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?
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 / 1.087^{3}] + [$2.349 / 1.087^{4}] + [($4.375 + $103.31) / 1.087^{5}]
= $1.65 + $1.68 + $70.96 = $74.29
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