Reference no: EM132956910

Question - Gartside plc owns and manages garden centres. It is a highly profitable company and analyses very carefully possible locations for its centres. As the most profitable locations have now been exploited its management recognises that the rate of return on further investments will tend to be lower than those the company has achieved on its investments in recent years.

But while the rate of return on new investments is falling, it remains above the shareholders' required rate of return. The company has financed its growth from retentions, and will continue to do so for the next few years. It is anticipated that the company's earnings next year will be £40 million, and the company will reinvest 80 per cent of its earnings. The company has 1 million common shares outstanding.

The company is expected to earn 40 per cent in perpetuity on these investments. The following year the company will again reinvest the same proportion of its earnings, but the rate of return on these investments is expected to fall to 30 per cent. Three years from now the company is expected to earn a rate of return of 25 per cent on its investments, which will be limited to 60 per cent of earnings. This is the last year that the company is expected to produce rate of return above the required rate of return. By year four the company's investments are expected to earn no more than 15 per cent - the lowest return acceptable to shareholders. From year four onwards' the company is expected to limit investments to 40 per cent of earnings and to pay out 60 per cent of earnings to shareholders in the form of dividends.

Required -

i. Estimate the prospective price-earnings ratio of the company and comment on its anticipated change in value after the first three years.

ii. Estimate the proportion of the value accounted for by the company's growth prospects.