Please provide PESTEL ANALYSIS for the following case:

Please provide PESTEL ANALYSIS for the following case:

In 2012, Teuer Furniture—a privately owned, moderately sized chain of upscale home furnishing showrooms in the United States—had survived the economic recession and was growing. As the firm was now on secure financial ground, a number of long-term investors, including several of Teuer's original non-management investors, asked to sell their shares. Up until this point, Teuer had distributed its excess cash flow in the form of dividends and had avoided repurchasing stock from its investors because of the difficulty of valuing a private firm. The firm had never repurchased shares from its investors. Teuer's decision of whether to finance the investor buyout from cash generated by the business or to seek new equity investors was postponed until a valuation of the business could be obtained. To begin the valuation process, Teuer's chief financial officer, Jennifer Jerabek, and her finance team were asked to assemble a set of forecasts upon which the valuation and stock price would be based.

Teuer Furniture was launched in 2003 to serve the demand for high-quality designer furniture sold in a high-touch environment outside of the major metropolitan areas. The firm opened its first showroom at the end of 2003 in Kansas City, Missouri, and had since grown to twenty-nine showrooms (see Exhibit 1). Teuer had concentrated on second-tier cities in terms of size in the Midwest and now had showrooms in Des Moines (Iowa), Columbia (Missouri), Kansas City (Missouri and Kansas), Lawrence (Kansas), and the outlying suburbs of St. Louis (Missouri). The current plan was to open an additional six showrooms over the next three years. As these showrooms would be in the same cities in which Teuer currently had showrooms, they would all be supplied from Teuer's centrally located distribution center.

Teuer Furniture's Market Niche

Teuer's furniture lines ranged from French Country to Queen Anne. The firm sold furniture for all rooms in the home, from the bedroom to the dining room. Its seating offerings ranged from sofas and chairs appropriate for formal living areas to more casual furniture for family gathering spaces. Teuer's target market was upper-income individuals who valued high-quality furnishings. The furniture was well-designed and well-made but not inexpensive. The firm's target customers appreciated quality and were willing to pay for it with money but not time. Thus, providing a convenient and attentive shopping experience was essential to its strategy.

Teuer did not manufacture any of the furniture it sold. It had a network of domestic producers, mainly in the Southeast, who designed and manufactured furniture that was then sold under the Teuer brand name. Teuer offered fewer lines of furniture than some of its competitors, as it targeted only the upper-end market. Its customers, however, expected a wide variety of styles, sizes, and patterns. Thus, having a large selection of inventory in its showrooms or the distribution center (which was less than one day's drive from any of the twenty-nine showrooms) was a significant selling point for its customers.

In addition to a large selection, Teuer placed great value on its sales associates. It had a rigorous selection process for hiring and ongoing training programs to provide its sales associates with the skills they needed to succeed. Teuer recruitment focused on finding outgoing individuals that enjoyed "helping a friend furnish their home"—the firm's philosophy. Customers were encouraged not to buy until they were ready. "Please don't feel any pressure to make a decision today. We trust you will be back when you are ready." was the associates' message to uncertain customers. As a result, a large fraction of sales after the first year were repeat customers or friends of past customers. Staff turnover was low, and compensation was appropriately generous. A well-paid and well- trained sales associate provided the low-key, high-personal-touch customer experience that Teuer aimed for.

A Limited Capital Investment Strategy

Teuer Furniture began as an experiment by Kim Smithson and Scott Casper. Both had been in the retail sector for a number of years, albeit in different roles. Casper worked as a consultant after business school. Since then he had moved between industry and consulting, but always with a focus on retail logistics. He spent a number of years at Heilig-Meyers, one of the largest furniture retailers in the United States in the mid-1990s.1 Through his work for Heilig-Meyers and other retail clients, he had come to appreciate the importance of understanding the supplier's operational and financial constraints. Smithson started with Jennifer Convertibles after business school and worked in a number of management roles, becoming familiar with all aspects of the firm's retail operations.

