Assignment:
1.  Provide a detailed analysis of the share price if Prairie Home
Stores were to go public.
2.  What should she (the CEO) assume about investment and growth based
on the scenario below?
3.  What rate of return should she use?  

Scenario
    Terrance 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?s had grown slowly
but steadily and was solidly profitable.  (Table 5.6 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 common stock was distributed
among 15 grandchildren and nephews of Jacob Breezeway, most of who had
to come to depend on generous regular dividends.  The commitment to
high dividend payout had reduced the earnings available for
reinvestment and thereby constrained growth.
    Mr. Breezeway believes 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 of part of their holdings.  Others with more interest in
the business could hold on to their shares and be rewarded by future
earnings and stock prices.
    But if Prairie Home did not go public, what should it shares sell
for?  Mr. Breezeway family members or by the company itself, at too of
a price.  One relative was about to accept a private offer for $200,
the current book value per share, but Mr. Breezeway had intervened and
convinced the would-be seller to wait.
    Prairie Home?s value did not just depend on its current book value
earnings, but its future prospects, which were good.  One financial
projection  (shown in the top panel of Table 5.7) called for growth in
earnings of over 100 percent by 2011.  Unfortunately this plan would
require reinvestment of all of Prairie Home?s earnings from 2006 to
2010.  After that company could resume its normal dividend payout and
growth rate.  Mr. Breezeway believed this plan was feasible.
    He was determined to step aside for the next generation of top
management. But before retiring he had to decide whether to recommend
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 horse
at the south corral and ambled down the dusty street to Mike?s
Gordon?s saloon, where Francine Firewater, the company?s CFO, was
having her usual steak-and-beans breakfast.  He asked Ms. Firewater to
prepare a formal report to Prairie Home stockholders, valuing the
company on the assumption that its shares were publicly traded.
    Ms. Firewater asked two questions immediately.  First, what should
she assume about investment and growth?  Mr. Breezeway suggested two
valuations, one assuming more rapid expansion as in the top panel of
Table 5.7) and another just projecting past growth as in the bottom of
Table 5.7).
    Second, ?what rate of return should she use?  Mr. Breezeway said
that 15 percent, 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 chains, with
risks similar to Prairie Home Stores, expected to earn about 11
percent on average.
Table 5.6

Financial data for Prairie Home Stores, 2000-2004 (figures in millions)

	2000	2001	2002	2003	2004
Book value, start of year 	$62.7	66.1	69.0	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	$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 $40,000 common shares.
2.	The company?s policy is to pay cash dividends equal to 10 percent
of start-of-year book value.
 
The company traditionally paid out cash dividends equal to 10 percent
of start-of- period book value.  See table 5.6.


Table 5.7

Financial projections for Prairie Home Stores, 2005-2010 (figures in millions)

	2005	2006	2007	2008	2009	2010
Rapid-Growth Scenario
						
Book value, start of year	80	92	105.8	121.7	139.9	146.9
Earnings	12	13.8	15.9	18.3	21.0	22.0
Dividends	0	0	0	0	14	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	140.0	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
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 percent of start-of-year
book value. This profitability rate is constant.
2.	The top panel assumes all earnings are reinvested from 2005 to
2009.  In 2010 and later years, two-thirds of earnings are paid out as
dividends and one-third reinvested.
3.	The bottom panel assumes two-third of earnings are paid out as
dividends in all years.
4.	Columns may not add up because of rounding.