Question

Halliford Corporation expects to have earnings this coming year of $3.199 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 46% of its earnings. It will retain 18% of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of 27.3% 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 9.6%​, what price would you estimate for Halliford​ stock?

Answer 1

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)			27.3%	27.3%	12.558%	12.558%	4.914%
2). EPS		$3.199	$4.072	$5.184	$5.835	$6.568	$6.891
Dividends
3). Retention Ratio		100%	100%	46%	46%	18%	18%
4). Dividend Payout Ratio		0%	0%	54%	54%	82%	82%

Dividends(2 x 4) $0 $0    $2.799 3.151 $5.386 $5.650

From year 5 on, dividends grow at constant rate of 4.914%. Therefore,

P(5) = D6 / (r - gC) = $5.650 / (9.6% - 4.914%) = $5.650 / 0.04686 = $120.58

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

= [$2.799 / 1.096³] + [$3.151 / 1.096⁴] + [($5.386 + $120.58) / 1.096⁵]

= $2.13 + $2.18 + $79.65 = $83.96