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Ragan, Inc
Ragan, Inc., was founded nine years ago by brother and sister John and Mary Ragan. The company manufactures and installs commercial heating, ventilation, and cooling (HVAC) units. Ragan, Inc., has experienced rapid growth because of a proprietary technology that increases the energy efficiency of its units. The company is equally owned by John and Mary. The original partnership agreement between the siblings gave each 50,000 shares of stock. In the event either wished to sell the stock, the shares first had to be offered to the other at a discounted price.
Although neither sibling wants to sell, they have decided they should value their holdings in the company. To get started, they have gathered the following information about their main competitors (EPS: earnings per share, DPS: dividends per share, ROE: return on equity, R: cost of capital)
|
Ragan, Inc. - Competitors |
||||||
|
EPS |
DPS |
Stock Price |
ROE |
R |
||
|
Arctic Cooling, Inc. |
$ 0.82 |
$ 0.16 |
$ 15.19 |
11% |
10% |
|
|
National Heating & Cooling |
$ 1.32 |
$ 0.52 |
$ 12.49 |
14% |
13% |
|
|
Expert HVAC Corp. |
$ (0.47) |
$ 0.40 |
$ 11.47 |
14% |
12% |
|
|
Industry average |
$ 0.56 |
$ 0.36 |
$ 13.05 |
13% |
11.67% |
|
1) Assume the company's growth rate declines to the industry average after five years. What percentage of stock's value is attributable to growth opportunities?
2) Assume Company's growth rate slows to the industry average in five years. What future return on equity does this imply?
Expert Solution
| To find growth rate for Raga Inc. |
| g=Return on equity*Retention Ratio |
| ROE= 25% ie. 0.25 |
| Retention ratio =1-Dividend payout ratio |
| Dividend= 54000*2=108000; DPS=108000/100000= 1.08 |
| Dividend pay-out ratio= 1.08/4.32= 0.25 or 25% |
| RR=1-0.25= 0.75 |
| So,g=0.25*0.75= 0.1875 ie. 18.75% |
| Value or Price of Raga Inc. stock= Next yr's dividend/(Reqd.return- growth rate) |
| (1.08*1.1875)/(0.20-0.1875) |
| 102.6 |
| To find growth rate as per Industry average |
| g=Return on equity*Retention Ratio |
| ROE= 13% ie. 0.13 |
| Retention ratio =1-Dividend payout ratio |
| Dividend pay-out ratio= 0.36/0.56= 0.64 or 64% |
| RR=1-0.64= 0.36 |
| So,g=0.13*0.36= 0.0468 ie. 4.68% |
| Value or Price of Raga Inc. stock= Next yr's dividend/(Reqd.return- growth rate)(assuming this growth rate &industry COC |
| (1.08*1.0468)/(0.1167-0.0468) |
| 16.17 |
| 3.Industry P/E ratio= Market price/EPS=13.05/0.56=23.30 |
| Same P/E ratio for Ragan Inc. |
| Stock price will be |
| Price/4.32=23.3 |
| So,Price= 100.66 |
| 4. 20% more than 23.3 = 27.96 (P/E Ratio of Raga Inc.) |
| Stock price will be |
| Price/4.32=27.96 |
| So,Price= 120.79 |
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