TABLE 7.6 Financial data for Prairie Home Stores, 2019-2023 (figures in millions) 2019 2020 2021 2022 2023 Book value, start of year $62.7 $66. 1 $69.0 $73.9 $76.5 Earnings 9.7 9.5 11.8 11.0 1 1.2 Dividends 6.3 6.6 6.9 7.4 7.7 Retained earnings 3.4 2.9 4.9 2.6 3.5 Book value, end of year 66.1 69.0 73.9 76.5 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% of start-of-year book value. Breezeway descendants who needed (or just wanted) more cash to recommend that Prairie Home Stores "go public"-and before that spend could sell off part of their holdings. Others with more inter- decision he had to know what the company was worth. est in the business could hold on to their shares and be rewarded by The next morning, he rode thoughtfully to work. He left his higher future earnings and stock prices. horse at the south corral and ambled down the dusty street to Mike But if Prairie Home did go public, what should its shares sell Gordon's Saloon, where Francine Firewater, the company's CFO, for? Mr. Breezeway worried that shares would be sold, either by was having her usual steak-and-beans breakfast. He asked Ms. Fire- Breezeway family members or by the company itself, at too low a water to prepare a formal report to Prairie Home stockholders, price. One relative was about to accept a private offer for $200, the valuing the company on the assumption that its shares were pub- current book value per share, but Mr. Breezeway had intervened licly traded. and convinced the would-be seller to wait. Ms. Firewater asked two questions immediately. First, what Prairie Home's value depended not just on its current book should she assume about investment and growth? Mr. Breezeway value or earnings but on its future prospects, which were good. One suggested two valuations, one assuming more rapid expansion (as financial projection (shown in the top panel of Table 7.7) called for in the top panel of Table 7.7) and another just projecting past growth in earnings of more than 100% by 2030. Unfortunately, this growth (as in the bottom panel of Table 7.7). plan would require reinvestment of all of Prairie Home's earnings Second, what rate of return should she use? Mr. Breezeway said from 2024-2027. After that, the company could resume its normal that 15%, Prairie Home's usual return on book equity, sounded dividend payout and growth rate. Mr. Breezeway believed this plan right to him, but he referred her to an article in the Journal of was feasible. Finance indicating that investors in rural supermarket chains, with He was determined to step aside for the next generation of top risks similar to Prairie Home Stores, expected to earn about 11% management. But before retiring, he had to decide whether to on average. TABLE 7.7 Financial projections for Prairie Home Stores, 2024-2029 (figures in millions) 2024 2025 2026 2027 2028 2029 Rapid-Growth Scenario Book value, start of year $80 $ 92.0 $105.8 $121.7 $139.9 $146.9 Earnings 12 13.8 15.9 18.3 21.0 22.0 Dividends 0 14.0 14.7 Retained earnings 12 13.8 15.9 18.3 7.0 7.4 Book value, end of year 92 105.8 121.7 139.9 146.9 154.3 Constant-Growth Scenario Book value, start of year $80 $84.0 $88.2 $92.6 $ 97.2 $102.1 Earnings 12 12.6 13.2 13.9 14.6 15.3 Dividends 8 8.4 8.8 9.3 9.7 10.2 Retained earnings 4 4.2 4.4 4.6 4.9 5.1 Book value, end of year 84 88.2 92.6 97.2 102.1 107.2 Notes; 1, Both panels assume earnings equal to 15% of start-of-year book value. This profitability rate is constant. 2. The top panel assumes all earnings are reinvested from 2024-2027. In 2028 and later years, two-thirds of earnings are paid out as dividends and one-third reinvested. 3. The bottom panel assumes two-thirds of earnings are paid out as dividends in all years. 4. Columns may not add up because of rounding.MINICASE Terence Breezeway, the CEO of Prairie Home Stores, wondered Mr. Breezeway was proud of this record, although he wished what retirement would be like. It was almost 20 years to the day that Prairie Home could have grown more rapidly. He had passed since his uncle Jacob Breezeway, Prairie Home's founder, had up several opportunities to build new stores in adjacent counties. asked him to take responsibility for managing the company. Now it Prairie Home was still just a family company. Its common stock was time to spend more time riding and fishing on the old Lazy was distributed among 15 grandchildren and nephews of Jacob Beta Ranch. Breezeway, most of whom had come to depend on generous regular Under Mr. Breezeway's leadership, Prairie Home had grown dividends. The commitment to high dividend payout had reduced slowly but steadily and was solidly profitable. (Table 7.6 shows the earnings available for reinvestment and thereby constrained earnings, dividends, and book asset values for the last 5 years.) growth. Most of the company's supermarkets had been modernized, and its Mr. Breezeway believed the time had come to take Prairie brand name was well known. Home public. Once its shares were traded in the public market, the 18 The company traditionally paid out cash dividends equal to 10% of start-of-period book value. See Table 7.6