East Coast Yachts Case

In $1969,$ Tom Warren founded East Coast Yachts. The company$$s operations

are located near Hilton Island, South Carolina, and the company is structured

as a sole proprietorship. The company has manufactured custom midsize,

high$-$performance yachts for clients and its products have received high

reviews for safety and reliability. The company$$s yachts are primarily

purchased by wealthy individuals to pleasure use. Occasionally a yacht is

manufactured for purchase by a company for business purposes.

The custom yacht industry is fragmented, with a number of

manufacturers. As with any industry, there are market leaders, but the

diverse nature of the industry ensures that no manufacturer dominates the

market. The competition in the market, as well as the product cost, ensures

that attention to detail is a necessity. For instance, East Coast yacht spent $80$

to $100$ hours on hand$-$buffing the stainless steel stem$-$iron, which is a metal

cap on the yacht$$s bow that conceivably could collide with a dock or another

boat.

Several years ago, Tom retired from the day$-$to$-$day operations of the

company and turned the operations of the company over to his daughter

Larissa. Because of the dramatic growth of East Coast Yachts, Larissa

decided that the company should be reorganized as a corporation. Time has

passed, and today the company is publicly traded under the ticker symbol

$$ECY$.$

$1$

Dan Irvin was recently hired by East Coast Yachts to assist company

with its short$-$term financial planning, and also to evaluate company$$s

financial performance. Dan graduated from college five years ago with a

finance degree, and he has been employed in the treasury department of a

Fortune $500$ company since then. Larissa decided to expand the company's

operations, and she asked Dan to enlist an underwriter to help sell $$45$

million in new $30-$year bonds to finance new construction. Dan has entered

into discussions with Renata Harper, an underwriter from the firm of Crowe &

Mallard, about which bond features East Coast Yachts should consider, and

also what coupon rate the issue would likely have. Although Dan is aware of

bond features, he is uncertain as to the cost and benefit of some of them, so

he isn't clear on how each feature would affect the coupon rate of the bond

issue.

Larissa has also 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 Irvin to analyze

Ragan's value.

Ragan Engines, Inc. was founded $9$ years ago by a brother and sister $$

Carrington and Genevieve Ragan $$ and has remained a privately owned

company. The company manufacturers 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 $125,000$

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 per

share

Estimat

ed

growth

rate

Required

rate of

return

$($R$)$

Blue Ribband

Motors Corp.

$$1\mathrm{.}24$ $$0\mathrm{.}39$ $$20\mathrm{.}107\mathrm{.}54\%15\%$

Bon Voyage

Marine, Inc.

$$1\mathrm{.}55$ $$0\mathrm{.}47$ $$16\mathrm{.}859\mathrm{.}75\%17\%$

Nautilus

Marine

Engines

$-$$$0\mathrm{.}25*$ $$0\mathrm{.}67$ $$31\mathrm{.}608\mathrm{.}06\%13\%$

$2$

$*$ Nautilus Marine Engine$$s negative EPS was the result of a non$-$recurring

accounting write$-$off last year. Without the write$-$off, EPS for the company

would have been $$1\mathrm{.}93.$

Questions:

$1.$ Please name at least $2$ advantages and $1$ disadvantage of changing East

Coast Yacht$$s organization from a sole proprietorship to a corporation.

$2.$ Please prepare a memo to Dan on behalf of Renata Harper, to describe

the effect of each of the following bond features on the coupon rate of the

bond, assuming the coupon rate is similar to the estimated yield to

maturity at issuance. $($Hint: discuss whether each of the following feature

would increase or lower the coupon rate based on whether it benefits the

company or the bondholders.$)$

a$.$ Whether the bond has collateral or not

b$.$ The seniority of the bond

c$.$ The presence of a sinking fund

d$.$ A call provision with a specific price $($e$.$g$.,$ deferred call provision$)$

e$.$ Protective covenants

$3.$ Dan is considering whether to issue coupon$-$bearing bonds or zero$-$coupon

bo