Ten years ago, in 2001, George Reeby founded a small mail-order company selling
ID: 2807228 • Letter: T
Question
Ten years ago, in 2001, George Reeby founded a small mail-order company selling high-quality
sports equipment. Since those early days Reeby Sports has grown steadily and been consistently
profitable. The company has issued 2 million shares, all of which are owned by George Reeby
and his five children.
For some months George has been wondering whether the time has come to take the company
public. This would allow him to cash in on part of his investment and would make it
easier for the firm to raise capital should it wish to expand in the future.
But how much are the shares worth? George’s first instinct is to look at the firm’s balance
sheet, which shows that the book value of the equity is $26.34 million, or $13.17 per share. A
share price of $13.17 would put the stock on a P/E ratio of 6.6. That is quite a bit lower than
the 13.1 P/E ratio of Reeby’s larger rival, Molly Sports.
George suspects that book value is not necessarily a good guide to a share’s market value.
He thinks of his daughter Jenny, who works in an investment bank. She would undoubtedly
know what the shares are worth. He decides to phone her after she finishes work that evening
at 9 o’clock or before she starts the next day at 6.00 a.m.
Before phoning, George jots down some basic data on the company’s profitability. After
recovering from its early losses, the company has earned a return that is higher than its estimated
10% cost of capital. George is fairly confident that the company could continue to grow
fairly steadily for the next six to eight years. In fact he feels that the company’s growth has
been somewhat held back in the last few years by the demands from two of the children for the
company to make large dividend payments. Perhaps, if the company went public, it could hold
back on dividends and plow more money back into the business.
There are some clouds on the horizon. Competition is increasing and only that morning
Molly Sports announced plans to form a mail-order division. George is worried that beyond the
next six or so years it might become difficult to find worthwhile investment opportunities.
George realizes that Jenny will need to know much more about the prospects for the business
before she can put a final figure on the value of Reeby Sports, but he hopes that the information
is sufficient for her to give a preliminary indication of the value of the shares.
QUESTIONS
Help Jenny to forecast dividend payments for Reeby Sports and to estimate the value of
the stock. You do not need to provide a single figure. For example, you may wish to calculate
two figures, one on the assumption that the opportunity for further profitable investment
is reduced in year 6 and another on the assumption that it is reduced in year 8. How much of your estimate of the value of Reeby’s stock comes from the present value of growth opportunities?
Explanation / Answer
Assumption:1
Assumption:2
Estimate of the value of Reeby’s stock that comes from the present value of growth opportunities using both assumptions=11.46-10.3= $ 1.16
Year EPS DPS Retention per share(EPS-DPS) Retention/EPS ROE% g=Retention%*ROE% (Next-Previous)/Previous 2002 2.1 0 2.1 100.00% 27.1 27% -73.80% 2003 0.7 0 0.7 100.00% 7.1 7% -57.75% 2004 0.23 0 0.23 100.00% 3 3% 191.19% 2005 0.81 0.2 0.61 75.31% 11.6 9% 35.80% 2006 1.1 0.2 0.9 81.82% 14.5 12% -0.80% 2007 1.3 0.3 1 76.92% 15.3 12% 9.12% 2008 1.52 0.3 1.22 80.26% 16 13% -24.45% 2009 1.64 0.6 1.04 63.41% 15.3 10% 22.65% 2010 2 0.6 1.4 70.00% 17 12% -21.59% 2011 2.03 0.8 1.23 60.59% 15.4 9% -100.00% Sum= -19.62% Av.growth rate= Sum/10= -1.96%Related Questions
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