Case 2 Goodwind Tires

Case#1
Stock Valuation at Ragan Engines

Ans. 1

EPS= $5.08
No. of shares= 300,000 r=20% ROE=25%
DPS=Total dividend/No. of shares=640000/300000=$2.13

Net income = EPS*No. of shares =5.08*300000 =1524000 g=Retention ratio*ROE =[1-(640000/1524000)*0.25 = (1-0.42)*0.25 =0.58*0.25=0.145=14.5%

Po=D1/r-g =Do (1+g)/r-g =2.13(1+0.145)/0.20-0.145 =2.43885/0.055 = $44.34

Ans. 2

Industry growth rate g = Retention ratio*ROE = (1-0.41)*0.13 = 0.59*0.13 = 7.67%

For the initial 5 years company will grow at actual growth rate and afterwards it will grow at industry’s growth rate.

P6=D7/r-g =5.48/0.17-0.0767 =5.48/0.0933 =$58.73

Po=2.44/ (1.17) + 2.79/ (1.17)2 +3.19/ (1.17)3 +3.65/ (1.17)4 +4.18/ (1.17)5 +4.79/ (1.17)6 + 58.73/ (1.17)6

= 2.09+2.04+1.99+1.95+1.91+1.87+22.89 =$34.74

Ans. 3

P/E ratio = Stock’s price/EPS Industry’s P/E ratio= 16.91/0.64 = 26.42

Ragan Engine’s P/E ratio= 44.34/5.68 = 8.73

Higher P/E ratio refers to better growth opportunities. Since Industry’s P/E is higher than Ragan Engine’s P/E, it implies that industry has better growth opportunities than Ragan Engines.

Ans. 4

Ragan Engine’s stock price without growth opportunities=

Po=P1/r =2.13/0.17 =$12.53

The percentage of the stock’s value attributable to growth opportunities= (44.34-12.53)/44.34 = 71.74%

Ans. 5

g = ROE * Retention ratio

ROE= g/Retention ratio = 0.0767/0.59 = 13%

Ans.6

For Ragan Engines Inc., ROE>r. In this case, the price per share increases with the retention ratio. So, if the company wants to increase the price of the stock, it should increase its retention ratio because an increase in the retention ratio implies an increase in the number of