Question

Halliford Corporation expects to have earnings this coming year of $ 3.00 per share. Halliford plans to retain all of its earnings for the next two years. For the subsequent two​ years, the firm will retain 50 % of its earnings. It will then retain 20 % of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of 25.00 % 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 10.0 %​, what price would you estimate for Halliford​ stock? ​Note: Remenber that growth rate is computed​ as: retention rate times rate of return.

The price per share is __________

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)			25.00%	25.00%	12.50%	12.50%	5.00%
2). EPS		$3.00	$3.75	$4.6875	$5.2734	$5.9326	$6.2292
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    $2.3438 $2.6367 $4.7461 $4.9834

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

P(5) = D6 / (r - gC) = $4.9834 / (10% - 5%) = $4.9834 / 0.05 = $99.67

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

= [$2.3438 / 1.10³] + [$2.6367 / 1.10⁴] + [($4.7461 + $99.67) / 1.10⁵]

= $1.76 + $1.80 + $64.83 = $68.39