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Halliford Corporation expects to have earnings this coming year of $3.000 per share. Halliford plans to...

Halliford Corporation expects to have earnings this coming year of $3.000 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 50% of its earnings. It will retain 20% of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of 25.0% 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 10.0%​, what price would you estimate for Halliford​ stock?

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Expert Solution

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)

25%

25%

12.50%

12.50%

5%

2). EPS

$3.000

$3.75

$4.6875

$5.2734

$5.9326

$6.2292

Dividends

3). Retention Ratio

100%

100%

50%

50%

20%

20%

4). Dividend Payout Ratio

0%

0%

50%

50%

80%

80%

Dividends(2 x 4) $0 $0    $2.344 2.637 $4.746 $4.983

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

P(5) = D6 / (r - gC) = $4.983/ (10% - 5%) = $4.983 / 0.05 = $99.67

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

= [$2.344 / 1.13] + [$2.637 / 1.14] + [($4.746 + $99.67) / 1.15]

= $1.76 + $1.80 + $64.83 = $68.39


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