Reference no: EM133153358

Question - Raglan Stores PLC has grown rapidly since its stock market flotation five years ago. Despite its rapid growth the company has been able to finance all its new development from retained earnings and employs no debt in its capital structure. The company's earnings for the year that has just ended was 80€ MILLION, a new high, and with 200 million shares outstanding this produced EPS (earnings per share) of 40p. Last year the company re-invested 80% of its earnings and recorded a rate of growth of earnings 32%, well above the minimum rate of return of 20% sought by investors in its sector of the market. Exactly this growth is also expected for next year for the earnings.

The company has now opened stores in all the larger cities in the UK and new stores it plans to open will be located in towns with smaller markets that will produce lower turnover and profits per store. For the next 4 years or so it is anticipated that expansion will continue to be profitable, but less so than in the past even if the process is managed with the same degree of efficiency that has characterised the company's development over the last few years. As the coverage of the UK market becomes more complete it is planned to reduce the amount of annual investment. It is anticipated that the company will again invest 80% of its earnings next year, 60% of its earnings the following year and 40% the subsequent year.

It is expected that the rate of return on new investment will fall to 35% next year, 30% the year after, and 25% three years from now. After the next three years management believes that there is unlikely to be scope for any investment offering internal rates of return of more than 20%. With the disappearance of opportunities for profitable growth it is intended in 4 years time to increase the dividends to 75% of earnings.

Required -

1. Estimate the value of the company using both the dividend and earnings based models, as well as the current price of the company's shares. Set out the assumptions on which the models are based and discuss how appropriate they appear to be in this context. Determine the contribution of Growth opportunities to the estimated value of the company.

2. How would the value of the company change if the required Rate of Return was 15% ? Alternatively if it was 25%? Comment on your reply.

3. Determine the expected price/earnings ratio today. Explain the determinants of the PE in reference to the two valuation models used.