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the Class B voting stock, controlled by the Blum family, was eliminated via a stock offering
this spring.
Looking ahead to ¬scal 1999 (and assuming a 33% tax rate), Black sees Maxwell earn-
ing $1.65 a share. Which works out to P/E of 7.3.
“That™s one third of the market multiple,” he stresses, “and for a company with a legiti-
mate 20% growth rate.”
Of course, shoe companies rarely command sexy multiples. But even putting a humble
P/E of 12 on Black™s estimate translates into a stock price of $20.
401
Prospective Analysis: Forecasting




10-27 Part 2 Business Analysis and Valuation Tools




EXHIBIT 2
Maxwell's Abridged Financial Statements

MAXWELL SHOE COMPANY, INC.”BALANCE SHEET ($ millions)

31-Oct-98 31-Oct-97 31-Oct-96
..................................................................................................................................................
Maxwell Shoe Company




Assets
Cash and cash equivalents 18.7 3.1 10.4
Accounts receivable, net 35.7 28.6 16.9
Inventory 22.9 20.1 12.2
Prepaid expenses 1.6 0.3 0.1
Deferred income taxes 1.1 1.5 0.8
Total Current Assets 80.0 53.6 40.4
Property, plant and equipment 8.7 3.0 2.5
Accumulated depreciation and amortization “2.5 “1.7 “1.5
Property plant and equipment, net 6.2 1.3 1.0
Trademarks and other assets, net 4.8 5.1 5.5
Total Assets 91.0 60.1 46.9

Liabilities
Accounts payable 3.8 2.2 0.9
Current portion of capital leases 0.1 0.1 0.1
Accrued expenses and other current liabilities 6.2 6.9 3.8
Total Current Liabilities 10.2 9.2 4.8
Capitalized lease obligations 0.2 0.3 0.5
Deferred taxes 1.3 0.0 0.0
Total Liabilities 11.7 9.5 5.3

Stockholders™ Equity
Common stock 0.1 0.1 0.1
Additional paid-in capital 43.0 27.3 27.3
Retained earnings 36.5 23.2 14.2
Deferred compensation “0.3 0.0 0.0
Total Shareholders™ Equity 79.3 50.6 41.6
Total Liabilities and Shareholders™ Equity 91.0 60.1 46.9
Shares outstanding 8.8 2.5 2.5
..................................................................................................................................................
Note: some numbers may not add up because of rounding errors.
402 Prospective Analysis: Forecasting




10-28
Prospective Analysis: Forecasting




MAXWELL SHOE COMPANY, INC.”ANNUAL INCOME STATEMENT ($ millions)

31-Oct-98 31-Oct-97 31-Oct-96
..................................................................................................................................................
Total sales 165.9 134.2 104.3
Cost of goods sold 121.0 98.2 79.9
Gross pro¬t 44.9 36.0 24.4




Maxwell Shoe Company
Selling expense 10.2 7.9 5.6
General and administrative expense 14.9 13.1 9.8
Total operating expenses 25.1 21.0 15.4
Interest expense “0.0 “0.1 “0.0
Other income-net 0.2 “0.3 0.6
Pretax income 20.0 14.6 9.6
Income taxes 6.6 5.5 3.6
Net income 13.4 9.1 6.0
Basic EPS 1.61 1.19 0.78
Shares to calculate basic EPS (millions) 8.2 7.6 7.6
Diluted EPS 1.44 1.06 0.72
Shares used to calculate diluted EPS (millions) 9.2 8.5 8.3
..................................................................................................................................................
Note: some numbers may not add up because of rounding errors.




MAXWELL SHOE COMPWANY, INC.”STATEMENT OF CASH FLOWS ($ millions)

31-Oct-98 31-Oct-97 31-Oct-96
..................................................................................................................................................
Net income 13.3 9.0 5.9
Depreciation 1.2 0.7 0.2
Deferred taxes 1.9 “0.7 0.2
Other noncash items 0.1 0.1 0.1
Changes in operating current assets and liabilities “9.7 “15.6 3.0
Cash from operations 6.8 “6.5 9.4
Capital expenditures “5.7 “0.7 “5.6
Cash from investing “5.7 “0.7 “5.6
Purchase or sale of stock 14.5 0.0 0.0
Payment of capital lease obligations “0.1 “0.1 “0.2
Cash from ¬nancing 14.4 “0.1 “0.2
Net change in cash 15.5 “7.3 3.6
Cash interest paid 0.0 0.1 0.0
Cash taxes paid 4.8 6.8 2.4
..................................................................................................................................................
403
Prospective Analysis: Forecasting




10-29 Part 2 Business Analysis and Valuation Tools




EXHIBIT 3
Maxwell Shoe Company, Inc.”Monthly Stock Price History

Month Month End Closing Price
...............................................................................
December 1998 10.938
November 1998 11.875
Maxwell Shoe Company




