Larissa has been talking with the company’s directors about the future of East Coast Yachts. To this point, the company has used outside suppliers for various key components of the company’s yachts, including engines. Larissa has decided that East Coast Yachts should consider the purchase of an engine manufacturer to allow East Coast Yachts to better integrate its supply chain and get more control over engine features. After investigating several possible companies, Larissa feels that the purchase of Ragan Engines, Inc., is a possibility. She has asked Dan Ervin to analyze Ragan’s value. Ragan Engines, Inc., was founded nine years ago by a brother and sister—Carrington and Genevieve Ragan—and has remained a privately owned company. The company manufactures marine engines for a variety of applications. Ragan has experienced rapid growth because of a proprietary technology that increases the fuel efficiency of its engines with very little sacrifice in performance. The company is equally owned by Carrington and Genevieve. The original agreement between the siblings gave each 150,000 shares of stock. Larissa has asked Dan to determine a value per share of Ragan stock. To accomplish this, Dan has gathered the following information about some of Ragan’s competitors that are publicly traded: EPS DPS Stock Price ROE R Blue Ribband Motors Corp. $1.19 $.19 $16.32 10.00% 12.00% Bon Voyage Marine, Inc. 1.26 .55 13.94 12.00 17.00 Nautilus Marine Engines −.27 .57 23.97 N/A 16.00 Industry average $.73 $.44 $18.08 11.00% 15.00% Nautilus Marine Engines’s negative earnings per share (EPS) were the result of an accounting write-off last year. Without the write-off, EPS for the company would have been $2.07. Last year, Ragan had an EPS of $5.35 and paid a dividend to Carrington and Genevieve of $320,000 each. The company also had a return on equity of 21 percent. Larissa tells Dan that a required return for Ragan of 18 percent is appropriate. Total earnings=300000*5.35=$1,605,000 Payout ratio=$640000/1605000=.3988 or 39.88% Retention ratio=1-0.3988=0.6012= 60.12% Organizations growth rate= ROE*b=0.21(.6012)=0.1263= 12.63% Total equity value=D1/(R-g) Total equity value= 640000(1.1263)/(.18-.1263) Total equity value= $13,413,286.96 Value per share=13413286.96/300000 Value per share= $44.74 2. Industry EPS= (1.09+1.26+2.07)/3=0.2993 Industry payout ratio= 0.44/1.47=0.2993 Industry retention ratio= 1-.2993=.7007 Industry growth rate= .11(.7007)= .077 Total dividends for each of the next 6 years: D1= $640,000(1.1263)= $720,807.48 D2=$720,807.48(1.1263)=$811,817.84 D3=$811,817.84(1.1263)=$914,319.33 D4=$914,319.33(1.1263)=$1,029,762.82 D5=$1,029,762.82(1.1263)= $1,159,782.41 D6=$1,159,782.41(1.077)=$1,249,085.656 Total value of the stock in year 5 with the industry required return: Stock value in Year 5=$1,249,085.656/(.15-.077)=$17,110,762.41 Total value of the stock today: $720,807.48/1.15+$811,817.84/1.15^2+$914,319.33/1.15^3+$1029762.82^4+(1159782.41+17110762.41)/1.15^5= Value of stock today=$11,511,043.79 Value per share of stock today: 11511043.79/300000= $38.37 Value per share= $38.37 3. Industry PE= $18.08/$1.47=12.30 Ragan’s PE= $44.71/$5.35=7.17 Ragan’s price earnings is lower than the industry average. This is because the organization pays out a higher dividend than the industry. 4.Assume the company’s growth rate declines to the industry average after five years. What percentage of the stock’s value is attributable to growth opportunities? 5.Assume the company’s growth rate slows to the industry average in five years. What future return on equity does this imply? 6.Carrington and Genevieve are not sure if they should sell the company. If they do not sell the company outright to East Coast Yachts, they would like to try and increase the value of the company’s stock. In this case, they want to retain control of the company and do not want to sell stock to outside investors. They also feel that the company’s debt is at a manageable level and do not want to borrow more money. What steps can they take to try to increase the price of the stock? Are there any conditions under which this strategy would not increase the stock price?
Please help with questions 4-6. Questions 1-3 are already finished.
