4 5 Happy, Inc. was founded 9 years ago by siblings Brandon and Rachael Happy. The company manufactures and installs commercial heating, ventilation, and cooling (HVAC) units. Happy, Inc. experienced rapid growth because of a proprietary technology that increases the energy efficiency of its units. The company is equally owned by Brandon and Rachael. The original partnership agreement between the siblings gave each 50,000 shares of stock. In the event either wished to sell stock, the shares first had to be offered to the other at a discounted price. Although neither sibling wants to sell, they had decided they should value their holdings in the company. To get started, they have gathered the following information about their main competitors: Dividends per share (DPS) 6 Earnings per share (EPS) Return on Stock price Equity (ROE) Required Return Competitor A $ 1.30 $ 0.16 $ 25.34 8.50% 10.00% Competitor B $ 1.95 $ 0.23 $ 29.85 10.50% 13.00% Competitor C S (0.37) $ 0.14 $ 22.13 9.78% 12.00% 10 Industry Average $ 0.96 $ 0.18 $ 25.77 9.59% 11.67% 11 12 13 Competitor C's negative earnings per share were the result of an accounting write-off last year. Without the write-off, earnings per share for the company would have been $1.10. Last year, Happy, Inc. had an EPS of $3.15 and paid a dividend to Brandon and Rachael of $45,000 each. The company also had a return on equity of 17 percent. The siblings believe that 14 percent is an appropriate required retum for the company. 15 Question 1 16 Assuming the company continues its current growth rate, what is the value per share of company's stock? Question 2 To verify their calculations, Brandon and Rachael hired ABC Consultants, an equity analysts that covers the HVAC industry. ABC has examined the company's financial statements as well as those of its competitors. Although Happy, Inc. currently has technological advantage, their research indicates that other companies are investigating methods to improve efficiency. Given this, ABC believes that the company's technological advantage will last only for the next five years. After that period, the company's growth will likely slow to the industry growth average. Additionally, ABC believes that the required return used by the company is too high. ABC believes the industry average required return is more approrpriate. Under this growth rate assumption, what is your estimate of the stock price? Complete the boxes in yellow highlighted area to answer the two questions. Here are some basic facts to get you started: 24 Shares owned by each sibling 50,000 25 Happy EPS $ 3.15 26 Dividend to each sibling $ 45,000 27 Happy ROE 17% 28 Happy required return 14% 29 30 31 Complete the following output areas to answer the questions 32 33 Total dividends 34 Total earnings Chapter 7 hint: EPS x shares outstanding D E 31 Complete the following output areas to answer the questions 32 33 Total dividends 34 Total earnings 35 Retention ratio 36 Growth rate 37 Current dividend per share 38 39 40 Dividend per share next year Question 1 Answer: hint: EPS x shares outstanding this is the percentage of earnings not paid out in dividends hint: retention ratio x ROE 41 Value per share 42 43 Industry EPS hint: for competitor C, use the expert EPS w/o write-off 44 Industry payout ratio 45 Industry retention ratio 46 Industry growth rate 47 48 Year 49 1 Dividends/share hint: use the following growth rates to fill in the shaded area Company growth rate 50 2 51 3 52 4 Company growth rate Company growth rate Company growth rate 53 5 54 6 Chapter 7- Company growth rate INDUSTRY growth rate Industry EPS Industry payout ratio Industry retention ratio Industry growth rate Year 9 1 50 2 51 3 52 4 53 54 5 6 hint: for competitor C, use the expert EPS w/o write-off Dividends/share hint: use the following growth rates to fill in the shaded area Company growth rate Company growth rate Company growth rate Company growth rate Company growth rate 333 55. 56 Stock value in Year 5 INDUSTRY growth rate 57 58 Question 2 Answer: 59 Stock price today 60 61 62 63 64 65 66 322 Chapter 7-