Calculate average price-earnings ratio, Finance Basics

Regan Inc., was founded nine years ago by brother and sister Carrington and Genevieve Regan. The company manufactures and installs commercial heating, ventilation, and cooling (HVAC) units. Regan, Inc., has experienced a rapid growth because of a proprietary technology that increases the energy efficiency of its units. The company is equally owned by 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.

Although neither sibling wants to sell, they have decided they should value their holdings in the company. To get started, they have gathered the information about their main competitors in the table below.

Ragan, Inc., competitors




Stock price



Arctic cooling, Inc.

$ 1.30

$ .15




National heating and cooling

$ 1.95

$ .22




Expert HVAC corp.

(.37) value is in minus

$ .12

$ 22.13



The Industry Average

$ .96

$ .16

$ 25.77




1-   Assuming the company continues its current growth rate, what is the value per share of the company's stock?

2-  To verify their calculations. Carrington and Genevieve have hired Josh Schlessman as a consultant. Josh was previously an equity analyst and covered the HVAS industry. Josh has examined the company's financial statement, as will as examining its competitors. Although Regan 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 assumption, what is your estimate of the stock price?

3-  What is the industry average price-earnings ratio?What is the 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-earning ratio:

 P0/E1 = 1-b / R -(ROE * b)

Beginning with the dividend growth model, verify this result. What does this expression imply about the relationship between the dividend payout ratio, the required return on the stock, and the company's ROE?

5-  Assume the company's growth rate slows to the industry average in five years. What future return on equity does this imply, assuming a constant payout ratio?

6-   After discussing the stock value with Josh. Carrington and Genevieve agree that they would like to increase the value of the company stock. Like many small business owners, they want to retain control of the company, but they do not 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?

Posted Date: 3/7/2013 4:39:03 AM | Location : United States

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