East Coast Yachts CaseIn $1969$

Tom Warren founded East Coast Yachts. The companys 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 companys 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 yachts 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.Dan Irvin was recently hired by East Coast Yachts to assist company with its short$-$term financial planning, and also to evaluate companys 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 $$45$ million in new $30-$year bonds to finance new construction. Dan has entered into discussions with Renata Harper, an underwriter from the firm of Crowe & Mallard, about which bond features East Coast Yachts should consider, and also what coupon rate the issue would likely have. Although Dan is aware of bond features, he is uncertain as to the cost and benefit of some of them, so he isn't clear on how each feature would affect the coupon rate of the bond issue.Larissa has also been talking with the company's directors about the future of East Coast Yachts. To this point, the company has used outside suppliers for various key components of the company's yachts, including engines. Larissa has decided that East Coast Yachts should consider the purchase of an engine manufacturer to allow East Coast Yachts to better integrate its supply chain and get more control over engine features. After investigating several possible companies, Larissa feels that the purchase of Ragan Engines, Inc. is a possibility. She has asked Dan Irvin to analyze Ragan's value.Ragan Engines, Inc. was founded $9$ years ago by a brother and sister Carrington and Genevieve Ragan and has remained a privately owned company. The company manufacturers marine engines for a variety of applications. Ragan has experienced rapid growth because of a proprietary technology that increases the fuel efficiency of its engines with very little sacrifice in performance. The company is equally owned by Carrington and Genevieve. The original agreement between the siblings gave each $125,000$ shares of stock.Larissa has asked Dan to determine a value per share of Ragan stock. To accomplish this, Dan has gathered the following information about some of Ragan's competitors that are publicly traded:Earnings per share $($EPS$)$Dividend per share $($DPS$)$Stock price per shareEstimated growth rateRequired rate of return $($R$)$Blue Ribband Motors Corp.$$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\%*$ Nautilus Marine Engines 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 Yachts 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 bonds. The YTM $($yield to maturity$)$ on either bond issue will be $5\mathrm{.}5\%.$ The coupon bond would have a $5\mathrm{.}5\%$ coupon rate and coupon is paid semi$-$annually. Assume the companys tax rate is $21\%,$ and interest is compounded every $6$ months.

a$).$How many of the coupon bonds must East Coast Yachts issue to raise the $$45$ million? In $30$ years, what will be the principal repayment due if East Coast Yachts issues the coupon bonds?

b$).$How do the answers in $($a$)$ change if the coupon rate is set at $4\%$ instead of $5\mathrm{.}5\%?$

c$).$ How do the answers in $($a$)$ change if only using zeroes $($i$.$e$.,$ zero$-$coupon bonds$)$ as the source of financing?

d$).$ Would you recommend a zero coupon issue or a regular coupon issue, why?

$4.$ Last year, Ragan Engines had an EPS of $$3\mathrm{.}65$ and paid a dividend to Carrington and Genevieve of $$195,000$ each. Each of them has $125,000$ shares. The company also has an estimated earnings growth rate of $10\mathrm{.}3\%.$ Larissa tells Dan that a required return for Ragan Engines of $13\%$ is appropriate. Assuming Ragan Engines continues its current growth rate, what is its estimated stock price?$5.$ Dan has examined the companys financial statements and those of its competitors. Although Ragan Engines currently has a technological advantage, Dans research indicates that Ragans competitors are investigating other methods to improve efficiency. Given this, Dan believes that Ragans technological advantage will last only for the next $5$ years. After that period, the companys growth will likely slow to the industry average. Additionally, Dan believes that the required return of $13\%$ is too low. He believes that the industry average required return is more appropriate. Under Dans assumptions, what is the estimated stock price?