Question

Halliford Corporation expects to have earnings this coming year of $ 3.397 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 50 % of its earnings. It will retain 20 % of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of 18.3 % 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 10.3 %​, 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)			18.30%	18.30%	9.15%	9.15%	3.66%
2). EPS		$3.397	$4.0187	$4.7541	$5.1891	$5.6639	$5.8712
Dividends
3). Retention Ratio		100%	100%	50%	50%	20%	20%
4). Dividend Payout Ratio		0%	0%	50%	50%	80%	80%

Dividends(2 x 4) $0 $0    $2.3770 $2.5945 $4.5311 $4.6969

From year 5 on, dividends grow at constant rate of 3.66%. Therefore,

P(5) = D6 / (r - gC) = $4.6969 / (10.3% - 3.66%) = $5.1426 / 0.0664 = $70.74

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

= [$2.3770 / 1.103³] + [$2.5945 / 1.103⁴] + [($4.5311 + $70.74) / 1.103⁵]

= $1.77 + $1.75 + $46.10 = $49.63