Mini-Case - Finance
In order to decide on an IPO price, we must look at the current financial position of the company, as well as make projections for possible future scenarios.
From the data given, we know that Prairie Home Stores (PHS) has a current book value of $80,000,000. With 400,000 outstanding shares, the book equity per share is $200.
There are two possible paths for future performance to consider. The first, a constant growth scenario, assumes that PHS will continue on its current trajectory of paying out 2/3 of its earnings as dividends, and retaining the other 2/3 to grow the business. In this scenario, we will continue the company’s growth rate of 5%, with no change in plowback or dividends. In this scenario, price per share is determined by the current dividends, divided by (r-g)
The value of the company will be equal to the present value of all future cash flows ( i.e. dividend payments) that investors expect to receive.
Constant growth scenario:
EPS 2013 = $ 12,000,000 / 400,000 shares = $ 30.00
Book equity per share in 2013 = $80,000,000 / 400,000 shares = $200.00 per share
Dividends paid out per share in 2013 = $ 8,000,000 / 400,000 shares = $ 20.00 per share
Payout ratio in 2013 = $ 20.00 (DIV2013) / $ 30 (EPS 2013) = 0.67
Plowback ratio 2013 = $10.00 (RE per share 2013) / $ 30.00 (EPS 2013) = 0.33
Sustainable growth rate = 0.15 (rate of return) x 0.33 (plowback ratio) = 5 % Price per share 2012 = DIV2013/(r-g) = $20/(11%-5% ) = $ 333.33 $ 333.33 price per share x 400,000 shares = $ 133,333,333 - value of the company in 2012
P/E ratio = $ 333.33( price per share) / 30 (EPS) = 11.11
Rapid Growth Scenario:
Since Price = DIV / r-g, and there are no dividends paid in the years 2013 – 2016, we can calculate the value of the company in 2016 and discount it to obtain the Present value in 2012.
EPS 2017 = $21,000,000 / 400,000 shares = $52.50
Book equity per share 2017 = $139,900,000 / 400,000 shares = $349.75
From the data given, we know that Prairie Home Stores (PHS) has a current book value of $80,000,000. With 400,000 outstanding shares, the book equity per share is $200.
There are two possible paths for future performance to consider. The first, a constant growth scenario, assumes that PHS will continue on its current trajectory of paying out 2/3 of its earnings as dividends, and retaining the other 2/3 to grow the business. In this scenario, we will continue the company’s growth rate of 5%, with no change in plowback or dividends. In this scenario, price per share is determined by the current dividends, divided by (r-g)
The value of the company will be equal to the present value of all future cash flows ( i.e. dividend payments) that investors expect to receive.
Constant growth scenario:
EPS 2013 = $ 12,000,000 / 400,000 shares = $ 30.00
Book equity per share in 2013 = $80,000,000 / 400,000 shares = $200.00 per share
Dividends paid out per share in 2013 = $ 8,000,000 / 400,000 shares = $ 20.00 per share
Payout ratio in 2013 = $ 20.00 (DIV2013) / $ 30 (EPS 2013) = 0.67
Plowback ratio 2013 = $10.00 (RE per share 2013) / $ 30.00 (EPS 2013) = 0.33
Sustainable growth rate = 0.15 (rate of return) x 0.33 (plowback ratio) = 5 % Price per share 2012 = DIV2013/(r-g) = $20/(11%-5% ) = $ 333.33 $ 333.33 price per share x 400,000 shares = $ 133,333,333 - value of the company in 2012
P/E ratio = $ 333.33( price per share) / 30 (EPS) = 11.11
Rapid Growth Scenario:
Since Price = DIV / r-g, and there are no dividends paid in the years 2013 – 2016, we can calculate the value of the company in 2016 and discount it to obtain the Present value in 2012.
EPS 2017 = $21,000,000 / 400,000 shares = $52.50
Book equity per share 2017 = $139,900,000 / 400,000 shares = $349.75