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MINICASE _theCFDofPrai1ieHomeStores,wondered what retirement would be like. It was almost 20 years to the day since his uncle Jacob Breezeway, Prairie Home's founder, had asked him to take responsibility for managing the company. Now itwas time tospendmoretimeridingand shingonthe oldLazy Beta Ranch. Under Mr. Breezeway's leadership Prairie Home had grown slowly but steadily and was solidly protable. (Table 7.6 shows earnings, dividends, and book asset values for the last 5 years.) Most of the company's supermarkets had been modernized, and its brand name was well known. Mr. Breezeway was proud of this record. although he wist that Prairie Home could have grown more rapidly. He had passed up several opportunities to build new stores in adjacent counties. Prairie Home was still just a family company. Its common stock was distributed among 15 grandchildren and nephews of Jacob Breezeway, most of whom had come to depend on generous regu- lar dividends. The commitment to high dividend payout" had reduced the eamings available for reinvestment and thereby con- strained growth. Mr. Breezeway believed the time had come to take Prairie Home public. Once its shares were traded in the public market, the Breezeway descendants who nwded (or just wanmd} more cash to spendcouldsellopanoftheirholdings.0tberswithmmeimer- estindiebusinesscouldtnldontoieirsharesandbetewatdedby higher fuuueearningsmdstockptiws. ButifPraieHomedidgopubgwhatshoiditashatessell for?Mr. Breezeway worriedthatshares wouldbesold, eitherby Breereway family members or by the emnpany itself, attoo low a ptice.0ne1elavewasabouttoacceptapvateoerfor$2m,the mentbookvaluepershare,lthr.Breenewayhadimervened andconvinmdthewould-be seIlertowaiL Prairie Home's value depended not just on its current book valueoreamingsbutonilsfuturepmspects,whichwe1egmd.0ne nancial projection (shown in the top panelofTable 7.?) called for growth ineamings ofover 100% by 2025. Unfortlmately,tbis plan wouldl'equiiereimlesmientofallofPrairieI-Iome'seamings fmm2019t02022.Afterthattheeompanycouldresumeitsnormal dividend payoutand gmwlhrate.Mr. Breezeway believedthisplan wasfeasible. Hewasdeterminedtostepasidefta'thenextgenerationoftop managementhbefommnghehadtodecidewhemtorec- ommendtbatPrairieHome Stores "gopub' "andbeforethat decisionhehadtolmow whattheunnpanywasworth. Thenextmorningherodethougbtlytowa'kelehis horseatthesoutheorralandambleddownthedustystteettoMike Chapter 7 Valuing Stocks Gordon's Saloon, where Francine Firewater, the company's CFO, was having her usual steak-andbeans breakfast. He asked Ms. Firewater to prepare a formal report to Prairie Home stockhold- ers, valuing the company on the assumption that its shares were publicly traded. Ms. Firewater asked two questions immediately. First1 what should she assume about investment and growth? Mr. Breeaeway suggested two valuations, one assuming more rapid expansion (as in the top panel of Table 7.7) and another just projecting past growth (as in the bottom panel of Table 7.7). 233 Second, whatrate of return should she use? Mr. Breezewa}r said that 15%, Prairie Home's usual return on book equity, sounded right to him, but he referred her to an article in the Journal of Finrmce indicating that investors in rural supermarket chains, with risks similar to Prairie Home Stores, expected to earn about 11% on average. 2' The company traditionally paid out cash dividends equal to 10% of start-of-period book value. See Table 7.6. TABLE 7.6 Financial data ror Prairie Home Stores. 2014-2013 (gures in millions) Bookable. Wofyear- $82.1 Earnings 9.7 {Materials 6.3 Retained earnings 3.4 Blackmail at year- 86.1 9.5 as" 2.9 69.0 Notes: 1. Prairie Home Stores has 400,800 common shares. 2. The company's policy is to pay cash dividends equal 10 1031': of start-of-year book liralue. TABLE 7.7 Financial projections for Prairie Home Stores. 2019-2024 (gures in millions) Bookvajluei suitor-year $80 -$ 92 Earnings '12 13.8 Dhridends D 0 Retained earnings 12 13.3 amnesia-end tit-year .92 195.3: sock-value. start orient $30 $54 Earnings 12 12.6 DM- 8 8.4 Retained earnings 4 4.2 Notes: 31.05.82 15.9 10.3 21.0 22.0 0 0 14 1-4;? 15.9 1 6.3 7.0 7.4 '1 2-1.7' 146.0 15.3 $88.2 $233- .$ Lin-2.. $102.1 13.2 13.9 14.5 15.3 as 9.3 9.7 1.0.2 4.4 4.5 4.9 5.1 92.3 97.2 1021 107.2 1. Both panels assume earnings equal to 15% of starlet-year book value. This profitability rate is constant. 2. The top panel assumes all earnings are reinvested from 21:11 9 in 2022. In 2023 and later years. two-thirds of earnings are paid out as dividends and one-third reinvested. 3.The bottom panel assunes two-wires of earnings are paid out as dividends in all years. 4. Columns may not add up because of rounding