Regan Inc. was founded nine years ago by the brother and sister Carrington and Genevieve Regan. The company produces and installs commercial ventilation, heating, and cooling (HVAC) units. Regan, Inc. has experienced a fast enlargement because of a proprietary technology that raises the energy efficiency of its units. The company is equally owned by the Carrington and Genevieve. The original partnership agreement between the siblings gave each 50.000 shares of stock; the shared first had to be offered to the other at a discounted price.
Though neither sibling desires to sell, they have decided they must value their holdings in the company. To get started, they have collected the detail about their main competitors in the table below.
Ragan, Inc., competitors
EPS DPS Stock price ROE R
Arctic cooling, Inc. $ 1.30 $ .15 $25.34 9.00% 10.00%
National heating and cooling $ 1.95 $ .22 $29.85 11.00% 13.00%
Expert HVAC corp. (.37) value is in minus $ .12 $ 22.13 10.00% 12.00%
The Industry Average $ .96 $ .16 $ 25.77 10.00% 11.67%
Questions:
1- Supposing the company continues its current growth rate, what is the value per share of the company’s stock?
2- To verify their computation. Carrington and Genevieve have hired Josh Schlessman as a consultant. Josh was previously an equity analyst and covered the HVAS industry. Josh has determined the company’s financial statement, as well as determining its competitors. Though Regan Inc. currently has a technological benefit, his research indicates that other companies are investigating techniques to improve effectiveness. 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 enlargement average. Additionally Josh thinks that the required return used by company is too high. He thinks the industry average required return is more appropriate. Under this growth assumption, what is your estimate of the stock price?
3- What is the industry average price-earnings ratio? What is price-earning ration for Reagan Inc.? Is this the relationship you would expect between the two ratios? Why?
4- Carrington and Genevieve are unsure of how to interpret the price-earnings ratio after some head scratching. They have come up with the following expression for the price-earnings ratio:
P0/E1 = 1-b / R –(ROE * b)
Beginning with dividend growth model, prove this result. What does this expression imply about the relationship between the dividend payout ratio, the needed return on stock, and the company’s ROE?
5- Suppose the company’s growth rate slows to industry average in five years. What prospect return on equity does this imply, supposing a constant payout ratio?
6- After discussing the stock value with Josh. Carrington and Genevieve agree that they would like to raise the value of the company stock. Like many small business owners, they want to retain control of company, but they don’t 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. How can they increase the price of the stock? Are there any conditions under which this strategy would not increase the stock price?