Minicase Prairie Stores Essay

Custom Student Mr. Teacher ENG 1001-04 27 February 2016

Minicase Prairie Stores

What is the Rate of Return Percentage?

In the mini-case, Mr. Breezeway indicated two kinds of percentage to determine the required return. One of them is the companies’ return on book equity (% 15) and the other one is the investment return percentage in the rural supermarket industry (% 11) which shows that investors in rural supermarket chains, with risks similar to Prairie Home Stores, expected to earn about % 11 percent on average. Since the companies’ rate of return determined by the rate of return offered by other equally risky stocks, then it should be % 11. The Rapid Growth Scenario

Step 1: Being able to calculate the present value of the companies’ stocks, we should first calculate the present value of the companies’ dividends. Years 2016-2021= 0÷(1.11) + 0÷(1.11)2 +0÷(1.11)3 +0÷(1.11)4 +14÷(1.11)5 +14.7÷(1.11)6

= 8.31+7.86
= 16.17 $ Present value of the dividends between 2016-2021

Step 2 : In step 2, we should estimate the Prairie Stores’ stock price at the horizon year (2021), when growth rate has settled down. According to mini-case, after 2019 the company will resume its normal growth. Since the investment plan is going to continue 6 years, we should choose the year 2021 as a horizon year.

Growth rate: plowback ratio × return on equity (Given in the notes)

Plowback ratio = Retained earnings ÷ Earnings (2021)
= 7.4 million ÷ 22 million
= 0.33 % 33

Return on equity = Earnings ÷ Book value, start of the year (2021)
= 22 million ÷ 146.9 million
= 0.15 % 15

Growth rate = % 33 × % 15
= % 5

Div 2022 = 1.05 ×14.7P2021 = Dividend 2022 ÷ r – g
= 15.44 $ = 15.44 million ÷ 0.11- 0.05
= 257.33 million

Step 3 :Being able to find the present value of total stocks ( at the beginning of 2016), first we should discount the 2021 total stock value by 6 years and we should also add the present value of dividends to this amount.

P0 = 16.17 $ + 257.33 ÷ (1.11)6
= 153.75 million $

Present Value of the Stock Per share = 153.75 million ÷ 400,000 (Outstanding shares)
= 384.37 $
If the company did go public, its share price should be $384.37 for per share with the rapid growth scenario.

The Constant Growth Scenario:

Growth rate: plowback ratio × return on equity (Given in the notes)

Plowback ratio = Retained earnings ÷ Earnings (2016)
= 4/12
= % 33
Return on equity = Earnings ÷ Book value, start of the year (2016)
= 12 ÷ 80
= % 15

Growth rate = % 33 × % 15
= % 5

P0 = Div2016 ÷ r – g Per Share Value = 133.33 million ÷ 400,000 = 8 million ÷ 0.11 – 0.05 = 333.33 $
= 133.33 million

If the company did go public, its share price should be $333.33 for per share with the constant growth scenario.

Conclusion:

If I were Ms. Firewater, I would recommend the rapid growth scenario because with the rapid growth scenario the companies’ present per share value higher than it could have been with the constant rate scenario. In addition, this investment decision depends on shareholders’ opinion. As we know, some of the shareholders are dependent on the generous regular dividends. As a result, these shareholders might have not wanted to choose the rapid grow scenario. On the other hand, the shareholders who have more interest with the companies’ future stock value, will probably choose the rapid growth scenario.

Mr. Breezeway’s advise not to sell the companies’ per stock for $200 was right. Any price under $333.33 for per share will be not acceptable for me, if I am dependant on the dividend income. On the other hand, If I were not need the dividend income and want to sell my shares, I would not accept any price under $384.37 for per share.

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