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##### Professor Message Hello Class, Here is some gu...

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Professor Message Hello Class, Here is some guidance for the Reeby case study in week 1. The spreadsheet accompanying this solution sets out a forecast in the same general format as Table 4.5. Historical results from 2005 to 2010 are also shown. Earnings per share (EPS) equals return on equity (ROE) times starting book value per share (BVPS). EPS is divided between dividends and retained earnings, depending on the dividend payout ratio. BVPS grows as retained earnings are reinvested. The keys to Reeby Sports? future value and growth are profitability (ROE) and the reinvestment of retained earnings. Retained earnings are determined by dividend payout. The spreadsheet sets ROE at 15% for the five years from 2012 to 2016. If Reeby Sports will lose its competitive edge by 2017, then it cannot continue earning more than its 10% cost of capital. Therefore ROE is reduced to 10% starting in 2017. The payout ratio is set at .30 from 2012 onwards. Notice that the long-term growth rate, which settles in between 2017 and 2018, is ROE ? ( 1 ? dividend payout ratio) = .10 ? (1 - .30) = .07. Now, just compute the horizon value for 2016 using the constant growth formula. Respectfully, Dr. Cavendish Ten years ago, in 2011, George Reeby founded a small mail-order company selling high-quality sports equipment. Since those early days Reedy 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 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 estimate 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 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. 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E Earnings per share, \$ -2.10 -0.70 0.23 0.81 1.10 1.30 1.52 1.64 2.00 2.03 Dividend, \$ 0.00 0.00 0.00 0.20 0.20 0.30 0.30 0.60 0.60 0.80 Book value per share, \$ 9.80 7.70 7.00 7.61 8.51 9.51 10.73 11.77 13.17 14.40 ROE, % -27.10 -7.10 3.0 11.6 14.5 15.3 16.0 15.3 17.0 15.4 Q1. 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. Q2. How much of your estimate of the value of Reeby?s stock comes from the present value of growth opportunities?

Paper#5562 | Written in 18-Jul-2015

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