STOCK VALUATION AT RAGAN ENGINES
Larissa has been talking with the company’s directors about the future of East Coast Yachts. To this point, the company has used outside suppliers for various key components of the company’s yachts, including engines. Larissa has decided that East Coast Yachts should consider the purchase of an engine manufacturer to allow East Coast Yachts to better integrate its supply chain and get more control over engine features. After investigating several possible companies, Larissa feels that the purchase of Ragan Engines, Inc., is a possibility. She has asked Dan Ervin to analyze Ragan’s value.
Ragan Engines, Inc., was founded nine years ago by a brother and sister—Carrington and Genevieve Ragan—and has remained a privately owned company. The company manufactures marine engines for a variety of applications. Ragan has experienced rapid growth because of a proprietary technology that increases the fuel efficiency of its engines with very little sacrifice in performance. The company is equally owned by Carrington and Genevieve. The original agreement between the siblings gave each 150,000 shares of stock.
Larissa has asked Dan to determine a value per share of Ragan stock. To accomplish this, Dan has gathered the following information about some of Ragan’s competitors that are publicly traded:
| EPS | DPS | Stock Price | ROE | R | |
| Blue Ribband Motors Corp. | $1.19 | $.19 | $16.32 | 10.00% | 12.00% |
| Bon Voyage Marine, Inc. | 1.26 | .55 | 13.94 | 12.00 | 17.00 |
| Nautilus Marine Engines | −.27 | .57 | 23.97 | N/A | 16.00 |
| Industry average | $.73 | $.44 | $18.08 | 11.00% | 15.00% |
Nautilus Marine Engines’s negative earnings per share (EPS) were the result of an accounting write-off last year. Without the write-off, EPS for the company would have been $2.07. Last year, Ragan had an EPS of $5.35 and paid a dividend to Carrington and Genevieve of $320,000 each. The company also had a
- Total earnings=300000*5.35=$1,605,000
Payout ratio=$640000/1605000=.3988 or 39.88%
Retention ratio=1-0.3988=0.6012= 60.12%
Organizations growth rate= ROE*b=0.21(.6012)=0.1263= 12.63%
Total equity value=D1/(R-g)
Total equity value= 640000(1.1263)/(.18-.1263)
Total equity value= $13,413,286.96
Value per share=13413286.96/300000
Value per share= $44.74
2. Industry EPS= (1.09+1.26+2.07)/3=0.2993
Industry payout ratio= 0.44/1.47=0.2993
Industry retention ratio= 1-.2993=.7007
Industry growth rate= .11(.7007)= .077
Total dividends for each of the next 6 years:
D1= $640,000(1.1263)= $720,807.48
D2=$720,807.48(1.1263)=$811,817.84
D3=$811,817.84(1.1263)=$914,319.33
D4=$914,319.33(1.1263)=$1,029,762.82
D5=$1,029,762.82(1.1263)= $1,159,782.41
D6=$1,159,782.41(1.077)=$1,249,085.656
Total value of the stock in year 5 with the industry required return:
Stock value in Year 5=$1,249,085.656/(.15-.077)=$17,110,762.41
Total value of the stock today:
$720,807.48/1.15+$811,817.84/1.15^2+$914,319.33/1.15^3+$1029762.82^4+(1159782.41+17110762.41)/1.15^5=
Value of stock today=$11,511,043.79
Value per share of stock today:
11511043.79/300000= $38.37
Value per share= $38.37
3. Industry PE= $18.08/$1.47=12.30
Ragan’s PE= $44.71/$5.35=7.17
Ragan’s price earnings is lower than the industry average. This is because the organization pays out a higher dividend than the industry.
4.Assume the company’s growth rate declines to the industry average after five years. What percentage of the stock’s value is attributable to growth opportunities?
5.Assume the company’s growth rate slows to the industry average in five years. What future return on equity does this imply?
6.Carrington and Genevieve are not sure if they should sell the company. If they do not sell the company outright to East Coast Yachts, they would like to try and increase the value of the company’s stock. In this case, they want to retain control of the company and do not want to sell stock to outside investors. They also feel that the company’s debt is at a manageable level and do not want to borrow more money. What steps can they take to try to increase the price of the stock? Are there any conditions under which this strategy would not increase the stock price?
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