Principle of Corporate Finance

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 company’s 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 fiancé expansion.

George’s 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 company’s 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,...