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Halliford Corporation expects to have earnings this coming year of $3.081 per share. Halliford plans to...

Halliford Corporation expects to have earnings this coming year of $3.081 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 19% of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of 21.4% 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 8.2%​, what price would you estimate for Halliford​ stock?

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Expert Solution

ROE= 21.40% Required rate= 8.20% 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% 21.400% 3.081 0 0 1.082 0
2 3.081 100.00% 21.400% 3.740334 0 0 1.170724 0
3 3.740334 54.00% 11.556% 4.172566997 1.919380819 1.919380819 1.266723 1.515233
4 4.172566997 54.00% 11.556% 4.654748839 2.141184466 53.90046024 56.04164471 1.370595 40.88856
Long term growth rate = =ROE*long term ret. Rate= 4.066% Value of stock = Sum of discounted values= 42.4
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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