Question

In: Finance

Halliford Corporation expects to have earnings this coming year of $ 3.385$3.385 per share. Halliford plans...

Halliford Corporation expects to have earnings this coming year of

$ 3.385$3.385

per share. Halliford plans to retain all of its earnings for the next two years.​ Then, for the subsequent two​ years, the firm will retain

45 %45%

of its earnings. It will retain

19 %19%

of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of

19.4 %19.4%

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

10.5 %10.5%​,

what price would you estimate for Halliford​ stock?

Solutions

Expert Solution

ROE= 19.40% Required rate= 10.50% Long term ret. Rate= 19.00%
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% 19.400% 3.385 0 0 1.105 0
2 3.385 100.00% 19.400% 4.04169 0 0 1.221025 0
3 4.04169 45.00% 8.730% 4.394529537 2.416991245 2.416991245 1.349233 1.791382
4 4.394529537 45.00% 8.730% 4.778171966 2.627994581 39.98917613 42.61717071 1.490902 28.58482
Long term growth rate = =ROE*long term ret. Rate= 3.686% Value of stock = Sum of discounted values= 30.38
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

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