The two were looking for a new challenge and felt there was an opportunity to pool their respective areas of knowledge and create a new firm. Smithson felt there was an opportunity to create a shopping experience that would generate long-term customer loyalty, and this vision drove the firm's strategy. Casper's contacts in the industry allowed the firm to rapidly secure a set of suppliers who could help design and then manufacture the high-quality furniture Teuer needed in a timely manner.

The challenge they faced was limited capital, and this also drove their strategy. Because Smithson and Casper expected to spend heavily on hiring, training, and inventory, they looked for other methods of conserving capital. Their original showrooms were leased, which saved Teuer from having to raise capital to purchase the land and build the showrooms that it needed. Some of the early showrooms were modifications of existing retail space. After the first few years, Smithson and Casper had a better understanding of what kind of space fit with the firm's philosophy. At this point, they arranged with their landlords to build showrooms to their specifications. The arrangement had been successful, and Teuer continued to lease all twenty-nine of its locations. This strategy not only freed up capital for other uses but also let the firm concentrate on its product selection and employee development. Because it was located in few geographic areas, potential landlords would approach Teuer with locations. Eliminating the need to scout for new locations saved time for senior management, especially during Teuer's high growth period.2 Management only needed to evaluate the appropriateness of locations that were brought to them.

Although Teuer did not spend money on land and buildings, it did build out the interiors. The optimal layout of the showrooms was critical to producing high sales in each location. Figuring out the correct design took a few tries, and thus the design evolved through Teuer's first few showrooms. The challenge was to create easy flow through the sizeable showrooms without making the customer feel like he or she was visiting a warehouse.3 The showroom inventory had to be sizable but not overwhelming. The other challenge was to help customers envision what the furniture would look like in their homes. Thus, the showrooms were designed as a set of "rooms" that had multiple entries and exits so a customer could wander from a bedroom to a family room to a dining room. Design kiosks, available in several places in the showrooms, allowed sales associates to pull up 3D pictures of a requested sofa, for example, in a different size or fabric pattern. Combining the ability to visualize the pattern or style that the customer was interested in with the ability to try out a version of the sofa in the showroom proved to be an effective method for producing a sale.

Although customers might take a long time to decide on a purchase, once a decision was made, they wanted to have the furniture in their homes quickly. As part of the high-touch customer service, delivery and setup were included in the purchase price of any items customers did not take with them. Having a central distribution center made rapid delivery possible in most cases, but it also meant that Teuer had to have an extensive inventory in its showrooms and the distribution center. At the end of 2012, Teuer's inventory was about $33 million, which was approximately 48 percent of the next year's estimated cost of goods sold (CGS) (see Exhibit 3 (income statement) and Exhibit 4 (balance sheet)). This meant that Teuer maintained inventory equal to about six months of its anticipated sales for the next year. This investment was costly in terms of the amount of capital it tied up ($33 million), but it was worth the investment because of the greater quantity of sales as well as the gross margins Teuer was able to generate as a result (58 percent in 2012).

Teuer was initially tempted to ask its suppliers to help finance its inventory by requiring them to provide very long payment terms. However, many of Teuer's suppliers were reluctant, unable, or unwilling to provide longer terms. In addition, Teuer wanted to maintain goodwill with its suppliers for those cases in which Teuer ran unexpectedly low on a specific item. Suppliers could be in a position to decide whether to quickly ship an item or not. Thus, Teuer consistently paid its suppliers on the specified due date.4 This process was automated and thus required little additional attention by the office staff.

2 Teuer's early years were also a period of rapid growth in the industry. The growth of aggregate furniture sales peaked in 2004 at an annual growth rate of 7.3 percent

3 The showrooms ranged from 12,800 to 23,300 square feet, with an average of about 18,000 square feet. The basic footprint of the showrooms was similar (after the first few showrooms), but due to variation in the plots of land and expected volume, there was some variation in size across locations. Originally, Teuer management thought the similar layouts would be valuable to customers, as the familiar surroundings would make them feel comfortable when they visited different Teuer showrooms. Later research found that customers usually shopped only at the showroom closest to their homes, so this proved to be only a minor advantage.

