2. Comment on Kelly's preference of the corporate value model. Based on her approach, what would Orange Brite's selling price per share be if they were to issue 30 million shares? When Wayne concocted his cleaning compound some 20 years ago, all that his wife, Corrine, and he were trying to do was to come up with a sweeter, gentler yet tougher, cleaning product. Little did he realize that someday he would be the proud owner of a multimillion-dollar firm debat- ing whether or not to sell stock to the public? After having peddled vacuum cleaners and floor wax products at state fairs and trade shows throughout the Midwest, Wayne and Corrine Good- man realized that there was a dire need for a cleaning and polishing product that was free from harsh chemicals, environmentally friendly, and tough on dirt and grime. Wayne spent many hours in his garage at their country home in Chesterton, Indiana, experimenting with various oils, cleansing agents, and extracts until he finally came up with what he proudly calls "The perfect cleaner and polish." It was the pure citrus oil made from the peels of Valencia oranges that did the trick. Not only was the mixture sweet smelling, it was an effective solvent and degreaser that worked won- ders on their kitchen cabinets at home. Spurred on by their close friends, the Goodmans formed their company, Orange Brite (which they later changed to Orange Brite International) in December 1995, and took their dog-and-pony show on the road. Initially they sold their products mainly through word-of-mouth advertising at state fairs, and home and garden shows, but later, with the help of their three children, Kelly, Billy, and Joey, they used direct response television, direct mail, and e-commerce channels to help grow the company's revenues at a phenomenal rate. When the Home Shopping Network agreed to let them pro- mote their merchandise about five years ago, major retailers like Wal-Mart and Costco took notice and started stocking Orange Brite products on their shelves. Within 20 years, sales had grown to over $500 million and their pro- duction facilities were beginning to feel the strain. Their product line had expanded to include air fresheners, soap bars, liquid soaps, spot removers, and a variety of cleaning tools. Through all this success, the Goodmans always focused on customer needs and satisfaction, always encouraging their customers to provide them with feedback and testimonials. Their latest addition, an industrial-strength cleanser and wood protector, seemed to be gaining wide acceptance both in the United States and overseas. Wayne, who was nearing 75 years of age, knew that they would need to raise significant capital if they wanted to keep growing and expanding their product line. Still actively involved in the business, he had asked the rest of his family for their suggestions regarding the possibility of going public by issuing an initial public offering (IPO). Kelly and Joey strongly supported the idea because they felt that with competitors coming up with substitute products, they needed to stay ahead of the game. Billy, on the other hand, disagreed and recommended that they outsource production and concentrate on their marketing efforts. He preferred that the firm stay private, relying less on external capital and retaining control. After carefully weighing all the factors, Wayne decided to explore the possibility of raising the money via an IPO. "Billy, Kelly, and Joey," he said, "the three of you have MBAs from some of the most prestigious business schools in the country. I'm sure you guys can figure out what we're really worth! I hate to depend totally on investment bankers to come up with the right price. Why don't the three of you put your heads together and figure out what is the minimum price that we should sell our stock for if we were to go public. Let's say we sell 30 million shares. I'm sure we can find a way of retaining control of a large portion of the shareholding and still raise the much-needed cash. Billy's point of loss of control is a good one, but I am not in favor of outsourcing production. Our success has come from our quality and that would likely be jeopardized if we let others produce the product." Kelly, Billy, and Joey got to work. They realized that they would need industry and competitors' financial data. Table 1 presents key valuation data for 3 of their major publicly traded competitors in the personal and household products industry sector. Tables 2 and 3 present Orange Brite International's five-year income statements and balance sheets, respectively. Kelly preferred to use the corporate value model, whereby the firm's value was estimated as the sum of its discounted free-cash flows. Free cash flows were estimated by subtracting the firm's net capital investment from the year's net operating profits after taxes (NOPAT) and were discounted at a suitable risk-adjusted discount rate (weighted average cost of capital). Kelly assumed that the firm's free cash flows would grow at a rate of 20% during the first year, 10% during the second year, and finally settle down to a long-term growth rate of 6% thereafter. The firm's equity value was calculated by subtracting out the firm's outstanding debt owed to creditors from the overall value. Kelly used a risk-free rate of 4%, a market risk premium of 8%, and the average beta of the three competitors when deter- mining the firm's cost of equity. Having worked on various valuation projects for a major consulting firm, Billy was a strong advocate of the use of price-ratio models for valuing common stock. His method involved using suitable price-carnings, price- sales, price-book