$3.$ STOCK VALUATION $**$USE EXCEL FOR SOLUTIONS$**$

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 $50,000$ 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:

Earnings Per Share $($EPS$)$ Dividend Per Share $($DPS$)$ Stock Price Return on Equity $($ROE$)$ Required Rate of Return $($R$)$

Blue Ribbon Motors Corp. $ $\mathrm{.}81$ $$\mathrm{.}20$ $ $14\mathrm{.}1810\mathrm{.}00\%10\mathrm{.}00\%$

Bon Voyage Marine, Inc. $1\mathrm{.}38\mathrm{.}6211\mathrm{.}8713\mathrm{.}00\%13\mathrm{.}00\%$

Nautilus Marine Engines $-\mathrm{.}46\mathrm{.}3813\mathrm{.}2114\mathrm{.}00\%12\mathrm{.}00\%$

Industry Average $ $\mathrm{.}58$ $$\mathrm{.}404$ $$13\mathrm{.}0912\mathrm{.}33\%11\mathrm{.}67\%$

Nautilus Marine Engine$$s negative earnings per share $($EPS$)$ were the result of an accounting write$-$off last year. Without the write$-$off, EPS for the company would have been $$1\mathrm{.}60.$ Last year, Ragan had an EPS of $$4\mathrm{.}54$ and paid a dividend to Carrington and Genevieve of $$60,000$ each. The company also had a return on equity of $18$ percent. Larissa tells Dan that a required return for Ragan of $18$ percent is appropriate.

a$.$ Assuming the company continues its current growth rate, what is the value per share of

the company's stock?

b$.$ Dan has examined both the company's financial statements and those of its competitors. Although Ragan currently has a technological advantage, Dan's research indicates that Ragan's competitors are investigating other methods to improve efficiency. Given this, Dan believes that Ragan's technological advantage will last only for the next five years. After that period, the company's growth will likely slow to the industry average. Additionally, Dan believes that the required return the company uses is too high. He believes the industry average required return is more appropriate. Under Dan's assumptions, what is the estimated stock price?

c$.$ What is the industry average price$-$earnings ratio? What is Ragan's price$-$earnings ratio? Comment on any differences and explain why they may exist.

d$.$ 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?

e$.$ Assume the company's growth rate slows to the industry average in five years. What future

return on equity does this imply?