4 Suppliers billed Teuer after delivery, which took one to three weeks, depending on the supplier. Almost all of the suppliers expected payment sixty days after delivery. Teuer has approximately $11 million in accounts payable at the end of 2012, which is equal to 16 percent of the next year's (2013's) forecasted cost of goods sold. Although Teuer did not technically borrow from its employees or the TV, radio stations, or newspapers in which it advertised, neither did it pay these individuals and firms immediately. These bills were paid after two to three weeks, on average. Thus, Teuer forecasted its accrued expenses (such as wages, benefits, and advertising) as a percentage of expected selling, general, and administrative expense (SGA) and advertising expense.

Teuer's Financial Performance

Early Expansion Years

The timing of Teuer's launch was fortuitous. The economy had come out of a recession several years earlier and was growing nicely. Total sales in the furniture industry grew 5 percent per year from 2003 to 2006 (see Exhibit 2). As a newcomer to the market, Teuer's sales grew much faster. Sales were always low on a square footage basis in the first year of a showroom location. It took time for customers to become aware of a new location and initially for Teuer to build its brand. Teuer's low-pressure approach to selling also contributed to low sales initially. Management's intuition proved correct, however, as sales grew rapidly once the showrooms were established. The sales of Teuer's first showroom, which opened in 2003 in Kansas City, Missouri, grew 82 percent in 2005 and 39 percent in 2006. Through a combination of rapid organic growth and the opening of new showrooms, total firm sales grew from a little over $2 million in 2004 to $51.5 million by 2007.

Financial Crisis and Non-Durable Consumption

The past several years had not been good to the home furnishing industry. The recession of 2008 was the worst the United States had seen in more than two decades, and it hit consumer durables particularly hard. Although GDP fell only 2.2 percent in 2009, furniture sales fell more dramatically (see Exhibit 2). The growth rate of aggregate sales began falling in 2005, and growth turned negative in 2007 as the housing market peaked. Total furniture sales fell 13.4 percent in 2009, which brought total sales to $86.3 billion, or 24 percent below the 2006 peak of $113 billion (see Exhibit 2). Large home furnishings, like the purchase of homes and automobiles, were big- ticket purchases, were sometimes financed, and were purchases that consumers felt could be deferred. Thus, when economic times were tough—or worse, uncertain—customers postponed large furniture purchases.

The length of the recession and the anemic recovery from it had created enormous disruption in the industry. Since 2006, no fewer than six large home furnishing or appliance retailers had filed for bankruptcy or liquidated.5 Given the industry's performance, Teuer did surprisingly well during the recession. Its sales never declined, although the growth rate of sales dropped dramatically from 93 percent in 2007 to 15 percent in 2009. Teuer's ability to avoid a decline in sales was not because its showrooms and customers were unaffected by the recession—they were affected. Teuer's sales continued to grow only because of the rapid rate at which it opened showrooms as the country went into the recession. Looking at showroom-level growth (sales growth for showrooms open at least a year), the drop in sales is apparent. (Showroom-level income statements are contained in Exhibit 5 and showroom-level balance sheets are contained in Exhibit 6.) For example, sales at Teuer's original showroom in Kansas City peaked at $6.3 million in 2008 and then fell 13.2 percent

5 Some of the firms that had filed for bankruptcy and/or liquidated were: Venture Stores, Inc. (March 2007), Rowe Companies (October 2007), Jennifer Convertibles (July 2010), Gottschalks, Inc. (February 2011), RoomStore, Inc. (December 2011), and GuildMaster, Inc. (December 2012). Other firms were at risk. One analyst report noted that Furniture Brands International "could face the risk of bankruptcy or potential financial restructuring." Bradley Thomas, Jason Campbell, and Bonanza Chalaban, "Furniture Brands International: Challenges Remain But Leading Indicators Improve," KeyBanc Capital Markets, November 1, 2012. Furniture Brand International's sales had continued to shrink, the firm had lost money for each of the last four years, and it had consumed more cash than expected in the third quarter of 2012.

to $5.5 million in 2009 before recovering slowly. Sales for this first showroom had not yet regained their 2008 level, but were expected to by 2014 (see Exhibit 5).