value, and price-cash flow multiples in conjunction with forecasted values for the firm's earnings, sales, book value, and cash flows respectively. Billy used the four-year average compounded growth rate when forecasting the relevant variables and then discounted the year-ahead price forecasts by the required rate of return on equity (based on the capital asset pricing model using the same inputs that Kelly used). Joey's finance professor, Dr. Alex Hexter, on the other hand, had indoctrinated him in the art of common stock valuation via the discounting of future dividends. "Always use a realistic required rate of return and various growth rate scenarios in conjunction with industry benchmarks, when valuing growth companies," was Dr. Hexter's advice. Accordingly, Joey decided to use a variable growth rate model to value the firm's equity. "What will we do if our three estimates are totally different?" Asked Kelly looking rather con- cerned. "We'll have to go back to the drawing table and examine our inputs," said the ever-resourceful Billy, "We'll each have to be within a reasonable ballpark, or Dad's going to flip!" Table 1 Key Valuation Ratios for Top 3 Competitors Shine Brite ChemScape Ultra Clean 23.6 24.6 Price/Earnings Price/Book Price/Sales Price/Cash Flow Dividend Yield % Beta Recent Price 22.8 4.2 2.9 7.7 2.9 13 12.1 2.8 16.7 1.6 1.8 1.3 1.2 $ 62.47 14.7 1.7 1.15 $ 57.30 $ 57.29 Table 2 Orange Brite International's 5-year Income Statements 2011 2012 2013 2014 2015 Revenue COGS (excluding depreciation) Gross Profit 300,250,000 147,122,500 153,127,500 4,206,746 87,072,500 Depreciation Operating Expenses Earnings Before Interest & Taxes Interest Expense Earnings Before Taxes Income Taxes Net Income 100.700.000 45,315,000 55,385,000 3,061.646 33,231.000 19,092,354 1,743,025 17.349,328 6,939,731 10.409,597.0 225,000,000 108,000,000 117,000,000 3,600,000 72,000,000 41,400,000 2,760,000 38.640,000 15,456,000 23,184,000.0 400,150.000 184,069,000 216,081,000 7,042,640 141,653.100 67.385,260 5,165.760 62,219,500 24,887,800 37,331,700.0 500,000,000 255,000,000 245,000,000 9,703,125 140,000,000 95,296,875 8.006,250 87,290,625 34.916.250 52,374,375.0 61,848,254 1,876,865 59,971,389 23,988,556 35,982,833.5 Table 3 Orange Brite International's 5-year Balance Sheets 2011 2012 2013 2014 2015 Current Assets 25,049,832 30,616,462 39,000,000 36.000.000 45,573,081 42,067.459 57,621,600 70,426,400 64,687.500 97,031,250 Fixed Assets Total Assets 55,666,294 75,000,000 87,640,541 128,048.000 161,718,750 4.329,601 4,600,000 3,128,108 8,609,600 13,343,750 Current Liabilities Long-Term Debt (a 14% per year) 26,336,694 18,400,000 12,512,432 34,438,400 53,375,000 25,000,000 52,000,000 72,000,000 85,000,000 95,000,000 Owners' Equity Total Liabilities and Owners' Equity 55,666,294 75,000,000 87,640,541 128,048,000 161,718,750 2. Comment on Kelly's preference of the corporate value model. Based on her approach, what would Orange Brite's selling price per share be if they were to issue 30 million shares? When Wayne concocted his cleaning compound some 20 years ago, all that his wife, Corrine, and he were trying to do was to come up with a sweeter, gentler yet tougher, cleaning product. Little did he realize that someday he would be the proud owner of a multimillion-dollar firm debat- ing whether or not to sell stock to the public? After having peddled vacuum cleaners and floor wax products at state fairs and trade shows throughout the Midwest, Wayne and Corrine Good- man realized that there was a dire need for a cleaning and polishing product that was free from harsh chemicals, environmentally friendly, and tough on dirt and grime. Wayne spent many hours in his garage at their country home in Chesterton, Indiana, experimenting with various oils, cleansing agents, and extracts until he finally came up with what he proudly calls "The perfect cleaner and polish." It was the pure citrus oil made from the peels of Valencia oranges that did the trick. Not only was the mixture sweet smelling, it was an effective solvent and degreaser that worked won- ders on their kitchen cabinets at home. Spurred on by their close friends, the Goodmans formed their company, Orange Brite (which they later changed to Orange Brite International) in December 1995, and took their dog-and-pony show on the road. Initially they sold their products mainly through word-of-mouth advertising at state fairs, and home and garden shows, but later, with the help of their three children, Kelly, Billy, and Joey, they used direct response television, direct mail, and e-commerce channels to help grow the company's revenues at a phenomenal rate. When the Home Shopping Network agreed to let them pro- mote their merchandise about five years ago, major retailers like Wal-Mart and Costco took notice and started stocking Orange Brite products on their shelves. Within 20 years, sales had grown to over $500 million and their pro- duction facilities were beginning to feel the strain. Their product line had expanded to include air fresheners, soap bars, liquid soaps, spot removers, and a variety of cleaning tools. Through all this success, the Goodmans always focused on customer needs and satisfaction, always encouraging their customers to provide them with feedback and testimonials. Their latest addition, an industrial-strength cleanser and wood protector, seemed to be gaining wide acceptance both in the United States and overseas. Wayne, who was nearing 75 years of age, knew that they would need to raise significant capital if they wanted to keep growing and expanding their product line. Still actively involved in the business, he had asked the rest of his family for their