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What should she assume about investment and growth? mr. breezeway suggested two valuations, one assuming more rapid expansion and another just projecting past growth. What rate of return should she use?

308 SECTION THREE 8 a. The sustainable growth rate is g = return on equity plowback ratio = 10% .40 = 4% b. First value the company. At a 60 percent payout ratio, DIV1 = $3.00 as before. Using the constant-growth model, P0 = $3 = $37.50 .12 - .04 sh is ar stu ed d vi y re aC s o ou urc rs e eH w er as o. co m which is $4.17 per share less than the company's no-growth value of $41.67. In this example Blue Skies is throwing away $4.17 of potential value by investing in projects with unattractive rates of return. c. Sure. A raider could take over the company and generate a profit of $4.17 per share just by halting all investments offering less than the 12 percent rate of return demanded by investors. This assumes the raider could buy the shares for $37.50. MINICASE Terence Breezeway, the CEO of Prairie Home Stores, 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 it was time to spend more time riding and fishing on the old Lazy Beta Ranch. Under Mr. Breezeway's leadership Prairie Home had grown slowly but steadily and was solidly profitable. (Table 3.7 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 wished 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 com- Th TABLE 3.7 Financial data for Prairie Home Stores, 2000-2004 (figures in millions) Book value, start of year Earnings Dividends Retained earnings Book value, end of year mon stock was distributed among 15 grandchildren and nephews of Jacob Breezeway, most of whom had come to depend on generous regular dividends. The commitment to high dividend payout1 had reduced the earnings available for reinvestment and thereby constrained 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 needed (or just wanted) more cash to spend could sell off part of their holdings. Others with more interest in the business could hold on to their shares and be rewarded by higher future earnings and stock prices. But if Prairie Home did go public, what should its shares sell for? Mr. Breezeway worried that shares would be sold, either by Breezeway family members or by the company itself, at too low a price. One relative was about to accept a private offer for $200, the 2000 2001 2002 2003 2004 $62.7 $9.7 $6.3 $3.4 $66.1 66.1 9.5 6.6 2.9 69.0 69.0 11.8 6.9 4.9 73.9 73.9 11.0 7.4 2.6 76.5 76.5 11.2 7.7 3.5 80.0 Notes: 1. Prairie Home Stores has 400,000 common shares. 2. The company's policy is to pay cash dividends equal to 10 percent of start-of-year book value. 1 The company traditionally paid out cash dividends equal to 10 percent of start-of-period book value. See Table 5.6. https://www.coursehero.com/file/10503275/corporatefinance1320/ Powered by TCPDF (www.tcpdf.org)