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# How to Solve the Reeby Sports Mini Case with Ease

## Reeby Sports Mini Case: A Comprehensive Guide to the Solution

If you are looking for a solution to the Reeby Sports mini case, you have come to the right place. In this article, we will walk you through the steps to forecast the dividend payments and estimate the value of the stock for Reeby Sports, a small mail-order company selling high-quality sports equipment founded by George Reeby in 2007.

## What is the Reeby Sports mini case?

The Reeby Sports mini case is a fictional scenario presented in the textbook Principles of Corporate Finance by Brealey, Myers and Allen. The case is designed to illustrate the concepts of dividend policy, growth rate, return on equity, and valuation. The case provides some basic data on the company's profitability, such as earnings per share, return on equity, payout ratio, and dividends. The case also gives some information about the company's competitor, Molly Sports, which has a higher price-to-earnings ratio than Reeby Sports.

## What is the problem statement?

The problem statement of the case is as follows: George Reeby, the founder and owner of Reeby Sports, is considering taking the company public to improve the firm's ability to raise capital and to cash in on part of his investment. He wants to know how much the shares are worth and asks his daughter Jenny, who works in an investment bank, for help. Jenny needs to forecast the dividend payments for Reeby Sports and estimate the value of the stock. She does not need to provide a single figure, but can calculate two figures based on different assumptions about the duration of the growth opportunity for Reeby Sports.

## What are the assumptions?

The assumptions that Jenny can make are as follows:

• The cost of capital for Reeby Sports is 10%.

• The company has issued 2 million shares, all of which are owned by George Reeby and his five children.

• The company has a stable return on equity (ROE) of 15%.

• The company has a stable payout ratio of 40%.

• The company can grow steadily at a rate equal to its retention ratio times its ROE for six or eight years.

• After six or eight years, the growth opportunity disappears and the company becomes a mature firm with zero growth.

• The price-to-earnings ratio of Reeby Sports converges to that of Molly Sports (13.1) when the growth opportunity disappears.

## How to forecast the dividend payments?

To forecast the dividend payments for Reeby Sports, we need to use the following formula:

DIVt = EPSt x Payout ratiot

where DIVt is the dividend per share in year t, EPSt is the earnings per share in year t, and Payout ratiot is the fraction of earnings paid out as dividends in year t.

We can use the data given in the case to calculate the dividend payments for Reeby Sports from 2011 to 2020. For example, for 2011, we have:

DIV2011 = EPS2011 x Payout ratio2011

DIV2011 = \$2.03 x 0.394

DIV2011 = \$0.80

We can repeat this process for the other years and obtain the following table:

YearEarnings per share (EPS)Payout ratioDividends per share (DIV)

2011\$2.030.394\$0.80

2012\$2.160.300\$0.65

2013\$2.390.300\$0.72

2014\$2.640.300\$0.79

2015\$2.910.300\$0.87

2016\$3.220.300\$0.97

2017\$2.370.300\$0.71

2018\$2.540.300\$0.76

2019\$2.720.300\$0.81

2020\$2.910.300<t

## How to estimate the value of the stock?

To estimate the value of the stock for Reeby Sports, we need to use the following formula:

P0 = PV(DIV1 + DIV2 + ... + DIVn) + PV(Pn)

where P0 is the current stock price, DIVt is the dividend per share in year t, Pn is the stock price in year n, and PV stands for present value.

We can use the data given in the case and the dividends forecasted in the previous step to estimate the value of the stock for Reeby Sports under two scenarios: one assuming that the growth opportunity disappears after six years (n = 6), and another assuming that it disappears after eight years (n = 8).

### Scenario 1: Growth opportunity disappears after six years (n = 6)

In this scenario, we need to calculate the present value of the dividends from 2011 to 2016 and the present value of the stock price in 2016. To calculate the stock price in 2016, we need to use the following formula:

P6 = EPS6 x P/E ratio6

where EPS6 is the earnings per share in 2016 and P/E ratio6 is the price-to-earnings ratio in 2016.

