th edition, by Ross, Westerfield and Jaffe>

STOCK VALUATION AT RAGAN ENGINES

Larissa has been talking with the companys directors about the future of East Coast Yachts. To this point, the company has used outside suppliers for various key components of the companys 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 Ragans 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.

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 Ragans competitors that are publicly traded:

Nautilus Marine Enginess 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 companys stock?

2. Dan has examined the companys financial statements, as well as examining those of its competitors. Although Ragan 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 five years. After that period, the companys 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 Dans assumptions, what is the estimated stock price?

3. What is the industry average priceearnings ratio? What is Ragans priceearnings ratio? Comment on any differences and explain why they may exist.

4. Assume the companys growth rate declines to the industry average after five years. What percentage of the stocks value is attributable to growth opportunities?

5. Assume the companys 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 companys 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 companys 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?

Blue Ribband Motors Bon Voyage Marine, Inc. Nautilus Marine Engine Industry average EPS $1.09 1.26 (27) $.19 .55 .57 $ .73 $.44 DPS Stock Price ROE $16.32 13.94 23.97 $18.08 10.00% 2.00 N/A 1 1 .00% 12.00% 17.00 16.00 15.00% Corp