Question

Mini Case

Share Valuation At Gold Coast Constructions.

Gold Coast Constructions was founded nine years ago by siblings Elise and Paul Nelson. The company constructs prestige homes in the Gold Coast region of Queensland. Gold Coast Constructions has experienced rapid growth because a number of celebrity customers have used them to build their homes on the new canal developments. The company is equally owned by Elise and Paul. The original partnership agreement gave each sibling 50,000 shares. In the event that either wished to sell their shares, the shares first had to be offered to the other partner 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 following information about their main competitors:

Gold Coast Constructions’ competitors	EPS	DPS	Share Price	ROE	R
Aaron cool homes	$1.30	$0.16	$25.34	8.5%	10%
National Celebrity Homes	1.95	0.23	29.85	10.5	13
Expert Homes	-0.37	0.14	22.13	9.78	12
Industry average	$0.96	$0.18	$25.77	9.59%	11.67%

Expert Homes Ltd negative earnings per share were the result of an accounting write-off last year. Without the write-off, earnings per share for the company would have been $1.10. Last year, Gold Coast Constructions had an EPS of $3.15 and paid a dividend to Elise and Paul of $45,000 each. The company also had a return on equity of 17%. The siblings believe that 14% is an appropriate required return for the company.

Questions.

1. Assuming the company continues its current growth rate, what is the value per share of the company’s shares?

2. To verify their calculations Elise and Paul have hired Josh Schessman as a consultant. Josh was previously an equity analyst and covered the building industry. Josh has examined the company’s financial statements, as well as those of their competitors. Although Gold Coast Constructions currently has a reputational advantage, his research indicates that other companies are investigating ways to improve their own standing. Given this, Josh believes that Gold Coast Constructions’ reputational advantage will last only for the next five years. After that period, the company’s growth will probably 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 rate assumption, what is your estimate of the share price?

Answer 1

Answer1.

As per Gordon Growth Model,

Value per Share = D0*(1+g) / r – g

where;

D0   = Current Value of Dividend

r     = appropriate required rate of return = 0.14 or 14%

g    = dividend growth rate

∴ In order to find the value per share of the company shares, we need to find out the following :

1. Total Earnings = Current EPS x no. of outstanding shares

                                 = $3.15 x (50,000 + 50,000)

                                 = $315,000

2. Dividend Payout Ratio = Total Dividend Paid ÷ Total Earnings

                                     = (45,000 + 45,000) ÷ $315,000

                                     = 0.2858 or 28.57%

3. Dividend per Share = Total Dividend Paid ÷ no. of outstanding shares

                                = $(45,000 + 45,000) ÷ $(50,000 + 50,000)

                                = $0.9

4. Retention ratio = 100% – Dividend Payout Ratio%

                         = 100% – 28.57%

                         = 71.43%

5. Growth Rate (g) = Retention ratio x Return on Equity (ROE)

                     = 71.43% x 17%

                     = 0.121431 or 12.1431%

∴ Value per Share = 0.9 * (1 + 0.121431) / (0.14 – 0.121431)

                             = $54.35 (approx)

Answer2.

Now due to the change in the required rate of return and taking the industry values, by using the same concept, the estimated value of share is as follows —

1. Industry EPS = $0.96 (given)

2. Industry DPS = $0.18 (given)

3. required rate of return = 0.1167 or 11.67%

4. ROE = 0.0959 or 9.59%

5. Industry Dividend Payout Ratio = Industry DPS ÷ Industry EPS

                                                           = 0.18 ÷ 0.96

                                                           = 0.1875 or 18.75%

6. Industry Retention ratio = 100% – Dividend Payout Ratio%

                                       = 100% – 18.75%

                                       = 81.25%

7. Industry Growth Rate (g) = Retention ratio x Return on Equity (ROE)

                                       = 81.25% x 9.59%

                                         = 0.07791875 or 7.80% (approx)

8. Dividend for the 6th year = DD x (1 + new growth rate)

                      where; DD = [Dividend per share x (1 + g)n]

    = 0.9 x (1 + 0.121431)5 x (1 + 0.07791875)

                                        = $1.720645179 or $1.72 (approx)

∴ Value of share = 1.72 ÷ (11.67% – 7.80%)

                           = $44.44 or $44.50 (approx)

Comment: Josh Schessman is correct that after 5 years period, the company’s growth will probably slow (from $54.35 to $44.5) to the industry growth average.

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