Question 2

2 a)

Brecon ple's expected earnings for next year is 200 million and is expected to pay out 60 per cent of

the earnings in the form of dividends. The retentions of 40 per cent of earnings will be reinvested in

the company to expand its assets and thereby to allow its earnings and dividends to increase in

subsequent years. The company is expected on this basis to maintain a growth rate of 6 per cent

indefinitely into the future. Given shareholders require a rate of return of 12 per cent on their shares

derive a value for the company and an estimate of the proportion of this value that is accounted for

by its growth potential.

2 b)

Penarth pl is expected to produce earnings per share of f10.00 next year and it is anticipated that the

company will pay a dividend of 60 per cent of its earnings as dividends. The residual earnings will be

retained to finance investment in the expansion of the company's assets. The growth rate in earnings

as a result of the investment of retentions is expected to be 10 per cent per annum. The company is

anticipated to maintain paying out of 60 per cent of earnings as dividends, with 40 per cent of earnings

being retained for investment into the future indefinitely into the future. But it is also anticipated that

after 4 years the growth rate of earnings will fall to 5 per cent per annum as a result of increasing

competition in Penarth's markets. It is however assumed that the 5 per cent growth rate can be

maintained indefinitely into the future.

The required rate of return in the market for the shares in Penarth has been estimated at 12 per cent.

Determine a value for a share the company and the rate of returns on the company's investments

underlying the growth rates of 10 per cent and 5 per cent.