Terence Breczoway, the CEO of Prairic Home Stores, wonderedwhat retirement would be like. It was almost 20 years to the day or camings but on its future prospects, which were good. One finan-since his uncle Jacob Breezeway, Prairie Home's founder, hadasked him to take responsibility for managing the company. Now itwas time to spend more time riding and fishing on the old Lazy require reinvestment of all of Prairie Home's carmings from 2016 toPrairic Home's value depended not just on its current book valuecial projection (shown in the top panel of Table 7.7) called for growthin carnings of over 100% by 2022. Unfortunately, this plan would2019. After that the company could resume its normnl dividend pay-out and growth rate. Mr. Breezeway believed this plan was feasible.He was determined to step aside for the next generation of topBeta Ranch.Under Mr. Breezeway's leadership Prairie Home had grownslowly but steadily and was solidly profitable. (Table 7.6 showscarnings, dividends, and book asset values for the last 5 years.) manngement. But before retiring, he had to decide whether to rec-Most of the company's supermarkets had been modernized and itsommend that Prairie Home Stores "go public"-and before thatdecision he had to know what the company was worth.The next morning he rode thoughtfully to work. He left hisbrand name was well known.Mr. Breczeway was proud of this record, although he wishedthat Prairic Home could have grown more rapidly. He had passed horse at the south corral and ambled down the dusty street to Mikeup several opportunities to build new stores in adjacent counties.Prairie Home was still just a family company. Its common stockwas distributed among 15 grandchildren and nephews of JacobBreczewny, most of whom had come to depend on generous regu-lar dividends. The commitment to high dividend payoutl6 hadreduced the earnings available for reinvestment and thereby con-strained growth.Mr. Breezeway believed the time had come to take PrairieHome public. Once its shares were traded in the public marketL theBreczeway descendants who nceded (or just wanted) more cash tospend could sell off part of their holdings. Others with more inter-est in the business could hold on to thcir shares and be rewarded byhigher future earnings and stock prices.But if Prairie Home did go public, what should its shares sellfor? Mr. Breczeway worried that shares would be sold, either byBreczeway family mcmbers or by the company itself, at too low aprice. One relative was about to accept a private offer for $200, thecurrent book valuc per share, but Mr. Breczeway had intervenedand convinced the would-be seller to wait.Gordon's Saloon, where Francine Firewater, the company's CFO,was having her usunl steak-and-beans breakfast. He asked Ms.Firewater to prepare a formal report to Prairic Home stockholders,valuing the company on the assumption that its shares were pub-licly tradedMs. Firewater asked two questions immediately. First, whatshould she assume about investment and growth? Mr. Breezewaysuggested two valuations, one asouming more rapid expansion (asin the top panel of Table 7.7) and another just projecting pastgrowth (as in the bottom panel of Table 7.7).Second, what rate of return should she use? Mr. Breezeway saidthat 15%, Prairie Home's usual return on book equity, soundedright to him, but he referred her to an article in the Journal ofFinance indicating that investors in rural supermarket chnins, withrisks similar to Prairie Home Stores, expected to carn about 11%on average.16 The company traditionally paid out cash dividends cqual to 10% of start-of-period book value. Sec Table 7.6.TABLE 7.6 Flnanclal data for Prairio Home Stores, 2011-2015 (figures in millions)20112012201320142015Book value, start of yoar$62.7$66.1S69.0$73.9$76.5Earnings9.79.511.811.011.2Dividends6.36.66.97.47.7Retained earningsBook value, end of year3.42.94.92.63.566.169.073.976.580.0Notos:1 Prairio Homo Storos has 400,000 common shares.2 Tho company's policy is to pay cash dividonds equal to 10% of start-of-year book value. TABLE 7.7 Financlal projoctions for Prairie Home Stores, 2016-2021 (figures in millions)201620172018201920202021Rapid-Growth ScenarioBook valuo, start of yearS80$ 92$105.8$121.7$139.9$146.9Earnings1213.815.918.321.022.01414.7Dividonds1213.815.918.37.07.4Rotainod earningsBook value, and of yoar92105.8121.7139.9146.9154.3Constant-Growth ScenarioBook value, start of year$80$84$88.2$92.6$ 97.2$102.1Earnings1212.613.213.914.615.3Dividonds8.8.48.89.39.710.2Rotainod earnings44.24.44.64.95.1Book value, end of year8488.292.697.2102.1107.2Notos:1 Both panels assumo oarnings oqual to 15% of start-of-yoar book valuo. This proftability rato is constant.2 Tho top panol assumos afl carnings aro reinvosted from 2016 to 2019. In 2020 and lator yoars, two-thirds of oarnings aro paidout as dividends and one-third roinvosted.3. Tho botlom panel assumos two-thirds of oarnings aro paid out as dividends in all yoars.4. Columna may not add up bocauso of rounding.

