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CHAPTER 8
STOCK VALUATION AT RAGAN, INC.
1. The total dividends paid by the company were $90,000. Since there are 100,000 shares outstanding,
the total earnings for the company were:
This means the payout ratio was:
So, the retention ratio was:
Using the retention ratio, the company’s growth rate is:
g = ROE × b
The dividend per share paid this year was:
Now we can find the stock price, which is:
P0 = D1/(R – g)
2. Since Expert HVAC had a write off which affected its earnings per share, we need to recalculate the
industry EPS. So, the industry EPS is:
Using this industry EPS, the industry payout ratio is:
CHAPTER 8 C-2
So, the industry retention ratio is:
This means the industry growth rate is:
The company will continue to grow at its current pace for five years before slowing to the industry
growth rate. So, the total dividends for each of the next six years will be:
D1 = $.90(1.1214) = $1.01
D2 = $1.01(1.1214) = $1.13
The stock price in Year 5 with the industry required return will be:
This means the total value of the stock today is:
3. Using the revised industry EPS, the industry PE ratio is:
Using the original stock price assumption, Ragan’s PE ratio is:
Obviously, using the original assumptions, Ragan’s PE is too high. The PE using the revised
assumptions is close to the industry PE ratio. Using the industry average PE, we can calculate a
stock price for Ragan, which is:
CHAPTER 8 C-3
4. If the ROE on the company’s projects exceeds the required return, the company should retain
earnings and reinvest. If the ROE on the company’s projects is lower than the required return, the
5. Again, we will assume the results in Question 2 are correct. The growth rate of the company we
g = ROE × b
If we assume the payout ratio remains constant, the ROE is:
6. The most obvious solution is to retain more of the company’s earnings and invest in profitable