We can use the data given in the case to calculate these values. For example, for EPS6, we have:

EPS6 = ROE6 x BVPS5

EPS6 = 0.15 x \$19.43

EPS6 = \$2.91

We can repeat this process for P/E ratio6, using the assumption that it converges to that of Molly Sports (13.1). Therefore, we have:

P/E ratio6 = 13.1

P6 = EPS6 x P/E ratio6

P6 = \$2.91 x 13.1

P6</sub

P6 = \$38.11

Now we can calculate the present value of the dividends from 2011 to 2016 and the present value of the stock price in 2016, using the cost of capital of 10% as the discount rate. For example, for DIV2011, we have:

PV(DIV2011) = DIV2011 / (1 + r)

PV(DIV2011) = \$0.80 / (1 + 0.10)

PV(DIV2011) = \$0.73

We can repeat this process for the other dividends and the stock price in 2016 and obtain the following table:

YearDividends per share (DIV)Present value of dividends (PV)

2011\$0.80\$0.73

2012\$0.65\$0.54

2013\$0.72\$0.54

2014\$0.79\$0.53

2015\$0.87\$0.52

2016\$0.97 + \$38.11 = \$39.08\$22.18

Total PV of dividends and stock price in 2016:\$24.54

Therefore, the value of the stock for Reeby Sports under this scenario is \$24.54 per share.

### Scenario 2: Growth opportunity disappears after eight years (n = 8)

In this scenario, we need to calculate the present value of the dividends from 2011 to 2018 and the present value of the stock price in 2018. To calculate the stock price in 2018, we need to use the same formula as before:

P8 = EPS8 x P/E ratio8

We can use the data given in the case to calculate these values. For example, for EPS8, we have:

EPS8 = ROE8 x BVPS7

EPS8 = 0.15 x \$23.72

EPS8 = \$3.56

We can repeat this process for P/E ratio8, using the same assumption as before. Therefore, we have:

P/E ratio8 = 13.1

P8 = EPS8 x P/E ratio8

P8 = \$3.56 x 13.1

P8 = \$46.64

Now we can calculate the present value of the dividends from 2011 to 2018 and the present value of the stock price in 2018, using the same discount rate as before. For example, for DIV2011, we have:

PV(DIV2011) = DIV2011 / (1 + r)

PV(DIV2011) = \$0.80 / (1 + 0.10)

PV(DIV2011) = \$0.73

We can repeat this process for the other dividends and the stock price in 2018 and obtain the following table:

YearDividends per share (DIV)Present value of dividends (PV)

2011\$0.80\$0.73

2012\$0.65\$0.54

2013\$0.72\$0.54

2014\$0.79\$0.53

2015\$0.87\$0.52

2016\$0.97\$0.51

2017\$0.71\$0.34

2018\$0.76 + \$46.64 = \$47.40

PV(DIV2018) = DIV2018 / (1 + r)

PV(DIV2018) = \$47.40 / (1 + 0.10)

PV(DIV2018) = \$20.24

2018\$47.40\$20.24

Total PV of dividends and stock price in 2018:\$23.41

Therefore, the value of the stock for Reeby Sports under this scenario is \$23.41 per share.

## How to compare the two scenarios and choose the best one?

To compare the two scenarios and choose the best one, we need to consider the following factors:

• The value of the stock under scenario 1 (\$24.54) is slightly higher than under scenario 2 (\$23.41). This means that the market would prefer a shorter growth period with a higher dividend payout ratio than a longer growth period with a lower dividend payout ratio.

• The value of the stock under both scenarios is significantly higher than the book value of the equity (\$13.17). This means that the company has a positive net present value of its future investments and that it can create value for its shareholders by reinvesting its earnings.

• The value of the stock under both scenarios is lower than the market valuation of Molly Sports (\$38.11), which has a higher P/E ratio and a lower dividend yield than Reeby Sports. This means that Reeby Sports is undervalued compared to its competitor and that it has a potential for growth and appreciation in the market.

Based on these factors, we can conclude that scenario 1 is more favorable than scenario 2, and that Reeby Sports should go public with a price of \$24.54 per share.

## Conclusion

In this article, we have performed a financial analysis and valuation of Reeby Sports, a small mail-order company selling high-quality sports equipment. We have used the dividend discount model to estimate the value of the stock under two scenarios, one assuming that the growth opportunity disappears after six years and another assuming that it disappears after eight years. We have found that the value of the stock under scenario 1 (\$24.54) is slightly higher than under scenario 2 (\$23.41), and that both values are higher than the book value of the equity (\$13.17) and lower than the market valuation of Molly Sports (\$38.11). We have concluded that scenario 1 is more favorable than scenario 2, and that Reeby Sports should go public with a price of \$24.54 per share.

https://www.primeawardsja.com/group/prime-awards-ja-group/discussion/12902bde-e36d-4e87-a2f4-2e922536d1e5

https://www.premaura.com/group/mysite-231-group/discussion/807e3c63-3cd6-49ac-b67e-54fd8d06fee3