Question

Sanford Corporation expects to have earnings this coming year of $3 per share. Sanford
plans to retain all of its earnings for the next two years. For the subsequent two years, the
firm will retain 50% of its earnings. It will then 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% per year. Any earnings that are not retained will be paid out as dividends.
Assume Sanford’s share count remains constant and all earnings growth comes from the
investment of retained earnings. If Sanford’s equity cost of capital is 10%, what price
would you estimate for Sanford stock?

(a) What are the earnings and dividends over the first three years?

(b) At what rate will the earnings and dividends grow in year 4 and 5 s? What are
the dividends at the end of year 4 and 5?

(c) What price would you estimate for Sanford stock?

Answer 1

	years
	0	1	2	3	4	5	6
EPS Growth Rate			25.00%	25.00%	12.50%	12.50%	5.00%
EPS		$       3.00	$       3.75	$       4.69	$         5.27	$       5.93	$       6.23
Dividend payout ratio(1-retention ratio)		0	0	50%	50%	80%	80%
dividend		$           -	$            -	$       2.34	$         2.64	$       4.75	$       4.98
Add stock price in p5						124.585
Total		$           -	$            -	$       2.34	$         2.64	$ 129.33
Pv factor @10%	1	0.909091	0.826446	0.751315	0.6830135	0.620921
		$           -	$            -	$       1.76	$         1.80	$     80.30
Stock Price Today		$83.87
	years
	0	1	2	3	4	5	6
EPS Growth Rate			0.25	0.25	=+E4*50%	=+E4*50%	=+E4*20%
EPS		3	=+C5*(1+D4)	=+D5*(1+E4)	=+E5*(1+F4)	=+F5*(1+G4)	=+G5*(1+H4)
Dividend payout ratio(1-retention ratio)		0	0	0.5	0.5	0.8	0.8
dividend		=+C5*C6	=+D5*D6	=+E5*E6	=+F5*F6	=+G5*G6	=+H5*H6
Add stock price in p5						=H5/(10%-H4)
Total		=+C7+C8	=+D7+D8	=+E7+E8	=+F7+F8	=+G7+G8
Pv factor @10%	1	=1/1.1	=+C10/1.1	=+D10/1.1	=+E10/1.1	=+F10/1.1
		=+C10*C9	=+D10*D9	=+E10*E9	=+F10*F9	=+G10*G9
Stock Price Today		=NPV(10%,C9:G9)