Question

Halliford Corporation expects to have earnings this coming year of $ 3.00 per share. Halliford 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 25.00 % 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? ​Note: Remenber that growth rate is computed​ as: retention rate times rate of return. The price per share is __________

Answer 1

Growth rate formula = Return on invstment * Retention ratio

Return on assets = 25%

Retention ratio of next 2 years = 100%

So, Growth rate of first 3 years = 25%*100% = 25.00%

For next 2 years after that retention ratio = 50%

Growth rate = 25%*50% 12.50%

After that retention ratio = 20%

Growth rate = 25%*20% = 5%

Required rate of return = 10% or 0.1

Calculation of earnings and Dividends

Growth rate. EPS Payoutratio= 1-retention ratio Dividend

1 25% 3 (given). 0. 0

2 25% 3 *(1+25%) = 3.75 0 0

3 12.50%. 3.75*(1+12.5%) = 4.21875 50% 2.109375

4 12.50% 4.21875*(1+12.50%)= 4.7460 50% 2.373046

5 5%. 4.7460*(1+5%)= 4.98339. 80%. 3.98671

Growth after 5th year is constant as retention ratio is constant. So Growth model formula shall be applicable

P4 = D5/(ke-g)

3.98671875 /(0.10-0.05)

79.73437

Value of stock shall be Dividend received upto 4 th year and present value of stock at end of 4 th year

Year Cash flows P.V.F. = 1/(1+0.10)^year Present value

1. D1. 0. 0.9090909091. 0

2 D2. 0 0.826446281 0

3 D3. 2.109375 0.7513148009 1.5848

4 D4 2.3730. 0.6830134554 1.6208

4 P4 79.7344 0.6209213231 49.5088

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Total 52.7144

So, price of share is $52.71