Chapter 4

M I N I C A S E
Reeby Sports
Ten years ago, in 1990, George Reeby founded a small mail-order
company selling high-quality sports equipment. Reeby Sports has grown
steadily and been consistently profitable (see Table 4.6). The company
has no debt and the equity is valued in the companys books at nearly $41
million (Table 4.7). It is still wholly owned by George Reeby.
George is now proposing to take the company public by the sale of
90000 of his existing shares. The issue would not raise any additional
cash for the company, but it would allow George to cash in on part of his
investment. It would also make it easier to raise the substantial capital
sums that the firm would later need to fianc expansion.
Georges business has been mainly in the East coast of the United
States, but he plans to expand into the Midwest in 2002. This will require
a substantial investment in new warehouse space and inventory. George is
aware that it will take time to build up a new customer base, and in the
meantime there is likely to be a temporary dip in profits. However, if the
venture is successful, the company should be back to its current 12
percent return on book equity by 2007.
George settled down to estimate what his shares are worth. First he
estimates the profits and investment through 2007(Table 4.8 and 4.9). The
companys net working capital includes a growing proportion of cash and
marketable securities which would help to meet the cost of the expansion
into the Midwest. Nevertheless, it seemed likely that the company would
needs to raise about $4.3 million in 2002 by the sale of new shares.
(George distrusted banks and was not prepared to borrow to finance the
expansion.)
Until the new venture reached full profitability, dividend payments
would have to be restricted to conserve cash, but from 2007 onward
George expected the company to pay out about 40 percent of its net
profits. As a first stab at valuing the company, George assumed that after
2007 it would earn 12 percent on book equity indefinitely and that the
cost computed a more conservative valuation, which recognized that the
mail-order sports business was likely to get increasingly competitive. He
also looked at the market valuation of comparable business on the West
coast, Molly Sports. Mollys shares were currently priced at 50 percent
above book value and were selling on a prospective price-earnings ratio
of 12 and a dividend yield of 3 percent.
George realized that a second issue of shares in 2002 would dilute his
holdings. He set about calculating the price at which these shares could
be issued and the number of shares that would need to be sold. That
allowed him to work out the dividends per share and to check his earlier
valuation by calculating the present value of the stream of per-share

dividends.
T A B L E 4. 6
Summary income data (figures in $millions)
1996
1997
1998
1999
2000
Gross profits
5.84
6.40
7.41
8.74
9.39
Depreciation
1.45
1.60
1.75
1.97
2.22
Pretax profits
4.38
4.80
5.66
6.77
7.17
Tax
1.53
1.68
1.98
2.37
2.51
After-tax profits 2.85
3.12
3.68
4.40
4.66
Note: Reeby Sports ha never paid a dividend and all the earnings have
been retained in the business.
T A B L E 4. 7
Summary balance sheet for year ending December 31 st (figures in
$millions)
ASSETS
LIABILITIES AND EQUITY
1999
2000
1999
2000
Cash & securities
3.12
3.61
Current Liabilities 2.90
3.20
Other current assets 15.08
16.93
Net fixed assets
20.75
23.38
Equity
36.05
40.71
Total
38.95
43.91
Total
38.95
43.91
T A B L E 4. 8
Forecasted profits and dividends (figures in $millions)
2001 2002 2003 2004 2005 2006 2007
Gross investment 10.47 11.87 7.74 8.40 9.95 12.67 15.38
Depreciation
2.40 3.10 3.12 3.17 3.26 3.44 3.68
Pretax profits
8.08 8.77 4.62 5.23 6.69 9.23 11.69
Tax
2.83 3.07 1.62 1.83 2.34 3.23 4.09
After-tax profits 5.25 5.70 3.00 3.40 4.35 6.00 7.60
Dividends
2.00 2.00 2.50 2.50 2.50 2.50 3.00
Retained profits 3.25 3.79 .50
.90 1.85 3.50 4.60
T A B L E 4. 9
Forecasted investment expenditures (figures in $millions)
2001
Gross investment in 4.26
fixed assets
Investments in net 1.39
working capital
Total
5.65

2002
10.50

2003
3.34

2004
3.65

2005
4.18

2006
5.37

2007
6.28

.60

.28

.41

.93

1.57

2.00

11.10

3.62

4.07

5.11

6.94

8.28