Question

Halliford Corporation expects to have earnings this coming year of $ 2.862 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 54 % 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  25.4 % 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 11.9 % what price would you estimate for Halliford? stock?

Answer 1

Year	EPS	Retention	Growth	Dividend
1	$2.8620	100%	25.40%	$               -
2	$3.5889	100%	25.40%	$               -
3	$4.5005	54%	13.72%	$            2.07
4	$5.1178	54%	13.72%	$            2.35
5	$5.8198	18%	4.57%	$            4.77
			Horizon	$          65.12
			Price	$ 44.51

Growth Rate, g = ROE x Retention Ratio, where ROE = 25.4%

Earnings will grow by the growth rate.

Dividends = Earnings x (1 - Retention Ratio)

Horizon Value is the price in year 4, P4 = D5 / (r - g) = 4.77 / (11.9% - 4.57%) = $65.12

Price today, P0 = D3 / (1 + r)^3 + (D4 + P4) /(1 + r)^4 = 2.07 / 1.119^3 + (2.35 + 65.12) / 1.119^4 = $44.51