Question

Terence Breczoway, the CEO of Prairic Home Stores, wonderedwhat retirement would be like. It was almost 20 years to the day or camings but on its future prospects, which were good. One finan-since his uncle Jacob Breezeway, Prairie Home's founder, hadasked him to take responsibility for managing the company. Now itwas time to spend more time riding and fishing on the old Lazy require reinvestment of all of Prairie Home's carmings from 2016 toPrairic Home's value depended not just on its current book valuecial projection (shown in the top panel of Table 7.7) called for growthin carnings of over 100% by 2022. Unfortunately, this plan would2019. After that the company could resume its normnl dividend pay-out and growth rate. Mr. Breezeway believed this plan was feasible.He was determined to step aside for the next generation of topBeta Ranch.Under Mr. Breezeway's leadership Prairie Home had grownslowly but steadily and was solidly profitable. (Table 7.6 showscarnings, dividends, and book asset values for the last 5 years.) manngement. But before retiring, he had to decide whether to rec-Most of the company's supermarkets had been modernized and itsommend that Prairie Home Stores &#34;go public&#34;-and before thatdecision he had to know what the company was worth.The next morning he rode thoughtfully to work. He left hisbrand name was well known.Mr. Breczeway was proud of this record, although he wishedthat Prairic Home could have grown more rapidly. He had passed horse at the south corral and ambled down the dusty street to Mikeup several opportunities to build new stores in adjacent counties.Prairie Home was still just a family company. Its common stockwas distributed among 15 grandchildren and nephews of JacobBreczewny, most of whom had come to depend on generous regu-lar dividends. The commitment to high dividend payoutl6 hadreduced the earnings available for reinvestment and thereby con-strained growth.Mr. Breezeway believed the time had come to take PrairieHome public. Once its shares were traded in the public marketL theBreczeway descendants who nceded (or just wanted) more cash tospend could sell off part of their holdings. Others with more inter-est in the business could hold on to thcir shares and be rewarded byhigher future earnings and stock prices.But if Prairie Home did go public, what should its shares sellfor? Mr. Breczeway worried that shares would be sold, either byBreczeway family mcmbers or by the company itself, at too low aprice. One relative was about to accept a private offer for $200, thecurrent book valuc per share, but Mr. Breczeway had intervenedand convinced the would-be seller to wait.Gordon's Saloon, where Francine Firewater, the company's CFO,was having her usunl steak-and-beans breakfast. He asked Ms.Firewater to prepare a formal report to Prairic Home stockholders,valuing the company on the assumption that its shares were pub-licly tradedMs. Firewater asked two questions immediately. First, whatshould she assume about investment and growth? Mr. Breezewaysuggested two valuations, one asouming more rapid expansion (asin the top panel of Table 7.7) and another just projecting pastgrowth (as in the bottom panel of Table 7.7).Second, what rate of return should she use? Mr. Breezeway saidthat 15%, Prairie Home's usual return on book equity, soundedright to him, but he referred her to an article in the Journal ofFinance indicating that investors in rural supermarket chnins, withrisks similar to Prairie Home Stores, expected to carn about 11%on average.16 The company traditionally paid out cash dividends cqual to 10% of start-of-period book value. Sec Table 7.6.TABLE 7.6 Flnanclal data for Prairio Home Stores, 2011-2015 (figures in millions)20112012201320142015Book value, start of yoar$62.7$66.1S69.0$73.9$76.5Earnings9.79.511.811.011.2Dividends6.36.66.97.47.7Retained earningsBook value, end of year3.42.94.92.63.566.169.073.976.580.0Notos:1 Prairio Homo Storos has 400,000 common shares.2 Tho company's policy is to pay cash dividonds equal to 10% of start-of-year book value. TABLE 7.7 Financlal projoctions for Prairie Home Stores, 2016-2021 (figures in millions)201620172018201920202021Rapid-Growth ScenarioBook valuo, start of yearS80$ 92$105.8$121.7$139.9$146.9Earnings1213.815.918.321.022.01414.7Dividonds1213.815.918.37.07.4Rotainod earningsBook value, and of yoar92105.8121.7139.9146.9154.3Constant-Growth ScenarioBook value, start of year$80$84$88.2$92.6$ 97.2$102.1Earnings1212.613.213.914.615.3Dividonds8.8.48.89.39.710.2Rotainod earnings44.24.44.64.95.1Book value, end of year8488.292.697.2102.1107.2Notos:1 Both panels assumo oarnings oqual to 15% of start-of-yoar book valuo. This proftability rato is constant.2 Tho top panol assumos afl carnings aro reinvosted from 2016 to 2019. In 2020 and lator yoars, two-thirds of oarnings aro paidout as dividends and one-third roinvosted.3. Tho botlom panel assumos two-thirds of oarnings aro paid out as dividends in all yoars.4. Columna may not add up bocauso of rounding.

Accepted Answer

price of a share is the present value of the dividends discounted at the required rate of return…