Ragan Engines, Inc., was founded nine years ago by a brother and sister-- Carrin
ID: 2737633 • Letter: R
Question
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 engine 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 in 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 her Ragan's competitors that are publicly traded; (chart shown in picture). Nautilus Marine Engines' negative earnings per share (EPS) was the result of an accounting write-off last year. Without the write-off, EPS for the company would have been $1.75. Last year, Ragan had an EPS of $4.10 and paid a dividend to Carrington and Genevieve of $215,000 each. The company also had a return on equity of 18 percent. Larissa tells Dan that a required return for Ragan of 13 percent is appropriate. 1. Assuming the company continues its current growth rate, what is the value per share of the company stock? 2. Dan has examined the company's financial statements, as well as examining those of its competitors. Although Ragan currently has a technology advantage, Dan's research indicates that Ragan's competitors are investigating other methods to improve efficiency. Given this, Dan believes that Ragan's technological advantages only last 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 for 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 oh? What is Ragan's price earnings ratio? Comment on any differences and explain why they may exist. 4. Assume the company's growth rate slows to the industry average in five years. What future return on equity does this imply? 5. Carrington and Genevieve are not sure if they should sell the company. If they do not sell the company out right to east coast yachts, they would like to try and increase the value of the company 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 the strategy would not increase the stock price?Explanation / Answer
1)Dividend per share=215000/125000=1.72
Retention ratio=1-Dividend per share/EPS =1-1.72/4.10=0.5804878
Thus the growth rate=Retention ratio*Return on Equity=0.5804878*0.18=0.104487804 (~10.45%)
Value of company stock according to Gordon growth model
=Dividend per share*(1+growth rate)/(required return-growth rate)
=1.72*(1+0.104487804)/(0.13-0.104487804)
=74.46
Thus Ragan's stock price is $74.46.
2)
3)Industry avg P/E= 20.76/0.77=26.96
Ragan P/E=98.82/4.10=24.10
The Ragan P/E is lower comparatively which indicates that Ragan has less price as compared to its earnings. The price of Ragan is too high as compared to industry and the earnings per share is also too high due to private shareholders.
4)Return on equity=(1-.46/.77)*12.5%/0.5804878 = 8.67%
growth for first 5 yrs 10.45% (=g=(1-1.72/4.10)*18% growth after 5 yrs 5.03% (=gL=(1-.46/.77)*12.5%) rate of return 7.36% (=r=(.46*(1+gL)/20.76)+gL)) PV CF Year(t) Dividend(Dt) HorizonValue CF=Dt+TV (=CF/(1+r)^t 0 1.72 1 1.900 1.900 1.7695 2 2.098 2.098 1.8204 3 2.317 2.317 1.8728 4 2.560 2.560 1.9267 5 2.827 127.5859 130.413 91.4350 6 2.969 current stock value $ 98.82 (Horizon Value=Div in year 6/(r-gL) (=P0=sum of above PVs) Div in yr 6=Div in yr 5*(1+gL),Div in yr t=Div in yr (t-1)*(1+g) for first 5 yearsRelated Questions
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