Problem:
Mr. David, founder and president of Heath Farm Company dealing in healthy dairy products, a profitable business and expanding rapidly, is wondering whether the company should make its first public offer of common stock and if so at what price. The company's financial performance over the past 5 years was as follows:
|
|
2008
|
2009
|
2010
|
2011
|
2012
|
|
Book value at beginning of year
|
48.80
|
51.00
|
53.30
|
55.81
|
58.99
|
|
Earnings
|
5.20
|
5.60
|
6.80
|
7.90
|
8.80
|
|
Dividends
|
3.00
|
3.30
|
4.29
|
4.72
|
5.19
|
|
Retained earnings
|
2.20
|
2.30
|
2.51
|
3.18
|
3.61
|
|
Book value at end of year
|
51.00
|
53.30
|
55.81
|
58.99
|
62.60
|
|
Notes: Farm Fresh has 200,000 common shares. The company attempts to maintain a dividend growth at 10% per year.
|
Mr. David foresees the company would be experiencing rapid growth over the next 3 years with the growing population getting more affluent and health conscious , and then settle down to moderate growth thereafter due to competitions. Financial forecasts in terms of earning s and dividends are as follows:
|
|
2013
|
2014
|
2015
|
2016
|
2017
|
|
Book value at beginning of year
|
62.60
|
66.50
|
71.40
|
77.40
|
84.00
|
|
Earnings
|
10.00
|
12.00
|
15.00
|
16.50
|
18.15
|
|
Dividends
|
6.00
|
7.20
|
9.00
|
9.90
|
11.89
|
|
Retained earnings
|
4.00
|
4.80
|
6.00
|
6.60
|
6.26
|
|
Book value at end of year
|
66.60
|
71.40
|
77.40
|
84.00
|
90.26
|
|
Notes: Forecasted rapid growth from 2010 to 2012 and thereafter constant growth of 10% per year. Assumes dividend payout at 60% of earnings.
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As his financial consultant, you are to lay out your recommendations in an informative manner for Mr. David, who is not well versed in investments and other financial techniques and aspects for his due consideration of listing his company public. Your valuation should also consider the followings conditions:
(i) In early 2013, Mr. David discovered that the company will not experience supernormal growth in 2013, 2014, and 2015 as expected, due to unforeseen economic circumstances. The perpetual growth rate will only be anticipated at 6% starting 2013. How much would the price difference be between the two calculations?
(ii) By adopting both discounted cash flow techniques and relative valuation techniques, which technique(s) give better IPO pricing for the company?
This question may require you to make certain assumptions. Please state these assumptions. You should also consider the value of any investment fundamentals, corporate finance techniques or theories that may be applicable in your valuation of a fair market price of its share for listing purpose.
Summary of problem:
This question basically belongs to Finance as well as the question explains about forecasting the market value of common shares as well as adopting discounted cash flow methods and relative valuation methods for IPO pricing.