Question

Halliford Corporation expects to have earnings this coming year of

$ 2.889$2.889

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

52 %52%

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

25.2 %25.2%

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

9.3 %9.3%​,

what price would you estimate for Halliford​ stock?

Answer 1

Step 1: Prepare Dividend Schedule

The dividend schedule is given as below:

	Dividend Schedule
	Years
	0	1	2	3	4	5	6
Earnings
EPS Growth Rate			25%	25%	13%	13%	5%
EPS (A)		2.889	3.617	4.529	5.122	5.793	6.070
Dividends
Retention Ratio		100%	100%	52%	52%	19%	19%
Dividend Payout Ratio (B)		0%	0%	48%	48%	81%	81%
Annual Dividend (A*B)		$0.000	$0.000	$2.174	$2.459	$4.692	$4.917

_____

Step 2: Calculate Stock Price

The stock price is determined as follows:

Stock Price = Dividend Year 1/(1+Cost of Capital)^1 + Dividend Year 2/(1+Cost of Capital)^2 + Dividend Year 3/(1+Cost of Capital)^3 + Dividend Year 4/(1+Cost of Capital)^4 + Dividend Year 5/(1+Cost of Capital)^5 + Dividend Year 6/(1+Cost of Capital)^5*1/(Cost of Capital - Growth Rate)

Substituting values in the above formula, we get,

Stock Price = 0/(1+9.3%)^1 + 0/(1+9.3%)^2 + 2.174/(1+9.3%)^3 + 2.459/(1+9.3%)^4 + 4.692/(1+9.3%)^5 + 4.917/(1+9.3%)^5*1/(9.3%-5%) = $76.26 (answer)

_____

Notes:

1) There can be a slight difference in the final answer on account of rounding off values.

2) The actual growth rates (and not the rounded off values) and actual dividend values (and not the rounded off values) have been used while calcuating the final stock price.