Problem 2 Emma Li successfully finished her MBA and now works as the CFO of the Great Lake Industries, a manufacturer of snowmobiles, all-terrain vehicles (ATVs), and neighborhood electric vehicles. To this point, the company has used outside suppliers for various key components of the company's vehicles, including engines. Emma has decided that Great Lake Industries should consider the purchase of an engine manufacturer to allow it to better integrate its supply chain and get more control over engine features. After investigating several possible companies, Emma feels that the purchase of Polaris Engines Inc. is a possibility. She has asked you to analyze Polaris's value. Polaris Engines Inc. was founded some years ago by a brother and sister, Richard and Kelly Polaris, and has remained a privately owned company. The company manufactures engines for a variety of applications. Polaris 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 Richard and Kelly. The original agreement between the siblings gave each 75,000 shares of stock. Emma asked you to value Polaris stock. To accomplish this, you have gathered the following information about some of Polaris's competitors that are publicly traded: Blue Motors Corp. Continental Motors Inc. Nautilus Engines Industry average EPS DPS Price ROE $1.19 $0.19 $16.32 1.26 0.55 -0.27 0.57 $0.73 $0.44 r 10.00% 12.00% 13.94 12.00 17.00 23.97 N/A 13.00 $18.08 11.00% 14.00% Nautilus Engines' negative EPS was the result of an accounting write-off last year. With- out the write-off, EPS for the company would have been $2.07. Last year, Polaris had an EPS of $5.35 and paid a dividend to Richard and Kelly of $160,000 each. The company also had an ROE of 21%. Emma tells you that the required return for Polaris is 18%. 1. Assuming the company continues its current growth rate, what is the value per share of the company's stock? 2. Although Polaris currently has a technological advantage, your research indicates that Polaris's competitors are investigating other methods to improve efficiency. Given this, you believe that Polaris'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. Addi- tionally, you believe that the required return the company uses is too high. You believe the industry average required return is more appropriate. Under these assumptions, what is the estimated stock price? 3. What is the industry average P/E ratio? What is Polaris's P/E ratio? Comment on any differences and explain why they may exist. 4. Assume the company's growth rate slows to the industry average after five years. What future ROE does this imply? What percentage of the stock's value is attributable to growth opportunities? 2