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 com

pany'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 sisterCarrington

and Genevieve Raganand 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.

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.

Bon Voyage Marine, Inc.

Nautilus Marine Engines

Industry average

$1.09

1.26

(.27)

$ .69

$.19

.55

.57

$.44

$16.32

13.94

23.97

$18.08

10.00%

12.00

N/A

11.00%

12.00%

17.00

16.00

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.

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

the company's stock?

2. Dan has examined the company's financial statements, as well as examining 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 aver

age. 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 assump

tions, what is the estimated stock price?

3. 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.

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

and increase the price of the stock? Are there any conditions under which this strategy

would not increase the stock price?

MINI CASE WORTH 15 MARKS