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    Using Initial Public Offering

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    Value a privately held company that plans to go public with an Initial Public Offering (IPO). The valuation will provide necessary information to price the IPO.

    Helen Troy started a Teabucks teashop in Troy, Michigan a few years ago. She formed a corporation, and owned all the shares of this corporation. She played various roles as the CEO and a cashier. Fortunately for Helen her teashop became very popular and her firm grew at a very rapid pace. She expanded her business to all the big cities. She added more staff and even hired a MBA graduate from the University of Michigan. The firm has negligible debt, and all the growth has been financed with equity. The stock was owned by only a few individuals and hence a privately held corporation. Therefore no market price has been established for the stock. Now she wants to expand into tea packaging and tea bottling operations, which require large investment outlays. So Helen decided to take her company public. Valuation of a privately held firm requires:

    1. An understanding of the PE ratio and its use in valuation

    2. An understanding of discounted cash flow methods and their application in valuation

    3. Using the growth rate to estimate future cash flows

    4. Using CAPM to calculate the discount rate using value from a proxy firm

    5. Knowledge of financial markets and the registration procedure for issuing securities to the public

    6. Knowledge of the Internet and how new securities can be issued through the Internet

    Perform the valuation using the P/E, Price/Sales, and Price/Cash Flow ratios. The data for the valuation is as follows:

    Valuation using P/E, Price/Sales, and Price/Cash Flow Ratio:

    Teabucks Income statement (in $Million and rounded to nearest million)

    Total Revenue 750
    Costs of goods sold 575
    Gross profit 175
    Selling and Administrative expenses 40
    Depreciation / Amortization 45
    Other expenses 25
    Income before taxes (EBIT) 65
    Taxes (38%) 25
    Net Income 40

    Industry Average Starbucks
    P/E Ratio 35 52
    Price / Sales Ratio 2.0 3.75
    Price / cash Flow 20 28

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    Solution Summary

    Valuation is performed using P/E, Price/Sales, and Price/Cash Flow ratios.