Question

CASE 2 Ryan International In the world of skateboard attire, instinct and marketing savvy are prerequisites to success. Moogy Ellis had both. During 2019, his international skateboarding company, Ryan, rocketed to $900 million in sales after 10 years in business. His fashion line covered the skateboarders from head to toe with hats, shirts, pants, shorts, sweatshirts, socks, and shoes. In L.A., there was a Ryan shop every five or six blocks, each featuring a different color. Some shops showed the entire line in mauve, and others featured it in canary yellow. Ryan had made it. The company's historical growth was so spectacular that no one could have predicted it. However, securities analysts speculated that Ryan could not keep up the pace. They warned that competition is fierce in the fad fashion industry and that the firm might encounter little or no growth in the future. They estimated that stockholders also should expect no growth in future dividends. Contrary to the conservative securities analysts, Moogy Ellis feels that the company could maintain a constant annual growth rate in dividends per share of 7% in the future, or possibly 9% for the next 2 years and 7% thereafter. Ellis based his estimates on an established long-term expansion plan into European and Latin American markets. Venturing into these markets was expected to cause the risk of the firm, as measured by the beta on its stock, to increase immediately from 1.3 to 1.5. In preparing the long-term financial plan, Ryan's chief financial officer has assigned a junior Financial analyst, Brad Harris, to evaluate the firm's current stock price. He has asked Brad to consider the conservative predictions of the securities analysts and the aggressive predictions of me company founder, Moogy Ellis.
CASE 2 Ryan International In the world of skateboard attire, instinct and marketing savvy are prerequisites to success. Moogy Ellis had both. During 2019, his international skateboarding company, Ryan, rocketed to $900 million in sales after 10 years in business. His fashion line covered the skateboarders from head to toe with hats, shirts, pants, shorts, sweatshirts, socks, and shoes. In L.A., there was a Ryan shop every five or six blocks, each featuring a different color. Some shops showed the entire line in mauve, and others featured it in canary yellow.

Ryan had made it. The company’s historical growth was so spectacular that no one could have predicted it. However, securities analysts speculated that Ryan could not keep up the pace. They warned that competition is fierce in the fad fashion industry and that the firm might encounter little or no growth in the future. They estimated that stockholders also should expect no growth in future dividends.

Contrary to the conservative securities analysts, Moogy Ellis feels that the company could maintain a constant annual growth rate in dividends per share of 7% in the future, or possibly 9% for the next 2 years and 7% thereafter. Ellis based his estimates on an established long-term expansion plan into European and Latin American markets. Venturing into these markets was expected to cause the risk of the firm, as measured by the beta on its stock, to increase immediately from 1.3 to 1.5.

In preparing the long-term financial plan, Ryan’s chief financial officer has assigned a junior financial analyst, Brad Harris, to evaluate the firm’s current stock price. He has asked Brad to consider the conservative predictions of the securities analysts and the aggressive predictions of the company founder, Moogy Ellis.

Mark has compiled these 2019 financial data to aid his analysis: Data item 2019 value
Earnings per share (EPS) $6.40
Price per share of common stock $38.00
Book value of common stock equity $60,000,000
Total common shares outstanding 5,000,000
Common stock dividend per share $4.20
Data Points:

Beta, b	Required Return, K
0	2.5%
.25	5.375%
.5	8.25%
.75	11.125%
1	14.0%
1.25	16.875%
1.5	19.75%

To Do
a.) What is the firm’s current book value per share?
b.) What is the firm’s current P/E ratio?
c.) (1) What is the current required return for Ryan stock (use CAPM)? (2) What will be the new required return for Ryan stock assuming that they expand into European and Latin American markets as planned (use CAPM)?
d.) If the securities analysts are correct and there is no growth in future dividends, what will be the value per share of the Ryan stock? (Note: use the new required return on the company’s stock here) e. (1) If Moogy Ellis’s predictions are correct, what will be the value per share of Ryan’s stock if the firm maintains a constant annual 7% growth rate in future dividends? (Note: Continue to use the new required return here.) (2) If Moogy Ellis’s predictions are correct, what will be the value per share of Ryan’s stock if the firm maintains a constant annual 9% growth rate in dividends per share over the next 2 years and 7% thereafter? (Note: Use the new required return here.) f. Compare the current (2019) price of the stock and the stock values found in parts a, d, and e. Discuss why these values may differ. Which valuation method do you believe most clearly represents the true value of the Ryan stock?

Answer 1

a.) Book value per share is the total common stock equity divided by the total common shares outstanding. Total common stock equity is preferred stock holders' equity deducted from total stockholders' equity. Total common shares are the total number of shares currently owned by the investors.

Both total common stock equity and total common shares outstanding are given in the question,

Hence substituting the values:

Book value per share = Book value of common stock equity / Total common shares outstanding

=  $60,000,000 / 5,000,000

= $12

b.) Price to earnings ratio or P/E ratio is price per share of common stock divided by earnings per share(EPS).

Hence substituting the values:

P/E ratio = Price per share of common stock / EPS

= 38 / 6.40

= 5.9375

c.) The question clearly states the beta( $\beta$ ) and the corresponding required rate.

Hence , 1) required rate = 16.875%

2) required rate = 19.75%

d.) To find the value per share when there is no growth in future dividends, we use the dividend discount model. Here,

Required Return = (Expected dividend payment / Share price of stock) + Expected dividend growth rate

From the above equation, Share price of stock = Expected dividend payment / (Required return - Expected dividend growth rate).

We have already calculated, Required return = 19.75 % , expected dividend growth = 7 % ( since there is no growth )

And from the question, Expected dividend payment = $ 4.20

Substituting the above values:

Share price of stock = 4.20 / (0.1975- 0.07)

= $32.94