Reeby Sports

Topics: Discounted cash flow, Generally Accepted Accounting Principles, Years in the future Pages: 8 (707 words) Published: April 19, 2015


REEBY SPORTS

George Reeby proposes to sell 90,000 shares, or about 22%, of his company. How much are those shares worth? We have to value the company using George's forecasts.

The forecasts presented in Tables 1 and 2 do not show free cash flow and financing requirements. These are calculated in Table A1. Note that free cash flow for 2015 is -$2.3 million. But dividends are $2.0, so the company will need 2.3 + 2.0 = $4.3 million in outside equity financing.

Table A2 shows that the book value of equity is forecasted to grow from $40.71 million in 2014 to $63.31 million at the end of 2020. Table A3 works out earnings, dividends and free cash flow for 2021. By that time Reeby Sports should be earning 12% on equity, paying out 40% of earnings, and growing steadily at 7.2% per year. Note that gross investment equals depreciation plus 60% of earnings.

It's easiest to value the company by assuming that its current shareholders contribute all of the $4.3 million required in 2012 and receive all of the free cash flow afterwards. Note from Table A1 that the present value of free cash flow from 2014 to 2020 is $8 million.

Of course there are several ways to calculate PVH, the horizon value in 2020. The constant-growth DCF formula gives

implying a company value in 2013 of:

Next suppose that Reeby Sports will lose its competitive edge by 2020 and will have no PVGO looking forward from that date. In that case we just capitalize 2021 earnings at 10%:

George also has a "comparable," Molly Sports. The case gives three ratios for Molly:

Ratio
2020 Valuation
PV in 2013

Market-to-book = 1.5
1.5 x 63.31 = 94.97
$56.73 million

Price-earnings = 12
12 x 7.60 = 91.20
$54.80 million

Dividend yield = .03

$60.00 million

These calculations imply higher current valuations for Reeby Sports -- higher than the DCF calculations presented earlier. Perhaps George should revisit the forecasts in Tables 1 and 2.

Note that all the valuations presented so far are Reeby Sports as a whole. To get per-share value, just divide by 200,000.

These valuations also assume that George (or the new shareholders that buy the share issue in 2013) put up all the additional equity financing in 2015. That is not George's plan. Let's work out the present value of Reeby Sports to current (year 2013) shareholders. We'll use the constant-growth formula for PVH.

First calculate PV at the end of 2015 after that year's investment and financing.

= $77.2 million.

To raise $4.3 million, new shares will have to comprise 4.3/77.2 = .0557, or 5.57% of the company, leaving 94.43% for the old shareholders. The number of new shares will be 70,141, because

The value to old shareholders in 2013 is:

PV = = $63.71 million,

just as in our earlier calculation. Again, all PVs and cash flows can be converted to per-share units by dividing by 200,000. Table A1: Reeby Sports -- Investment, Financing Requirements and Free Cash Flow (Figures in $ millions)

2014
2015
2016
2017
2018
2019
2020

After-tax profits

5.25

5.70

3.00

3.40

4.35

6.00

7.60

Dividends
2.00
2.00
2.50
2.50
2.50
2.50
3.00

Retained profits
3.25
3.70
.50
.90
1.85
3.50
4.60

+ Depreciation
2.40
3.10
3.12
3.17
3.26
3.44
3.68

= Retained cash flow
5.65
6.80
3.62
4.07
5.11
6.94
8.28

- Investment
5.65
11.10
3.62
4.07
5.11
6.94
8.28

= Financing required
0
- 4.30
0
0
0
0
0

Free cash flow
2.00
- 2.30
2.50
2.50
2.50
2.50
3.00
(= Dividends - financing required)

PV of free cash flow at 10% = 8.01, about $8 million

Table A2: Investment and book value
(Figures in $millions)

2014
2015
2016
2017
2018
2019
2020

Equity book value,
start of year

40.71...
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