Question

Halliford Corporation expects to have earnings this coming year of $ 3.278 per share. Halliford plans...

Halliford Corporation expects to have earnings this coming year of $ 3.278 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 54 % of its earnings. It will retain 18 % of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of 19.7 % 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?

Homework Answers

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)

19.7%

19.7%

10.638%

10.638%

3.546%

2). EPS

$3.278

$3.924

$4.697

$5.196

$5.749

$5.953

Dividends

3). Retention Ratio

100%

100%

54%

54%

18%

18%

4). Dividend Payout Ratio

0%

0%

46%

46%

82%

82%

Dividends(2 x 4) $0 $0    $2.161   $2.390 $4.714 $4.881

From year 5 on, dividends grow at constant rate of 3.546%. Therefore,

P(5) = D6 / (r - gC) = $4.881 / (9.4% - 3.546%) = $4.881 / 0.05854 = $83.39

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

= [$2.161 / 1.0943] + [$2.390 / 1.0944] + [($4.714 + $83.39) / 1.0945]

= $1.65 + $1.67 + $56.22 = $59.54

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