Question

New Stock Issue

Bynum and Crumpton Inc. (B&C), a small jewelry manufacturer, has been successful and has enjoyed a positive growth trend. Now B&C is planning to go public with an issue of common stock, and it faces the problem of setting an appropriate price for the stock. The company and its investment banks believe that the proper procedure is to conduct a valuation and select several similar firms with publicly traded common stock and to make relevant comparisons.
Several jewelry manufacturers are reasonably similar to B&C with respect to product mix, asset composition, and debt/equity proportions. Of these companies, Abercrombe Jewelers and Gunter Fashions are most similar. When analyzing the following data, assume that the most recent year has been reasonably "normal" in the sense that it was neither especially good nor especially bad in terms of sales, earnings, and free cash flows. Abercrombe is listed on the AMEX and Gunter on the NYSE, while B&C will be traded in the Nasdaq market.

Company data	Abercrombe		Gunter		B&C
Shares outstanding	5 million		11 million		500,000
Price per share	$38.00		$50.00		NA
Earnings per share	$2.20		$3.13		$2.60
Free cash flow per share	$1.63		$2.54		$2.00
Book value per share	$17.00		$24.00		$20.00
Total assets	$120 million		$314 million		$12 million
Total debt	$35 million		$50 million		$2 million

B&C is a closely held corporation with only 500,000 shares outstanding. Free cash flows have been low and in some years negative due to B&C's recent high sales growth rates, but as its expansion phase comes to an end B&C's free cash flows should increase. B&C anticipates the following free cash flows over the next 5 years:

Year	1	2	3	4	5
FCF	1,000,000	1,050,000	1,208,000	1,329,000	1,462,000

After Year 5, free cash flow growth will be stable at 7% per year. Currently, B&C has no non-operating assets, and its WACC is 12%. Using the free cash flow valuation model, estimate B&C's intrinsic value of equity and intrinsic per share price. Round your answers for the value of equity to the nearest dollar and for the value of equity per share to the nearest cent.

Value of equity	$
Per share value of equity	$

Calculate debt to total assets, P/E, market to book, P/FCF, and ROE for Abercrombe, Gunter, and B&C. For calculations that require a price for B&C, use the per share price you obtained with the corporate valuation model in part a. Round your answers to two decimal places. Round ROE to one decimal place.

	Abercrombe		Gunter		B&C
D/A	%		%		%
P/E
Market/Book
ROE	%		%		%
P/FCF

Using Abercrombe's and Gunter's P/E, Market/Book, and Price/FCF ratios, calculate the range of prices for B&C's stock that would be consistent with these ratios. For example, if you multiply B&C's earnings per share by Abercrombe's P/E ratio you get a price. What range of prices do you get? Round your answers to the nearest cent.

The range of prices:
from $   to $   

Answer 1

1.

Calculation of present value of cash flows

Year	FCF	PV @ 12 %	Present value of Cash flows
1	$ 1,000,000	0.892857143	$ 892,857.1429
2	$ 1,050,000	0.797193878	$ 837,053.5714
3	$ 1,208,000	0.711780248	$ 859,830.5394
4	$ 1,329,000	0.635518078	$ 844,603.5262
5	$ 1,462,000	0.567426856	$ 829,578.0630
Total PV of CF			$ 4,263,922.8428

Present value of free cash flows for 5 years = 4,263,923

Since after year 5. cash flows will be growing by 7 % each year. We would use Growing Free Cash Flow Perpetuity Method for valuation.

Terminal value = FCF6/(WACC -g)

the cash flow for year 6 = 1,462,000 + (1,462,000 * 0.07) = $ 1,564,340

Therefore, Terminal Value = 1564340 / 0.12 - 0.07

                                      = $ 31,286.800

Now, the present value of Terminal Value is = $ 31,286.800 * PVIF 12 %, 5

                                                              = $ 31,286.800 * 0.567426856

                                                              = $ 17,752,971

Total Value of the Firm = $ 4,263,923 + $ 17,752,971

                                 = $ 22,016,894

Value of Equity = Total Value of firm less Total Value of Debt

                       = $ 22,016,894 - $ 2,000,000

Value of Equity = $ 20,016,894

Value of Equity per share = Value of Equity / shares outstanding

                                     = $ 20,016,894 / 500,000

                                     = $ 40.03

2.

Debt to Total Assets = Total Debts / Total Assets

Abercrombe

D/A = $ 35 million / $ 120 million = 0.2917

Gunter

D/A = $ 50 million / $ 314 million = 0.1592

B&C

D/A = $ 2 milllion / $ 12 million = 0.1667

Price Earning Ratio (PE) = Price Per Share / Earning Per Share

Abercrombe

P/E = 38/ 2.20 = 17.27

Gunter

P/E = 50 / 3.13 = 15.97

B&C

P/E = 40.03 / 2.60 = 15.40

Market to Book Ratio = Share Price / Net Book Value Per Share

Abercrombe

Market to Book Ratio = 38/17 = 2.24

Gunter

Market to Book Ratio = 50/24 = 2.08

B&C

Market to Book Ratio = 40.03 /20 = 2.00

Price to Free Cash Flow ratio (Price/FCF ratio) = Price Per Share / Free Cash Flow Per Share

Abercrombe

Price/FCF ratio = 38 /1.63 = 23.31

Gunter

Price/FCF ratio = 50 / 2.54 = 19.69

B & C

Price/FCF ratio = 40.03 / 2.00 = 20.00

3.

The Range of Prices of Price is from $ 39 to $ 47

Explanation

Using B&C's earnings per share Abercrombe's P/E ratio you get a price.

Share price = $ 2.60 * 17.27 = $ 45

Using B&C's earnings per share Gunter P/E ratio you get a price

Sharer price = $ 2.60 * 15.97 = $ 42

Using B&C's Net Book Value Per Share and Abercrombe's Market to Book Ratio

Share price = $ 20 * 2.24 = $ 45

Using B&C's Net Book Value Per Share and Gunter Market to Book Ratio

Share price = $ 20 * 2.08 = $ 42

Using B&C's Free cash flow per share and Abercrombe's Price / FCF ratio

Share price = 2 * 23.31 = $ 47

Share price = 2 * 19.69 = $ 39