Like many in the consumer durables industry, Teuer did not see the recession coming. Because its business model had proven to be successful, Teuer took advantage of expansion opportunities and the unused capacity in its distribution center. It opened six showrooms in 2007, its highest number, just as the furniture market started to falter. It was planning on opening eight, but contract negotiations (fortunately) delayed two locations. An equal number of showrooms were planned for 2008, but most of those were shelved as it became apparent that further expansion was not wise in the economic climate at the time. Teuer only opened two showrooms in 2008 and just one in 2009. This was more than the firm would have preferred, but it was already committed in one case and wanted to secure prime locations in the other two. The rate of showroom expansions had dropped significantly. Teuer's current plan is to open only six more showrooms over the next three years (see Exhibit 1).

Unlike other home furnishing retailers, Teuer's profits did not drop in the recession. Teuer did not generate a profit until 2008 (at which point Teuer had twenty-one showrooms open).6 Because of the high start-up costs, the time it took for customers to become aware of the showrooms, and the fact that much of the firm's investment was expensed, new showrooms were not immediately profitable.7 Because Teuer was rapidly opening showrooms in its early years, the losses from the larger number of new showrooms initially swamped the profits from the smaller number of more established locations. As with sales, the profitability of some showrooms dipped in the recession (see Exhibit 5), but total profits did not (see Exhibit 3).8 The positive profitability helped Teuer finance its continued expansion through the recession. Unlike many of its competitors, it was not beholden to the financial markets.

Recent Financial Performance

Despite the recent economic disruption of its industry, Teuer's financial performance had been quite sound. Sales grew a healthy 11 percent in 2012 and were expected to continue growing, albeit at a declining rate as the showrooms matured and fewer new showrooms were opened. The firm's gross profit margin had risen to 58 percent and its net profit margin had risen to 15 percent.9 The firm expected to finance its remaining six showrooms with funds generated from operations. It did not anticipate a need for external financing to finance its growth.

6 Due to prior years' losses, Teuer did not start paying taxes until 2009 (see Exhibit 3).

7 As discussed above, Teuer did not invest large sums in land and buildings; it leased them. Its investment was in working capital, advertising, and employee training. Although the value of the advertising, employee training, and resulting consumer loyalty was captured over a number of years, these expenses were completely charged against earnings in the year in which they were spent. Firms that must expense their investment thus look less profitable in the early years.

8 The profits of the 2003 store dropped from $2,143,100 in 2007 to $1,753,800 in 2009.

9 The gross profit margin is calculated as [Sales - Cost of Goods Sold] / Sales. The net profit margin is after-tax profits over sales. The net profit margin includes the effects of corporate expenses (corporate level advertising, lease of the corporate offices and the distribution center, and corporate-level SGA).

Ownership and Financing

The initial investments in Teuer came from its two founders and a pool of private investors whom they recruited from the local area and their professional network. The initial round of capital they raised was less than $1 million, but as the business grew, the capital they were required to raise each year grew as well. Teuer raised equity capital from current shareholders on a pro rata basis.10 Teuer continued to raise capital for the first several years, including a $5.7 million equity infusion in 2008 (see Exhibit 7). Fortunately, this was the last time the firm had needed to raise capital, as it has been able to finance its growth internally ever since. The number of shareholders had grown from the original 3 to 187 by the end of 2012.11 The number of shareholders rose due to some shareholders selling their shares to new investors through private transactions and as a result of estate planning, as some shareholders had passed shares along to their children. The firm's cash flow in excess of its investment needs had been returned to the shareholders each year in the form of dividends.

Valuation Challenge: Financial Forecasting

Forecasting Sales Revenue

Although most of the investors were familiar with the business, Jennifer Jerabek and the finance team needed to assemble a set of forecasts upon which the valuation would be based. The first step was to forecast future income starting with sales revenue. The simplest way to forecast Teuer's sales revenue would be to look at past sales growth and project this forward. Teuer's sales growth had declined from triple-digit numbers in its early years to 11 percent in 2012 (see Exhibit 3). Although projecting historic growth rates is common, there were two problems in this case.

