Question

were the result of an accounting write-off last year. Without MINICASE Stock Valuation at Ragan, Inc. Ragan, Inc., was founded nine years ago by brother and sis started, they have gathered the information about their main ter Carrington and Genevieve Ragan. The company man competitors in the table below. ufactures and installs commercial heating, ventilation, and Expert HVAC Corporation's negative earnings per share cooling (HVAC) units. Ragan, Inc., has experienced rapid growth because of a proprietary technology that increases the the write-off, earnings per share for the company would have energy efficiency of its units. The company is equally owned been $1.10. The ROE for Expert HVAC is based on net in. by Carrington and Genevieve. The original partnership agree come excluding the write-off. ment between the siblings gave each 50,000 shares of stock. Last year, Ragan, Inc., had an EPS of $3.15 and paid a In the event either wished to sell stock, the shares first had to dividend to Carrington and Genevieve of $45,000 each. The be offered to the other at a discounted price. company also had a return on equity of 17 percent. The sib. Although neither sibling wants to sell, they have decided lings believe that 14 percent is an appropriate required retum they should value their holdings in the company. To get for the company. Arctic Cooling, Inc. National Heating & Cooling Expert HVAC Corp. Industry Average Ragan, Inc., Competitors EPS DPS Stock Price $1.30 $.16 $25.34 1.95 23 29.85 -.37 .14 22.13 $.96 $.18 $25.77 ROE 8.50% 10.50 9.78 9.59% R 10.00% 13.00 12.00 11.67%

2. To verify their calculations, Carrington and Genevieve have hired Josh Schlessman as a consultant. Josh was previously an equity analyst and covered the HVAC in- dustry. Josh has examined the company’s financial state- ments, as well as examining its competitors. Although Ragan, Inc., currently has a technological advantage, his research indicates that other companies are investigating methods to improve efficiency. Given this, Josh believes that the company’s technological advantage will last only for the next five years. After that period, the company’s growth will likely slow to the industry growth average. Additionally, Josh believes that the required return used by the company is too high. He believes the industry average required return is more appropriate. Under this growth rate assumption, what is your estimate of the stock price?

Answer 1

Ragan Inc.'s growth rate for the 1st five years

EPS= 3.15

DPS= (45000+45000)/100000=0.90

So, retention=3.15-0.9= 2.25

Retention ratio= 2.25/3.15=71.43%

Growth rate, g= ROE*RR

ie.17%*71.43%=

12.14%

The above 12.14% is the growth rate for the next 5 yrs.

Given that

After 5 yrs. the company’s growth will likely slow to the industry growth average

we will find the industry average growth rate

Industry average EPS =(1.30+1.95+1.10)/3=1.45

(taking Expert HVAC's normal EPS)

Now, Industry average pay-out ratio= DPS/EPS=

0.18/1.45=

12.41%

Industry retention ratio=

RR=1-Dividend pay-out ratio

ie. 1-12.41%=87.59%

Now, the industry average growth rate= Ind. Av.ROE*Ind. Av. RR

ie.9.59%*87.59%=

8.40%

To find the estimate of the stock price

we will estimate the dividend cash flows for the first 5yrs. At ragan's growth rate of 12.14% p.a.

& then find the terminal value/stock price at end yr. 5 using industry average growth rate of 8.40% p.a.& ind. Av. RRR -11.67%

& then discount all CFs using the industry average reqd. return of 11.67%

Year/D0=0.9	Dividend CFs		PV F at 11.67%	PV at 11.67%
D1	0.9*1.1214^1=	1.0093	0.89550	0.90379
D2	0.9*1.1214^2=	1.1318	0.80191	0.90759
D3=	0.9*1.1214^3=	1.2692	0.71811	0.91141
D4=	0.9*1.1214^4=	1.4233	0.64306	0.91525
D5=	0.9*1.1214^5=	1.5960	0.57586	0.91910
Terminal value	(1.5960*1.0840)/(11.67%-8.40%)=	52.90716	0.57586	30.46715
				35.02429
				35.02

So, the estimated stock price= $ 35.02   (ANSWER)