Answered: TABLE 7.7 Financlal projections for…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Transcribed Image Text:Terence Breczoway, the CEO of Prairic Home Stores, wondered what retirement would be like. It was almost 20 years to the day or camings but on its future prospects, which were good. One finan- 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 require reinvestment of all of Prairie Home's carmings from 2016 to Prairic Home's value depended not just on its current book value cial projection (shown in the top panel of Table 7.7) called for growth in carnings of over 100% by 2022. Unfortunately, this plan would 2019. After that the company could resume its normnl dividend pay- out and growth rate. Mr. Breezeway believed this plan was feasible. He was determined to step aside for the next generation of top Beta Ranch. Under Mr. Breezeway's leadership Prairie Home had grown slowly but steadily and was solidly profitable. (Table 7.6 shows carnings, dividends, and book asset values for the last 5 years.) manngement. But before retiring, he had to decide whether to rec- Most of the company's supermarkets had been modernized and its ommend that Prairie Home Stores "go public"-and before that decision he had to know what the company was worth. The next morning he rode thoughtfully to work. He left his brand name was well known. Mr. Breczeway was proud of this record, although he wished that Prairic Home could have grown more rapidly. He had passed horse at the south corral and ambled down the dusty street to Mike 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 Breczewny, most of whom had come to depend on generous regu- lar dividends. The commitment to high dividend payoutl6 had reduced the earnings 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 marketL the Breczeway descendants who nceded (or just wanted) more cash to spend could sell off part of their holdings. Others with more inter- est in the business could hold on to thcir 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. Breczeway worried that shares would be sold, either by Breczeway family mcmbers or by the company itself, at too low a price. One relative was about to accept a private offer for $200, the current book valuc per share, but Mr. Breczeway had intervened and convinced the would-be seller to wait. Gordon's Saloon, where Francine Firewater, the company's CFO, was having her usunl steak-and-beans breakfast. He asked Ms. Firewater to prepare a formal report to Prairic Home stockholders, valuing the company on the assumption that its shares were pub- licly traded Ms. Firewater asked two questions immediately. First, what should she assume about investment and growth? Mr. Breezeway suggested two valuations, one asouming 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). Second, what rate of return should she use? Mr. Breezeway 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 Finance indicating that investors in rural supermarket chnins, with risks similar to Prairie Home Stores, expected to carn about 11% on average. 16 The company traditionally paid out cash dividends cqual to 10% of start- of-period book value. Sec Table 7.6. TABLE 7.6 Flnanclal data for Prairio Home Stores, 2011-2015 (figures in millions) 2011 2012 2013 2014 2015 Book value, start of yoar $62.7 $66.1 S69.0 $73.9 $76.5 Earnings 9.7 9.5 11.8 11.0 11.2 Dividends 6.3 6.6 6.9 7.4 7.7 Retained earnings Book value, end of year 3.4 2.9 4.9 2.6 3.5 66.1 69.0 73.9 76.5 80.0 Notos: 1 Prairio Homo Storos has 400,000 common shares. 2 Tho company's policy is to pay cash dividonds equal to 10% of start-of-year book value.

TABLE 7.7 Financlal projoctions for Prairie Home Stores, 2016-2021 (figures in millions)
2016
2017
2018
2019
2020
2021
Rapid-Growth Scenario
Book valuo, start of year
S80
$ 92
$105.8
$121.7
$139.9
$146.9
Earnings
12
13.8
15.9
18.3
21.0
22.0
14
14.7
Dividonds
12
13.8
15.9
18.3
7.0
7.4
Rotainod earnings
Book value, and of yoar
92
105.8
121.7
139.9
146.9
154.3
Constant-Growth Scenario
Book value, start of year
$80
$84
$88.2
$92.6
$ 97.2
$102.1
Earnings
12
12.6
13.2
13.9
14.6
15.3
Dividonds
8.
8.4
8.8
9.3
9.7
10.2
Rotainod 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
Notos:
1 Both panels assumo oarnings oqual to 15% of start-of-yoar book valuo. This proftability rato is constant.
2 Tho top panol assumos afl carnings aro reinvosted from 2016 to 2019. In 2020 and lator yoars, two-thirds of oarnings aro paid
out as dividends and one-third roinvosted.
3. Tho botlom panel assumos two-thirds of oarnings aro paid out as dividends in all yoars.
4. Columna may not add up bocauso of rounding.

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