Question

Halliford Corporation expects to have earnings this coming year of $ 2.65 per share. Halliford plans to retain all of its earnings for the next two years. For the subsequent two​ years, the firm will retain 52 % 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 24.72 % 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 10.2 %​, 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)			24.72%	24.72%	12.8544%	12.8544%	4.4496%
2). EPS		$2.65	$3.3051	$4.1221	$4.6520	$5.2499	$5.4836
Dividends
3). Retention Ratio		100%	100%	52%	52%	18%	18%
4). Dividend Payout Ratio		0%	0%	48%	48%	82%	82%

Dividends(2 x 4) $0 $0    $1.9786 $2.2329 $4.3050 $4.4965

From year 5 on, dividends grow at constant rate of 4.675%. Therefore,

P(5) = D6 / (r - gC) = $4.4965 / (10.2% - 4.4496%) = $4.4965 / 0.057504 = $78.19

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

= [$1.9786 / 1.102³] + [$2.2329 / 1.102⁴] + [($4.3050 + $78.19) / 1.102⁵]

= $1.48 + $1.51 + $50.76 = $53.76