Question

Halliford Corporation expects to have earnings this coming year of $ 2.71 per share. Halliford plans to retain all of its earnings for the next two years. For the subsequent two​ years, the firm will retain 54 % of its earnings. It will then retain 22 % of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of 26.65 % 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 10.6 %.

What price would you estimate for Halliford​ stock?

​Note: Growth rate is computed​ as: retention rate times rate of return.

Answer 1

ROE=	26.65%	Required rate=	10.60%	Long term ret. Rate=	22.00%
Year	EPS previous year	Retention ratio	Growth rate	EPS current year	Dividend current year	Terminal value	Total Value	Discount factor	Discounted value
1	0	100.00%	26.650%	2.71	0		0	1.106	0
2	2.71	100.00%	26.650%	3.432215	0		0	1.223236	0
3	3.432215	54.00%	14.391%	3.926145061	1.806026728		1.806026728	1.352899	1.334931
4	3.926145061	54.00%	14.391%	4.491156596	2.065932034	46.16967763	48.23560967	1.496306	32.23645
	Long term growth rate =	=ROE*long term ret. Rate=	5.863%				Value of stock =	Sum of discounted values=	33.57

Where

Growth rate = ROE*retention rate for corresponding year

EPS curr. Year = EPS previous year*(1+growth rate) if not given

Dividend current year = EPS current year*(1-retention ratio)

Terminal value = Dividend Current year 4 *(1+long term growth rate)/( Required rate-long term growth rate)

Total value = Dividend + horizon value (only for last year)

Discount factor=(1+ Required rate)^corresponding period

Discounted value=total value/discount factor