Question

10) Halliford Corporation expects to have earnings this coming year of $2.79 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 21% of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of 20.33% 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 8.4%​, what price would you estimate for Halliford​ stock?

​Note: Remenber that growth rate is computed​ as: retention rate × rate of return.

The price per share is $? (Round to the nearest cent)

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)			20.33%	20.33%	10.5716%	10.5716%	4.2693%
2). EPS		$2.79	$3.36	$4.0397	$4.4668	$4.9390	$5.1499
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    $1.9391 $2.1441 $3.9018 $4.0684

From year 5 on, dividends grow at constant rate of 4.2693%. Therefore,

P(5) = D6 / (r - gC) = $4.0684 / (8.4% - 4.2693%) = $4.0684 / 0.041307 = $98.49

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

= [$1.9391 / 1.084³] + [$2.1441 / 1.084⁴] + [($3.9018 + $98.49) / 1.084⁵]

= $1.52 + $1.55 + $68.41 = $71.49