Question

Halliford Corporation expects to have earnings this coming year of $3.12 per share. Halliford plans to retain all of its earnings for the next two years. For the subsequent two years, the firm will retain 55% of its earnings. It will then retain 18% of its earnings from that point onward. Each year, retained earnings will be invested in new projects with an expected return of 25.03% 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 8.2%, what price would you estimate for Halliford stock?

The price per share is (Round to the nearest cent.)

Answer 1

Halliford	Earnings	Growth	Dividends
1	$3.12	25.03%	$0.00
2	$3.90	25.03%	$0.00
3	$4.88	13.77%	$2.19
4	$5.55	13.77%	$2.50
5	$6.31	4.51%	$5.18

Growth Rate = ROE x Retention Ratio, where ROE = 25.03%

Forecast the growth rate for each year given the retention ratio, and subsequently earnings.

Dividends = Earnings x (1 - retention ratio)

Price in year 5, P5 = D5 x (1 + g) / (r - g) = $6.31 x (1 + 4.51%) / (8.2% - 4.51%) = $178.71

Price today, P0 = D3 / (1 + r)^3 + D4 / (1 + r)^4 + (D5 + P5) / (1 + r)^5

= 2.19 / 1.082^3 + 2.50 / 1.082^4 + (5.18 + 178.71) / 1.082^5

= $127.56