The first issue was the effect of showroom openings and maturation. Teuer's sales growth was a combination of organic growth from the operation of current showrooms and from the opening of new showrooms. The rate of sales growth for each showroom declined as customers became aware of the location (the source of early rapid growth), but this is not apparent in the aggregate data because of the additional sales coming from showroom openings each year. As the rate of openings had differed across the years, the growth in total sales had been affected. A simple solution would be to examine the historic growth of Teuer's existing showrooms as a function of how long they had been open (the cohort age). This brought Jerabek to her second problem with using historic data: the economy. The recession and subsequent (anemic) recovery meant a simple projection of past showroom levels was not meaningful. Both the number of showrooms opened and their initial success depended upon the economy. Showrooms that opened in 2009 faced much greater headwinds than those opened in 2004. This was why Teuer's sales growth dropped from 54 percent in 2008 to 15 percent in 2009 before rising back to 23 percent in 2010. The effect of the economy also complicated examining sales growth by cohort (the year in which a showroom was opened). To address these two concerns, Jerabek decided to examine historic sales growth on a cohort basis while adjusting sales growth for growth in total furniture sales in the same year. The data is

10 Thus, when Teuer raised $5,747,115 in 2008, an investor who owned 1 percent of the equity contributed $57,471.15, or 1 percent of $5,747,115.

11 As of the end of 2012, there were 9,945,000 shares outstanding.

presented in Exhibit 8, Panel A.12 Once adjusted sales growth was calculated for each cohort and

year, the pattern of declining sales growth was apparent. Average adjusted sales growth declined

from 70.2 percent the first year a showroom was open to 1.5 percent the sixth year a showroom

was open.13 The average adjusted sales growth figures, along with the projected aggregate growth

of sales (see Exhibit 2), were then used to forecast sales for each cohort through 2018 (see Exhibit 5).14

The final step was to forecast the initial sales of the three showrooms that had opened in 2012 and the six that were expected to open in the next three years. Teuer had an internal model for estimating sales per square foot that depended upon the location of the store, traffic patterns, and local economic conditions (e.g., mean income) that had been developed over the last decade. Based on the firm's model, the forecasts for sales per square foot were 110.0, 113.2, 116.6, and 119.9 for showrooms opened in 2012, 2013, 2014, and 2015, respectively.

Forecasting Costs

To forecast net income, the finance team first forecast each cost line in the income statement. As with sales growth, the finance team calculated the ratio of costs to sales (CGS, SGA, and advertising).15 When these cost to sales ratios were examined by cohort (as was done with sales), it was apparent that costs fell relative to sales as the showrooms matured, but at different rates. For example, the CGS/sales ratio dropped from 71 percent the first year a showroom was open to 40 percent by the fourth year. A similar pattern was seen for both SGA and advertising, but the effect was less dramatic. SGA (excluding advertising and depreciation) dropped from 19.3 percent of sales the first year a showroom was open to 13.6 percent by the fourth year. Advertising at the showroom level dropped from 10.6 percent to 7.2 percent of sales.16 The showrooms became more efficient as the staff became more experienced and the showroom's manager developed a better understanding of the exact product mix that appealed to his local customer base. The showrooms advertised more heavily the first year to introduce the new showroom to potential customers. After the fourth year, it was still necessary to advertise but the expenditures declined relative to the larger sales amount.

The final showroom-level expenses were for facilities. Teuer signed a standard six-year lease with landlords. The lease rate was fixed for six years. Historically, the firm had renewed all of its leases and this was expected to continue. The lease rate usually increased when the leases were renegotiated. Depending upon the real estate market, the increase had been greater than or less than

12 For each cohort and each year, sales growth was calculated as the ratio of this year's sales to last year's sales. This ratio was then divided by one plus the growth rate of total furniture sales in the same year (from Exhibit 2). As an illustration, the showroom that was opened in 2003 had sales grow from $2,057,000 in 2004 to $3,754,000 in 2005, an increase of 82.5 percent. Total furniture sales grew by 5.17 percent between 2004 and 2005. Thus, the excess growth in sales is calculated as 73.6 percent [(3,754,000 / 2,057,000) / (1 + 0.0517) - 1].

