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.) Value of share price if it does not pursue growth strategy :

Value of Share = Expected Earning / Required Return

= 10 / 0.17

= 58.82

(b.) Value of Share price with growth

Value of share = Expected Dividend / (Required return - Growth rate)

Expected Dividend = Expected Earning * Payout ratio

= 10 * 40%

= 4

Growth rate = Return on Equity * (1 - Payout ratio)

= 0.23 * (1 - 0.40)

= 0.138 or 13.8%

Value of share = 4 / (0.17 - 0.138)

= 125

(c.) The difference in share value between the no-growth strategy and the growth strategy that St Lucia Green implements is 66.18 (125 - 58.82). Tis difference is also called present value of growth opprotunity.

(d.) We can conclude that by implementing growth plan its share price are increasing by double as in no growth strategy.So it is good to increase and implement growth strategy.