Question

Halliford Corporation expects to have earnings this coming year of $ 2.831 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 52 % 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 27.6 % 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 8.8 %​, what price would you estimate for Halliford​ stock?

Please also show your work! I have no clue how to solve this. Thank you in advance

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)			27.6%	27.6%	14.352%	14.352%	5.796%
2). EPS		$2.831	$3.612	$4.609	$5.271	$6.027	$6.377
Dividends
3). Retention Ratio		100%	100%	52%	52%	21%	21%
4). Dividend Payout Ratio		0%	0%	48%	48%	79%	79%

Dividends(2 x 4) $0 $0    $2.212 $2.530 $4.762 $5.038

From year 5 on, dividends grow at constant rate of 5.796%. Therefore,

P(5) = D6 / (r - gC) = $5.038 / (8.8% - 5.796%) = $5.038 / 0.03004 = $167.70

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

= [$2.212 / 1.088³] + [$2.530 / 1.088⁴] + [($4.762 + $167.70) / 1.088⁵]

= $1.72 + $1.81 + $113.12 = $116.64