13 Because the finance team had few observations on showrooms open more than six years and the numbers did not seem to vary dramatically, an average adjusted sales growth was calculated for all years beyond the sixth (see Exhibit 8).

14 For example, the two showrooms that opened in 2011 had first-year sales of $3,353,700 (2012). Because total furniture sales were projected to grow by 3 percent in 2013, projected sales for these two showrooms were $5,879,237 [3,353,700 * (1 + 0.702) * (1 + 0.030)].

15 Because the time pattern of advertising and depreciation was different than the other elements of SGA, Teuer broke these two components out separately when reporting costs at the store level. This also increased the accuracy of its cost forecasts.

16 After four years, these cost to sales ratios appeared to have stabilized. Thus, when forecasting CGS, SGA (excluding advertising and depreciation), and advertising after the third year, the average ratio for the fourth year and beyond was used.

the inflation rate over the prior six years of the lease. Because the finance staff did not feel that they could forecast the condition of the real estate market, they forecasted lease rates as rising by 2 percent per year when the leases were renegotiated. The lease rate for the 2012 showrooms had already been negotiated at approximately $20.45/square foot and negotiations for the 2013 leases are nearing completion.17 The lease rate for the 2013 showrooms is expected to be $20.88/square foot. After that lease rates are forecast to rise by 2 percent per year ($21.30/square foot for the 2014 showrooms and $21.72/square foot for the 2015 showrooms) (see Exhibit 5).

In addition to expenses incurred at the individual showrooms, Teuer had a number of corporate- level expenses, including the corporate-level advertising and SGA as well as expenses for Teuer's distribution center and corporate offices. Each showroom had a budget for local advertising (mainly print and radio advertising). Corporate was responsible for expenditures on TV advertising and for the design and production of all campaigns. Corporate expenses had been larger in Teuer's early years (9 percent of sales) but had stabilized at 5 percent of sales in recent years, and this rate was expected to continue.

Forecasting Investment: Showroom Improvements and Working Capital

Teuer's strategy of leasing its showrooms (building and land) meant that it did not need to finance these expenditures. Teuer's greatest capital investment was in working capital. For a retail chain, especially one focused on always having what the customer desired, large investments in inventory and accounts receivable (AR) were deemed a valuable investment. Jerabek's method for forecasting net working capital was standard. AR was forecast as a function of sales. As with the cost numbers, the finance team looked for patterns in the data by first calculating historic ratios for each cohort of showrooms. The ratio of AR to sales did not change over time for a cohort and was close to the contractual terms of fourteen weeks that Teuer gave customers to pay (see Exhibit 9). Both inventory and accounts payable were forecast as a function of the next year's CGS, and because no discernible pattern was seen in the data, an average of each cohort's year was taken (see Exhibit 9). Teuer carried a large inventory of almost six months of the next year's sales. As discussed above, the firm paid its suppliers on time, which was an average of sixty days.18

Teuer's only capital expenditure was the cost of building out the interiors of each showroom. These expenditures were calculated per square foot for each cohort. The cost of constructing the interiors had risen dramatically, as the construction industry had boomed and local construction firms were running at full capacity. Construction of Teuer's interiors had risen from $20.80/square foot in 2003 to $30.60/square foot in 2007 before falling back to $26.40/square foot in 2012.19 Based on the assumption that the construction industry had right-sized itself, the finance team assumed that the cost of building out the interiors would stay constant in real terms at $26.40/square foot. The construction costs were expected to rise at the rate of inflation (see Exhibit 9). The cost

