Question

Halliford Corporation expects to have earnings this coming year of $ 2.99 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 22 % of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of 18.25 % 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 8.2 %​, what price would you estimate for Halliford​ stock? ​Note: Remember that growth rate is computed​ as: retention rate x rate of return.

The price per share is ​$____.

Answer 1

Answer :- Price of Stock $74.04

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Explanations :-

Price of stock = present value of dividends of Years 3 and Year 4 + present value of terminal value at end of Year 4

(The stock does not pay any dividend in Years 1 and Year 2 as all the earnings are reinvested)

Growth rate of earnings = retention ratio * rate of return

Growth rate of earnings during Years 1 and 2 = 100% * 18.25% = 18.25%.

Growth rate of earnings during Years 3 and 4 = 50% * 18.25% = 9.125%.

Growth rate of earnings after Year 4 = 22% * 18.25% = 4.015%

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Terminal value at end of Year 4 = Year 5 dividend / (cost of equity capital - growth rate after Year 4)

The dividends, terminal value and their present values are calculated as below :

PP.