Mini Case: STOCK VALUATION AT RAGAN ENGINES Larissa has been talking with the company's directors about the future of East Coast Yachts. To this 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 Engines, Inc., Ragan 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 increases the fuel efficiency of its engines vwith 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. 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: Stock Price EPS DPS ROE Blue Ribband Motors Corp. $1.09 $16 $15.19 1.00% 14.00% Bon Voyage Marine Inc. Nautilus Marine Engines L.16 52 12.49 14.00 19.00 (32 54 23.05 18.00 N/A $4 17.00 % Industry average $.64 $16.9 13.00% 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 $1.97. Last year, Ragan had an EPS of $5.08 and paid a dividend to Carrington and Genevieve had a return on equity of 25 percent. Larissa tells Dan that a required return for Ragan of 20 percent is appropriate. $320,000 each. The company also 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 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? 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. Assume the company's growth rate declines to the industry average after five years. What percentage the stock's value is attributable to growth opportunities? Assume the company's growth rate slows to the industry average in five years. What future return on equity does this imply? 5 they should sell the company, If they do not sell the 6 Carrington and Genevieve are not sure company outright to East Coast Yachts, they would like to try and increase the value of the company's stock. stock to outside investors. They all the company and do not want to sell n this case, they want to retain control Wh e mpany s debt is at a manageable level and do stock? Are there any conditions under which this strategy would not increase the stock price? Mini Case: STOCK VALUATION AT RAGAN ENGINES Larissa has been talking with the company's directors about the future of East Coast Yachts. To this 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 Engines, Inc., Ragan 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 increases the fuel efficiency of its engines vwith 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. 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: Stock Price EPS DPS ROE Blue Ribband Motors Corp. $1.09 $16 $15.19 1.00% 14.00% Bon Voyage Marine Inc. Nautilus Marine Engines L.16 52 12.49 14.00 19.00 (32 54 23.05 18.00 N/A $4 17.00 % Industry average $.64 $16.9 13.00% 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 $1.97. Last year, Ragan had an EPS of $5.08 and paid a dividend to Carrington and Genevieve had a return on equity of 25 percent. Larissa tells Dan that a required return for Ragan of 20 percent is appropriate. $320,000 each. The company also 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 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? 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. Assume the company's growth rate declines to the industry average after five years. What percentage the stock's value is attributable to growth opportunities? Assume the company's growth rate slows to the industry average in five years. What future return on equity does this imply? 5 they should sell the company, If they do not sell the 6 Carrington and Genevieve are not sure company outright to East Coast Yachts, they would like to try and increase the value of the company's stock. stock to outside investors. They all the company and do not want to sell n this case, they want to retain control Wh e mpany s debt is at a manageable level and do stock? Are there any conditions under which this strategy would not increase the stock price