17 The total lease payment on the three showrooms would thus be $1,000,000 [20.45 = 1,000,000 / (3 * 16,300)].

18 Because inventory, accounts payable, and CGS all depend upon the price paid for merchandise, inventory and accounts payable can be forecast as a function of next year's CGS. For example, if Teuer purchases a sofa for $1,000, inventory and accounts payable increase by $1,000. When the suppliers are paid, accounts payable and cash both decrease by $1,000. In the future, when the sofa is sold, inventory will be reduced by $1,000 and CGS will be increased by $1,000. Accrued expenses, which are payments to other suppliers, are forecast as a function of the next year's advertising and SGA (excluding advertising and depreciation). This is another reason why depreciation was broken out separately from SGA. On average, Teuer paid its other suppliers, especially its sales associates and showroom managers, much faster than it paid its furniture suppliers (see Exhibit 9).

19 The real cost had risen from $25.90/square foot in 2003 to $33.50/square foot in 2007 in 2012 dollars (see Exhibit 9).

of building out the interiors was depreciated straight-line over five years as specified by the tax code.

The showrooms' layouts needed to be "refreshed" periodically. This was more than standard maintenance. From her prior experience, Kim Smithson had learned that if this decision was left to the showroom managers, the expenditures would be made every three to four years, and the effect on sales was not justified by the expense. If the decision was left to the finance staff, it would always be postponed until next year "when the firm could better afford the expenditure." As a result, she had implemented a policy that the expenditures be scheduled every eight years. Only the first four showrooms had gone through this process by 2012 (the 2003 and 2004 cohorts). These expenditures provided the basis for estimating future expenditures on refreshing the showrooms.20

Valuation of Teuer Furniture

Once the details of the financial forecasting model were constructed, the last step was to build the pro forma income statement and balance sheet for Teuer (see Exhibit 10 for a summary of the main forecasting parameters). These would be the basis of the discounted cash flow valuation of Teuer. Based on the forecasted numbers, it was decided that a six-year forecasting period would be used, so Jerabek's team needed to forecast the cash flow generated by Teuer from 2013 to 2018. The team was unable to predict the dynamics of the home furnishing industry or Teuer's specific performance after 2018. Thus, sales revenues, costs, investment, and cash flow were expected to grow at the long-term growth rate of 3.5 percent after 2018. Teuer's cost of capital was 12.1 percent.21 The finance team set to work building the pro forma financial statements.

20 The finance team had calculated the ratio of the expenditure to refresh the interiors in Year 8 to the initial expenditure. Given the effect of inflation, the team converted this ratio to real dollars by adjusting for the effects of inflation over the eight-year period. For example, the 2003 expenditures had been $358,000 to originally build out the interior and $324,400 to update it in 2011. Because the price index had risen by 22.4 percent from 2003 to 2011 (from 184.3 in 2003 to 225.7 in 2011) (see Exhibit 2), the real cost of refreshing was calculated as 74 percent of the original cost [(324,400 / 225.7) / (358,000 / 184.3) = (324,400 / 358,000) / (1.224)]. The ratio of the real cost of refreshing the 2004 showrooms to the original cost is calculated the same way and is equal to 66 percent. Thus, the finance team estimated the real cost of refreshing the showrooms as 70 percent of the original (see Exhibit 9). This number was then grossed up by the expected increase in the inflation rate (see Exhibit 2). The forecasted cost of refurbishing the 2005 showrooms in 2013 was $1,506,328 [1,814,000 * 0.70 * (233.5 / 196.8)].

In a prior version of the valuation, the finance team had forecasted cash flows out an additional ten years (through 2028). In this valuation, the finance team assumed that the stores would need to be refreshed every eight years. After the first refresh, the cost was estimated to be constant in real terms and so grew only as a result of inflation.

21 Although Teuer Furniture was private, for all but a few members of management, the investors' stake in Teuer was a small fraction of their wealth. Thus, Teuer used the capital asset pricing model to calculate its discount rate. As a private firm, it was not possible to estimate Teuer's own beta directly. Instead the finance team estimated the beta for several publicly traded firms in the home furnishing industry and used these as an estimate of Teuer's beta.