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Some of you got perfect scores on the case—that 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 PVH = = 108.57 .10 - .072

implying a company value in 2003 of:

PV = 8 +

By Donglin Li

108.57 7 = $63.71 million (1.1)

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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 PVH =

= 76

.10

76 PV = 8 + (1.1)

7 = $47 million .

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

2010 Valuation

PV in 2003

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

3.04

$60.00 million

.03

= 101.33

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

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Table 1: Reeby Sports -- Investment, Financing Requirements and Free Cash Flow (Figures in $ millions) 2004

2005

2006

2007

2008

2009

2010

After-tax profits

5.25

5.70

3.00

3.40

4.35

6.00

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

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

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

By Donglin Li

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

2004

2005

2006

2007

2008

2009

2010

40.71

43.96

51.96

52.46

53.36

55.21

58.71

+ Investment

5.65

11.10

3.62

4.07

5.11

6.94

8.28

- Depreciation

2.40

3.10

3.12

3.17

3.26

3.44

3.68

43.96

51.96

52.46

53.36

55.21

58.71

63.31

Equity book value, start of year

= Equity book value, end of year

By Donglin Li

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

After-tax profits

7.60

12 % on start-of-year book equity

Dividends

3.04

40 % payout

Retained profits

4.56

7.2 % growth

+ Depreciation

3.95

= Retained cash flow

8.51

- Investment

8.51

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

By Donglin Li

= depreciation + 60% of profits

0 3.04

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