# Chapter 9 case

Name: Thi Diem Thu, Le Chapter 9 Case: STOCK VALUATION AT RAGAN ENGINES 1. The company is equally owned by Carrington and Genevieve. The original agreement between the siblings gave each 150,000 shares of stock. ? There are 300,000 shares outstanding Last year, Ragan paid a dividend to Carrington and Genevieve of \$320,000 each ? total dividend paid is \$640,000 Total earnings = 300,000(\$5.08) = \$1,524,000 ?Payout ratio = \$640,000/\$1,524,000 = 0.4199 or 41.99% ?Retention ratio = 1 – 0.4199 = 0.5801 or 58.01% ? The company’s growth rate is:g = ROE ×b = 0.25(0.5801) = 0.145 or 14.5% ?Total equity value = D1 / (R – g)= \$640,000(1.145) / (0.20 – 0.145)= \$13,326,938 ?Value per share = \$13,326,968 / 300,000= \$44.42 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, so we need to recalculate the EPS ?Industry EPS = (\$1.09 + 1.16 + 1.97) / 3 = \$1.41 ?Industry payout ratio = \$0.41/\$1.41 = 0.2891 or 28.91% ?Industry retention ratio = 1 – 0.2891 = 0.7109 or 71.09% ?Industry growth rateg= 0.13(0.7109) =0.0924 or 9.24% 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 average. So, the total dividend for the next six years is: D1 = \$640,000.00(1.145) = \$732,808.40 D2 = \$732,808.40(1.145) = \$839,075.23 D3 = \$839,075.23(1.145) = \$960,752.15 D4 = \$960,752.15(1.145) = \$1,100,073.82 D5 = \$1,100,073.82(1.145) = \$1,259,598.97 D6 = \$1,259,598.97(1.0924) = \$1,376,007.40 Stock value in Year 5 = \$1,376,007.40 / (0.17 – 0.0924) = \$17,735,953.67 Value of stock today = \$732,808.40/1.17 + \$839,075.23/1.172 + \$960,752.15/1.173 + \$1,100,073.82/1.174 + (\$1,259,598.97 + \$17,735,853.67) / 1.175 = \$11,090,291.00 Value per share of the stock today = \$11,090,291 / 300,000= \$36.97 3.Industry PE = \$16.91 / \$1.41 = 12.02 Ragan’s PE ratio using original assumptions = \$44.42 / \$5.08 = 8.74 Ragan’s PE ratio under Dan’s assumptions = \$36.97 / \$5.08 = 7.28

2.

As we can see that Ragan’s PE ratio is lower than the industry average PE ratio. One reason may be because the company paid out too much dividends compared to the industry. 4. Assume the company’s growth rate declines to the industry average after five years, so we also assume that the rate of return is the industry average required return, which is R = 17% Total earnings = 2(150,000 shares)(\$5.08)= \$1,524,000 From question 2, we have the value of stock is \$11,090,291 ?Percentage of value not attributable to growth opportunities =
\$8,964,705.88 (\$1,524,000 / 0.17) = \$11,090,291 \$11,090,291

=

0.8083 ?Percentage of value attributable to growth opportunities = 1 – 0.8083 = 0.1917 or 19.17% 5. We have the growth rate as following: g = ROE × b = 0.0924 -->ROE = 0.0924/0.5801 = 0.1593 or 15.93% 6. The steps that Carrington and Genevieve can take to try and increase the price of the stock is that they should not take too much dividends. They are major stockholders and took 320,000 as dividends, this amount is nearly half of the earnings last year. Therefore, the company should retain more earnings to invest in some promising projects or opportunities. However, this strategy may not work and the price of stock will not increase if the investments fail and lead to lower profit.

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