suggestions regarding the possibility of going public by issuing an initial public offering (IPO). Kelly and Joey strongly supported the idea because they felt that with competitors coming up with substitute products, they needed to stay ahead of the game. Billy, on the other hand, disagreed and recommended that they outsource production and concentrate on their marketing efforts. He preferred that the firm stay private, relying less on external capital and retaining control. After carefully weighing all the factors, Wayne decided to explore the possibility of raising the money via an IPO. "Billy, Kelly, and Joey," he said, "the three of you have MBAs from some of the most prestigious business schools in the country. I'm sure you guys can figure out what we're really worth! I hate to depend totally on investment bankers to come up with the right price. Why don't the three of you put your heads together and figure out what is the minimum price that we should sell our stock for if we were to go public. Let's say we sell 30 million shares. I'm sure we can find a way of retaining control of a large portion of the shareholding and still raise the much-needed cash. Billy's point of loss of control is a good one, but I am not in favor of outsourcing production. Our success has come from our quality and that would likely be jeopardized if we let others produce the product." Kelly, Billy, and Joey got to work. They realized that they would need industry and competitors' financial data. Table 1 presents key valuation data for 3 of their major publicly traded competitors in the personal and household products industry sector. Tables 2 and 3 present Orange Brite International's five-year income statements and balance sheets, respectively. Kelly preferred to use the corporate value model, whereby the firm's value was estimated as the sum of its discounted free-cash flows. Free cash flows were estimated by subtracting the firm's net capital investment from the year's net operating profits after taxes (NOPAT) and were discounted at a suitable risk-adjusted discount rate (weighted average cost of capital). Kelly assumed that the firm's free cash flows would grow at a rate of 20% during the first year, 10% during the second year, and finally settle down to a long-term growth rate of 6% thereafter. The firm's equity value was calculated by subtracting out the firm's outstanding debt owed to creditors from the overall value. Kelly used a risk-free rate of 4%, a market risk premium of 8%, and the average beta of the three competitors when deter- mining the firm's cost of equity. Having worked on various valuation projects for a major consulting firm, Billy was a strong advocate of the use of price-ratio models for valuing common stock. His method involved using suitable price-carnings, price- sales, price-book value, and price-cash flow multiples in conjunction with forecasted values for the firm's earnings, sales, book value, and cash flows respectively. Billy used the four-year average compounded growth rate when forecasting the relevant variables and then discounted the year-ahead price forecasts by the required rate of return on equity (based on the capital asset pricing model using the same inputs that Kelly used). Joey's finance professor, Dr. Alex Hexter, on the other hand, had indoctrinated him in the art of common stock valuation via the discounting of future dividends. "Always use a realistic required rate of return and various growth rate scenarios in conjunction with industry benchmarks, when valuing growth companies," was Dr. Hexter's advice. Accordingly, Joey decided to use a variable growth rate model to value the firm's equity. "What will we do if our three estimates are totally different?" Asked Kelly looking rather con- cerned. "We'll have to go back to the drawing table and examine our inputs," said the ever-resourceful Billy, "We'll each have to be within a reasonable ballpark, or Dad's going to flip!" Table 1 Key Valuation Ratios for Top 3 Competitors Shine Brite ChemScape Ultra Clean 23.6 24.6 Price/Earnings Price/Book Price/Sales Price/Cash Flow Dividend Yield % Beta Recent Price 22.8 4.2 2.9 7.7 2.9 13 12.1 2.8 16.7 1.6 1.8 1.3 1.2 $ 62.47 14.7 1.7 1.15 $ 57.30 $ 57.29 Table 2 Orange Brite International's 5-year Income Statements 2011 2012 2013 2014 2015 Revenue COGS (excluding depreciation) Gross Profit 300,250,000 147,122,500 153,127,500 4,206,746 87,072,500 Depreciation Operating Expenses Earnings Before Interest & Taxes Interest Expense Earnings Before Taxes Income Taxes Net Income 100.700.000 45,315,000 55,385,000 3,061.646 33,231.000 19,092,354 1,743,025 17.349,328 6,939,731 10.409,597.0 225,000,000 108,000,000 117,000,000 3,600,000 72,000,000 41,400,000 2,760,000 38.640,000 15,456,000 23,184,000.0 400,150.000 184,069,000 216,081,000 7,042,640 141,653.100 67.385,260 5,165.760 62,219,500 24,887,800 37,331,700.0 500,000,000 255,000,000 245,000,000 9,703,125 140,000,000 95,296,875 8.006,250 87,290,625 34.916.250 52,374,375.0 61,848,254 1,876,865 59,971,389 23,988,556 35,982,833.5 Table 3 Orange Brite International's 5-year Balance Sheets 2011 2012 2013 2014 2015 Current Assets 25,049,832 30,616,462 39,000,000 36.000.000 45,573,081 42,067.459 57,621,600 70,426,400 64,687.500 97,031,250 Fixed Assets Total Assets 55,666,294 75,000,000 87,640,541 128,048.000 161,718,750 4.329,601 4,600,000 3,128,108 8,609,600 13,343,750 Current Liabilities Long-Term Debt (a 14% per year) 26,336,694 18,400,000 12,512,432 34,438,400 53,375,000 25,000,000 52,000,000 72,000,000 85,000,000 95,000,000 Owners' Equity Total Liabilities and Owners' Equity 55,666,294 75,000,000 87,640,541 128,048,000 161,718,750