Company Valuation Case Study Ka-Bang! Cleaning Supplies, Inc. When Ryan Bang concocted his cleaning compound, some twenty years ago, all that his wife, Riki, 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 multi-million dollar firm debating 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, Ryan and Riki 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. So Ryan spent many hours in his garage at their country home experimenting with various oils, cleansing agents, and extracts until he finally came up with what he proudly calls: Ka-Bang!TM "The perfect cleaner and polish" made from the peels of Valencia oranges. Not only was the mixture sweet smelling, it was an effective solvent and degreaser which worked wonders on their kitchen cabinets at home. So spurred on by their close friends, the family formed their own company, Ka-Bang! Cleaning Supplies, Inc. Later with the help of their 3 children, Deana, Dan, and Dave, 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 show off their merchandise about 5 years ago, major retailers like Wal-Mart and Costco took notice and started stocking their product on their shelves. Within twenty years, their sales had grown to over $500 million and their production 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 family always focused on customer need and satisfaction, always encouraging their customers to provide them with feedback and testimonials. Their latest addition, i.e. an industrial-strength cleanser and wood protector, seemed to be gaining wide acceptance both in the United States and overseas. Ryan, who was nearing 75 years of age, knew that they would need to raise significant amounts of 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). Deana and Dave strongly supported the idea because they felt that with competitors coming up with substitute products, they needed to stay ahead of the game. Dan, on the other hand, disagreed and recommended that they outsource the production and concentrate on their marketing efforts. He preferred that the firm stay private, thereby, relying less on external capital and retaining control. After carefully weighing all the factors, Ryan decided to explore the possibility of raising the money via an IPO. "Dan, Deana, and Dave," he said, "the three of you have MBAs from the most prestigious business school in the country (Northwood University, obviously). I hate to depend totally on the investment banking folks 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 issue 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. Dan'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." So Deana, Dan, and Dave got to work. They realized that they would need industry and competitors' financial data. Figure 1 presents key valuation data for three of their major publicly traded competitors in the personal and household products industry sector. Figures 2 and 3 present the companys past 5- year income statements and balance sheets respectively. They also reviewed current economic data and determined the risk free rate to be 4% and the market risk premium to be 7%. After reviewing many comparable companies they agreed to use Stepan Company (SCL) to calculate the Beta they should use. Dave's old finance professor, Dr. Dennis Witherspoon, 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. Witherspoon's advice. Accordingly, Dave decided to use a variable growth rate model to value the firms equity with growth assumptions of 30% for the first three years, followed by 20% for the next two years, and a long-term growth assumption of 5.6% thereafter. The companys most recent dividend was $1.25 per share. Deana preferred to use the Free Cash Flow Model to calculate the firms value. Deana projected 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 5.6% thereafter. It should also be noted that the companys tax rate is estimated at 40%. Having worked on various valuation projects for a major consulting firm, Dan was a strong advocate of the use of multiples models for valuing common stock. His method involved using suitable price- earnings, 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. Dan used the 4-year compound annual growth rate to forecast the companys financial performance to determine the indicated values and then discount the year-ahead price forecasts by the required rate of return on equity (based on the Capital Asset Pricing Model). "What will we do if our three estimates are totally different?" asked Deana looking rather concerned. "We'll have to go back to the drawing table and examine our inputs," said the ever-resourceful Dan, "We'll each have to be within a reasonable ballpark, or Dad's going to flip!" Figure 1 Key Valuation Ratios for Top 3 Competitors Price / Earnings Price / Book Price / Sales Price / Cash Flow Dividend Yield % Beta Recent Price Company A 23.6 8.7 2.9 12 2 1.2 $62.47 Company B 24.6 12.1 2.8 16.7 1.6 1.3 $57.29 Company C 22.8 4.2 2.9 14.7 1.7 1.15 $57.3 Revenue COGS Gross Profit Depreciation Operating Expenses Earnings Before Interest and Taxes Interest Expense Earnings Before Taxes Income Taxes Net Income Current Assets Fixed Assets Total Assets Current Liabilities Long Term Debt (@15% per year) Owners Equity Total Liabilities & Owners Equity Figure 2 Income Statements Ka-Boom! Cleaning Supplies, Inc. 2018 2019 2020 2021 2022 100,100,000 225,000,000 300,250,000 400,150,000 500,000,000 (45,315,000) (108,000,000) (147,122,500) (184,069,000) (255,000,000) 64,685,000 (3,061,646) (33,231,000) 28,392,354 (1,743,025) 26,649,329 (9,327,265) 17,322,064 117,000,000 (3,600,000) (72,000,000) 41,400,000 (2,760,000) 38,640,000 (13,524,000) 25,116,000 38,981,403 153,127,500 (4,206,746) (87,072,500) 61,848,254 (1,876,865) 59,971,389 216,081,000 (7,042,640) (141,653,100) 67,385,260 (5,165,760) 62,219,500 (21,776,825) 40,442,675 56,738,906 2021 2022 57,621,600 64,687,500 70,426,400 97,031,250 245,000,000 (9,703,125) (140,000,000) 95,296,875 (8,006,250) 87,290,625 (20,989,986) (30,551,719) Figure 3 Balance Sheets Ka-Boom! Cleaning Supplies, Inc. 2018 25,049,832 30,616,462 55,666,294 4,329,600 26,336,694 25,000,000 55,666,294 2019 39,000,000 36,000,000 75,000,000 4,600,000 18,400,000 52,000,000 75,000,000 2020 45,573,081 42,067,459 87,640,540 3,128,108 12,512,432 72,000,000 87,640,540 128,048,000 8,609,600 34,438,400 85,000,000 128,048,000 161,718,750 13,343,750 53,375,000 95,000,000 161,718,750

Using the comparable company noted in the case, calculate the Beta (60 month) to be used in your cost of funds calculations.