Question

Ryan International

In the world of skateboard attire, instinct and marketing savvy are prerequisites to success. Moogy Ellis had both. During 2015, 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 8% in the future, or possibly 10% for the next 2 years and 8% thereafter. Ellis based his estimates on an established long-term expansion plan into European and Latin American markets. Venturing into these markets is expected to cause the risk of the firm, as measured by the beta on its stock, to increase immediately from its current beta of 1.1 to a beta of 1.25.

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 2015 financial data to aid his analysis:

Data item		2015 value
Earnings per share (EPS)		$2.30
Price per share of common stock		$25.25
Book value of common stock equity		$60,000,000
Total common shares outstanding		20,000,000
Common stock dividend per share		$1.50
Data Points
Beta, b	Required Return, K
0	2.0%
.25	4.5%
.5	7.0%
.75	9.5%
1	12.0%
1.25	14.5%
1.5	17%

To Do (PLEASE COMPLETE PARTS A-F USING EXCEL - SHOW ALL FORMULAS USED)

1. What is the firm’s current book value per share?
2. What is the firm’s current P/E ratio?
3. (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 8.0% 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 10% growth rate in dividends per share over the next 2 years and 8% thereafter? (Note: Use the new required return here.)

f. Compare the current (2015) 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 and WHY?

Answer 1

a). Book value per share = total book value/shares outstanding

= 60,000,000/20,000,000 = $3 per share

b). Current P/E ratio = price per share/EPS = 25.25/2.30 = 10.98

c-1). Required return (using CAPM) = risk-free rate + beta*(market return - risk-free rate)

= 2% + 1.1*(12%-2%) = 13%

c-2). New required rate of return if they expand

= risk-free rate + beta*(market return - risk-free rate)

= 2% + 1.25*(12%-2%) = 14.50%

d). Value per share (assuming no growth model) = dividend per share/required return = 1.50/14.50% = $10.34 per share

e-1). Value per share (assuming constant growth model) = dividend per share*(1+growth rate)/(required return-growth rate) = 1.50*(1+8%)/(14.50%-8%) = $24.92 per share

e-2). Value per share = $25.83 per share

f). Except for the value derived using the no growth model ($10.34 per share), all other values are greater than the book value of $3 per share. The no growth model does not appear to be suitable for deriving the value of the firm because the firm does appear set to grow aggressively. In such a scenario, a high growth rate for few years and then a constant growth rate for perpetuity seems appropriate so the value of $25.83 per share should be the true value of the firm.