October 1998 11.750
September 1998 11.875
August 1998 13.125
July 1998 19.375
June 1998 19.875
May 1998 19.625
April 1998 17.750
March 1998 15.813
February 1998 15.750
January 1998 14.125

December 1997 10.750
November 1997 13.625
October 1997 13.125
September 1997 15.000
August 1997 11.000
July 1997 10.500
June 1997 12.250
May 1997 9.250
April 1997 8.250
March 1997 7.875
February 1997 7.625
January 1997 7.375

December 1996 6.625
November 1996 7.250
October 1996 6.625
September 1996 6.313
August 1996 6.125
July 1996 6.000
June 1996 7.750
May 1996 6.500
April 1996 5.000
March 1996 5.000
February 1996 5.000
January 1996 5.250
...............................................................................
Maxwell™s equity beta was estimated to be 0.81.
The yield on 30-year treasury bonds in December 1998 was approximately 5%.
Source: One Source Information Services, Inc.
11
11 P ro s p e c t ive An a lys i s : V a l u at i o n T h e or y
an d Co n c e pt s
chapter




T he previous chapter introduced forecasting, the ¬rst stage of prospec-
tive analysis. In this and the following chapter we describe the second and ¬nal stage of
prospective analysis, valuation. This chapter focuses on valuation theory and concepts,
and the following chapter discusses implementation issues.
Business Analysis and 2
Valuation Tools


Valuation is the process of converting a forecast into an estimate of the value of the
¬rm or some component of the ¬rm. At some level, nearly every business decision in-
volves valuation (at least implicitly). Within the ¬rm, capital budgeting involves consid-
eration of how a particular project will affect ¬rm value. Strategic planning focuses on
how value is in¬‚uenced by larger sets of actions. Outside the ¬rm, security analysts con-
duct valuation to support their buy/sell decisions, and potential acquirers (often with the
assistance of their investment bankers) estimate the value of target ¬rms and the syner-
gies they might offer. Valuation is necessary to price an initial public offering and to in-
form parties to sales, estate settlements, and divisions of property involving ongoing
business concerns. Even credit analysts, who typically do not explicitly estimate ¬rm
value, must at least implicitly consider the value of the ¬rm™s equity “cushion” if they
are to maintain a complete view of the risk associated with lending activity.
In practice, a wide variety of valuation approaches are employed. For example, in
evaluating the fairness of a takeover bid, investment bankers commonly use ¬ve to ten
different methods of valuation. Among the available methods are the following:
• Discounted dividends. This approach expresses the value of the firm™s equity as the
present value of forecasted future dividends.
• Discounted abnormal earnings. Under this approach the value of the firm™s equity
is expressed as the sum of its book value and discounted forecasts of “abnormal”
earnings.
• Valuation based on price multiples. Under this approach a current measure of per-
formance or single forecast of performance is converted into a value through appli-
cation of some price multiple for other presumably comparable firms. For example,
firm value can be estimated by applying a price-to-earnings ratio to a forecast of the
firm™s earnings for the coming year. Other commonly used multiples include price-
to-book ratios and price-to-sales ratios.
• Discounted cash flow (DCF) analysis. This approach involves the production of de-
tailed, multiple-year forecasts of cash flows. The forecasts are then discounted at
the firm™s estimated cost of capital to arrive at an estimated present value.


11-1




405
406 Prospective Analysis: Valuation Theory and Concepts




11-2
Prospective Analysis: Valuation Theory and Concepts




All of the above approaches can be structured in two ways. The ¬rst is to directly
value the equity of the ¬rm, since this is usually the variable the analyst is directly inter-
ested in estimating. The second is to value the assets of the ¬rm, that is, the claims of
equity and net debt, and to then deduct the value of net debt to arrive at the ¬nal equity
estimate. Theoretically, both approaches should generate the same values. However, as
we will see in the following chapter, there are implementation issues in reconciling the
approaches. In this chapter we illustrate valuation using an all-equity ¬rm to simplify the
discussion. However, where appropriate we discuss the theoretical issues in valuing the
¬rm™s assets.
From a theoretical perspective, shareholder value is the present value of future divi-
dend payoffs. This de¬nition can be implemented by forecasting and discounting future
dividends directly. However, it can also be framed by recasting dividends in terms of
earnings and book values, or in terms of free cash ¬‚ows to shareholders. These methods
are developed throughout the chapter, and their pros and cons discussed.
Valuation using multiples is also discussed. Multiples are a popular method of valu-
ation because, unlike the discounted dividend, discounted abnormal earnings, and dis-
counted cash ¬‚ow methods, they do not require analysts to make multiyear forecasts.
However, the identi¬cation of comparable ¬rms is a serious challenge in implementing
the multiple approach. The chapter discusses how the discounted abnormal earnings val-
uation approach can be recast to generate ¬rm-speci¬c estimates of two popular multi-

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