Question

Halliford Corporation expects to have earnings this coming year of

$3.067

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

49%

of its earnings. It will retain

17%

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

27.5%

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

9.4%​,

what price would you estimate for Halliford​ stock?The stock price will be

​$

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)			27.5%	27.5%	13.475%	13.475%	4.675%
2). EPS		$3.067	$3.910	$4.986	$5.658	$6.420	$6.720
Dividends
3). Retention Ratio		100%	100%	49%	49%	17%	17%
4). Dividend Payout Ratio		0%	0%	51%	51%	83%	83%

Dividends(2 x 4) $0 $0    $2.543 $2.885 $5.329 $5.578

From year 5 on, dividends grow at constant rate of 4.675%. Therefore,

P(5) = D6 / (r - gC) = $5.578 / (9.4% - 4.675%) = $5.578 / 0.04725 = $118.05

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

= [$2.543 / 1.094³] + [$2.885 / 1.094⁴] + [($5.329 + $118.05) / 1.094⁵]

= $1.94 + $2.01 + $78.73 = $82.69