Question

Halliford Corporation expects to have earnings this coming year of

$3.111

per share. Halliford plans to retain all of its earnings for the next two years.​ Then, for the subsequent two​ years, the firm will retain

53%

of its earnings. It will retain

21%

of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of

20.4%

per year. Any earnings that are not retained will be paid out as dividends. Assume​ Halliford's share count remains constant and all earnings growth comes from the investment of retained earnings. If​ Halliford's equity cost of capital is

8.7%​,

what price would you estimate for Halliford​ stock?

Answer 1

Halliford’s dividend forecast (g = retention rate × return on new investment)

Year	0	1	2	3	4	5	6
Earnings
1).EPS Growth Rate (vs. prior yr)			20.4%	20.4%	10.812%	10.812%	4.284%
2). EPS		$3.111	$3.746	$4.510	$4.997	$5.538	$5.775
Dividends
3). Retention Ratio		100%	100%	53%	53%	21%	21%
4). Dividend Payout Ratio		0%	0%	47%	47%	79%	79%

Dividends(2 x 4) $0 $0    $2.120 2.349 $4.375 $4.562

From year 5 on, dividends grow at constant rate of 4.284%. Therefore,

P(5) = D6 / (r - gC) = $4.562 / (8.7% - 4.284%) = $4.562 / 0.04416 = $103.31

P(0) = [D3 / (1 + r)³] + [D4 / (1 + r)⁴] + [(D5 + P5) / (1 + r)⁵]

= [$2.120 / 1.087³] + [$2.349 / 1.087⁴] + [($4.375 + $103.31) / 1.087⁵]

= $1.65 + $1.68 + $70.96 = $74.29