**Mini Case “Stock Valuation at Ragan Engines”**

**Answers to all 6 questions from case study “Stock Valuation at Ragan Engines” provided. **

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**Question 1: Calculate the value per share of the company’s stock at Ragan Engines.**

** Solution**

Total dividend paid = $640,000

Total earnings = $300,000 x 5.35 = $1,605,000

Payout Ratio = $640,000/$1,605,000 = 0.39

Retention Ratio = 1 – PR = 1 – 0.39 = 0.61

g = ROE x b = 0.21 x 0.61 = 0.13 or 13%

D_{0} = $320,000/$150,000 = 2.13

P_{0} = D_{1}/(R – g) = $640,000(1.18)/(0.18 – 0.13) = $13,413,286.96

*Concluding, the per share value of company stock will be (13,413,286.96/300,000) = $44.74 dollars approximately. *

**Question 2: What is the estimate of stock price?**

**Solution:**

*As analyst has done a write-off in order to affect the real answer calculated, so we must also re-calculate it as:*

EPS of industry = (1.19 + 1.26 + 2.07)/3 = 1.51

Payout Ratio of industry = 0.44/1.51 = 0.2898

Retention Ratio of industry = 1 – 0.2898 = 0.7102

g = ROE x b = 0.11 x 0.7102 = 0.0781

*Also, it is mentioned that company will be continuing to grow in next five years and the sequence of growth will be as:*

D_{1} = $640,000(1.1263) = $720,807.48; D_{2} = $720,807.48(1.1263) = $811,817.84; D_{3} = $811,817.44(1.1263) = $914,319.33; D_{4} = $914,319.33(1.1263) = $1,029,762.82; D_{5} =

41,029,762.82(1.1263) = $1,159,782.41; and D_{6} = $1,159,762.41(1.0781) = $1,250,384

*Now the price of stock in the 5th year with required return of industry will be:*

Stock value in 5th year = $1,250,384/(0.15 – 0.0781) = $17,395,308.29

Today-Value of Stock = 720,807.48/1.15 + 811,817.84/1.15^{2} + 914,319.33/1.15^{3} + 1,029,762.82/1.15^{4} + (1,159,782.41 + 17,395,308.29)/1.15^{5}

Today-Value of Stock = $11,655,749.48

**Question 3: ****What is the industry average price****–****earnings ratio? What is Ragan’s price****–****earnings ratio? Comment on any differences and explain why they may exist.**

**Solution **

Value per share = $11,655,749.48/300,000 = $38.85

After revision, industry PE ratio will be = 18.08/1.51 = 12

Original assumption – Ragan Inc. PE ratio = 44.71/5.35 = 8.36

Revised assumption – Ragan Inc. PE ratio = 38.85/5.35 = 7.26

*In my opinion, there is positive correlation existed between the two calculated ratios which means that if the price-earnings ratio of industry will increase, the price-earnings ratio of Ragan Inc. will also increase and vice versa in the case of decrease. *

**Question 4:**** Assume the company’s growth rate declines to the industry average after five years. What percentage of the stock’s value is attributable to growth opportunities?**

**Solution**

The company’s total earnings being paid out as dividends must be considered as cash cow are as follows;

Total earnings = 2(150,000 shares)($5.35) = $1,605,000

Cash cow value of Ragan Inc. = 1,605,000/0.15 = $10,700,000

Total stock value from question 2 is $11,655,749.48

The percentage of income which is not attributable towards the growth margin will be calculated as;

= 10,700,000/11,655,749.48 = 0.9180

Percentage of company income attributable to growth = 1 – 0.9180 = 0.0820 or 8.20%

**Question 5: ****Assume the company’s growth rate slows to the industry average in five years. What future return on equity does this imply?**

**Solution**

*Assumption that question 2has all correct answers;*

g = ROE × b

0.0781 = ROE(0.6012)

ROE = 0.0781/0.6012 = 0.1299

**Question 6: Solution**

*The stock price can easily be increased in this case by issuance of more dividends to shareholders. The stock price has been calculated as:*

D/(R – g)

*But in case of lowering growth rate, this strategy will not be helpful for Ragan Inc. in increasing the stock price. *