Valuation of Ross-Simon Company

Part -1

Ross-Simons, Inc., a multi-channel retailer, is a private company opened its first retail store in Rhode Island in 1952. Its goal is to provide quality and luxury products at the most affordable prices possible.

The company offers CZ diamond, gemstone, and pearl jewelry categories; and gold, silver, platinum, and vintage jewelry. It provides products, such as bracelets, earrings, necklaces, rings, watches, and bridal jewelry. The company offers jewelry for men, women, and children. It serves customers through its retail stores in Atlanta, Georgia; Boston, Natick, and Chestnut Hill, Massachusetts; Durham, North Carolina; Paramus and Short Hills, New Jersey; Providence and Warwick, Rhode Island; Raleigh, North Carolina; and Stamford, Connecticut and online stores. It also has outlets in Potomac Mills, Virginia; and Wrentham, Massachusetts Today, Ross-Simons is a thriving multi-channel retailer. In addition to its web presence, it mails more than 50 million catalogs annually across the globe and operate our flagship store in Warwick, RI.

The Company operates its retail stores in Atlanta, Georgia; Boston, Natick, and Chestnut Hill, Massachusetts; Durham, North Carolina; Paramus and Short Hills, New Jersey; Providence and Warwick, Rhode Island; Raleigh, North Carolina; and Stamford, Connecticut. It also has outlets in Potomac Mills, Virginia; and Wrentham, Massachusetts (Bloomberg).

Ross-Simon Company had sales of $630 million in 2018. The Company expects its sales to grow at 28% rate in 2019, but that this growth rate will drop slowly by 4% per year to a long-run growth rate for the industry of 4% by 2025.

Ross-Simon has been profitable, and it expects its EBIT to be 10% of sales, increases in net working capital requirements to be 8% of any increase in sales. Its capital investment is 6% of sales and depreciation expense is 3% of sales. The company plans to finance its capital investment of the first two years with $100 million debt with interest rate of 8% and continuing to finance the future investment annually. The company has estimated its stock price, under executive incentive stock option plans, to be $30.00 per share. The $30 value was calculated by using the industry multiple-of-earnings approach (shown below), common in the retail industry.

Ross-Simon has $125 million in cash and the unlevered cost of equity of 14%. The company has 25 million shares outstanding with a tax rate of 21%.

1. What is the weighted average cost of capital of the company? Hint you need to calculate the levered cost of equity to get WACC.
2. What is your estimate of the value of Ross-Simons stock in early 2019?
3. What is the value of equity and price per share?
4. Use adjusted present value (APV) to estimate price per share.

Steps for valuation Based on Adjusted Present Value.

When the capital structure is changing, as in many mergers, the WACC changes from year-to-year and it is difficult to apply the corporate valuation model in these cases. The APV model works better when the capital structure is changing. The steps are:

1. Using projected sales calculate the free cash flows (FCF) until it reaches its expected constant growth rate.
2. Calculate the unlevered cost of equity, R_EU
3. Calculate the pre-tax weighted average cost of capital, WACC=R_d D/V + R_EU E/V
4. Find the present value of FCF.
5. Project the terminal (horizon) value with the constant growth rate and estimate its present value.
6. Add the two values to get the unlevered value of the firm.
7. Calculate the interest tax shield for the entire period.
8. Find its present value using unlevered cost of equity.
9. Calculate terminal (horizon) value of tax shields using the constant growth rate.
10. Find the terminal value of the tax shield and its present value.
11. Calculate enterprise value as the sum of the unlevered value and the tax shield value.

Part 2

Assume the unlevered beta of the company is 1.5, risk-free rate of 5% and MRP of 6%. Repeat the questions 1-4 again.

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