Some of you got perfect scores on the casethat does not necessarily mean you did it perfectly correct.

Please refer to one suggested solution.

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 4.10 and 4.11 do not show free cash flow and financing requirements. These are calculated in Table 1. Note that free cash flow for 2005 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 2 shows that the book value of equity is forecasted to grow from $40.71 million in 2004 to $63.31 million at the end of 2010. Table 3 works out earnings, dividends and free cash flow for 2011. 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 2002 and receive all of the free cash flow afterwards. Note from Table 1 that the present value of free cash flow from 2004 to 2010 is $8 million. Of course there are several ways to calculate PVH, the horizon value in 2010. The constant-growth DCF formula gives
3.04 = 108.57 PVH = .10 - .072

implying a company value in 2003 of:

108.57 7 = $63.71 million (1.1)

PV = 8 +

By Donglin Li

Next suppose that Reeby Sports will lose its competitive edge by 2010 and will have no PVGO looking forward from that date. In that case we just capitalize 2011 earnings at 10%:
7.60 = 76 PVH = .10 76 PV = 8 + (1.1) 7 = $47 million.

George also has a "comparable," Molly Sports. The case gives three ratios for Molly: Ratio Market-to-book = 1.5 Price-earnings = 12 Dividend yield = .03 2010 Valuation 1.5 x 63.31 = 94.97 12 x 7.60 = 91.20
3.04 = 101.33 .03

PV in 2003 $56.73 million $54.80 million $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 4.10 and 4.11. Note that all the valuations presented so far are Reeby Sports as a whole. To get per-share value, just divide by 200,000. So you can get a range of per share estimates, from 47/0.2=$235 per share to 63.71/0.2=$318.55 per share, where 0.2 stands for 0.2 mm shares.

See Tables Below.

By Donglin Li

Table 1: Reeby Sports -- Investment, Financing Requirements and Free Cash Flow (Figures in $ millions) 2004 After-tax profits 5.25 2005 5.70 2006 3.00 2007 3.40 2008 4.35 2009 6.00 2010 7.60

Retained profits - Investment + Depreciation

3.25 5.65 2.40

3.70 11.10 3.10

.50 3.62 3.12

.90 4.07 3.17

1.85 5.11 3.26

3.50 6.94 3.44

4.60 8.28 3.68

= Financing required Free cash flow

0 2.00

- 4.30 - 2.30

0 2.50

0 2.50

0 2.50

0 2.50

0 3.00

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

By Donglin Li

Table 2: Investment and book value (Figures in $millions)

2004 Equity book value, start of year + Investment - Depreciation = Equity book value, end of year 40.71

2005 43.96

2006 51.96

2007 52.46

2008 53.36

2009 55.21

2010 58.71

5.65 2.40 43.96

11.10 3.10 51.96

3.62 3.12 52.46

4.07 3.17 53.36

5.11 3.26 55.21

6.94 3.44 58.71

8.28 3.68 63.31

By Donglin Li

Table 3: Earnings, Investment and Dividends for 2011 (Figures in $millions)

After-tax profits

7.60

12 % on start-of-year book equity 40 % payout 7.2 % growth

Dividends Retained profits + Depreciation = Retained cash flow - Investment

3.04 4.56 3.95 8.51 8.51

= depreciation + 60% of profits

= Financing required Free cash flow (= Dividends - financing required)

0 3.04

By Donglin Li