Question

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?

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