that the beginning of the year figures are the same as the end of year figures for the previous year, so that’s where I got those. Ultimately, it doesn’t really matter – I’m just reinforcing the point that we turn into a constant growth scenario beginning with year 6. Our non-constant growth model says this: PV = D1/(1+r)1 + D2 / (1+r)2 + †¦ + DH / (1+r)H + PH / (1+r)H and we get PH with this formula: PH = Dt+1 / (r-g) The dividends for the foreseeable future (years 1 – 4) will all be 0, so hose first numbers will add up to 0. We know that the dividend at the horizon year – year 5 – is $35. The expected future price of the stock at year 5 will be: P5 = D6 / (r-g) Plugging in numbers there, we have: P5 = $36. 75 / (. 15 – . 05) = $36. 75/. 1 = $367. 50 Again, that’s assuming a 15% required return. Then the third part of the process is to add up all of those numbers, discounting them to the present value: P0 = D1 + D2 + D3 + D4 + D5 / (1. 15)5 + P5 / (1. 15)5 = 0 + (35 + 367. 5) / (1. 15)5 = 402. 5/(1. 15)5 Or on the calculator: FV = 402. 50, I/YR = 15, N=5, PV = $200. 11 Then we go to the 11% required return.There, we’ll see that: P5 = D6 / (r-g) = $36. 75 / (. 11 – . 05) = $612. 50 And then: P0 = D1 + D2 + D3 + D4 + D5 / (1. 11)5 + P5 / (1. 11)5 = 0 + (35 + 612. 50) / (1. 11)5 = †¦ (Calculator: FV = 647. 50, I/YR = 11, N = 5, PV = $384. 26) In the rapid growth scenario, the stock is valued at $200. 11 if we assume a 15% expected return, and $384. 26 if we assume 11% expected return. This is the point where I defer to you, or we can talk about this more tomorrow. Our math says to price the stock somewhere between $200 and $384, but how do we choose? I get the sense that you understand that better than I do, so I can use your input for sure.We believe that Prairie Home Stores should value the stock at $384. xx because we should choose the We recommend choosing the rapid growth scenario, plowback more earnings into growing the company, and set the IPO price as $384. whatever. Our prospectus will show that we intend to invest more of our earnings into growing the company over the next 4 years, and as a result investors and the market will support a price of $384. We chose to use 11% as our expected rate of return, because this is the rate shown in the Journal of Finance as being the rate offered by other, equally risky stocks in the same industry as Prairie Home Stores.The PVGO is $153,700,000 – 133,333,333 = $20,366,667. This indicates that the company has room to grow, which will be attractive to investors. Investors believe that under the rapid growth scenario. According to our calculations, Mr. Breezeway was wise to counsel his son( ) to not sell the stock for $200, as we believe that the company is worth more than current BOOK VALUE PER SHARE – include something about this. $200 per the current values (this is what the whoever dude offered the son), but our calculations show that th e company is more valuable than the $200 price indicates.