Question

St Lucia Green Ltd. is a company that makes eco-friendly products. It is expected that the company will achieve an EPS of AUD 10 next year. The company’s current payout ratio is 40%. The required rate of return is 17%. Its return on equity is 23%.

a) What is the share price of St Lucia Green Ltd. if it does not pursue a growth strategy?

b) Suppose St Lucia Green now has a plan to pursue a growth strategy. Calculate its share price.

c) What is the difference in share value between the no-growth strategy and the growth strategy that St Lucia Green implements?

d) What can you conclude about this difference in relation to its growth plan?

Answer 1

a. Share price when the company St lucia green ltd doesn't pursue growth strategy:

Dividend pay out ratio = 1- Payout ratio

Given payout ratio is 40%

Eps = 10 AUD

So dividend per share = 10 AUD * 40% = 4 AUD

Rate of return =17%

Price (P0) = dividend / rate of return

Substitute values in above formula = 4AUD/17%

Price of the share without growth strategy= 23.53 AUD.

b) Calculation of price of the share with growth strategy:

Growth rate = retention ratio * return on equity

Given Payout ratio= 40%   

Retention ratio = 1- payout ratio= 1-40%

So retention ratio= 60%

Growth rate= 60%*23% = 13.8%

Price of the share = D/(Ke-g)

Where D= dividend per share

. Ke= rate of return

. g= Growth rate

So price = 4 AUD/(17%-13.8%)

So price = 125 AUD.

C) share price as per no growth strategy=23.53AUD

Share price as per growth strategy = 125 AUD

Difference in Share value as per non - growth strategy and growth strategy = 23.53AUD- 125 AUD= (101.47)

d) Share price is much more higher when the company adopts growth plan so its better to adopt growth strategy.