Question

Halliford Corporation expects to have earnings this coming year of $ 2.85 per share. Halliford plans to retain all of its earnings for the next two years. For the subsequent two​ years, the firm will retain 47 % of its earnings. It will then retain 23 % of its earnings from that point onward. Each​ year, retained earnings will be invested in new projects with an expected return of 20.33 % 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 8.5 %​, what price would you estimate for Halliford​ stock? ​Note: Remenber that growth rate is computed​ as: retention rate times rate of return.

Answer 1

1)	The first step is to find the growth rate:
	Growth rate = ROE*b
	where ROE = return on equity
	b = retention ratio
	Growth rate for the 2nd and 3rd years = 20.33%*100% =	20.33%
	Growth rate for years 4 and 5 = 20.33%*0.47) =	9.56%
	Perpetual constant growth rate from 65th year = 20.33%*0.23	4.68%
2)	Expected EPS, dividends and their PV:
	Year	EPS [$]	Growth rate [%]	Payout [%]	Dividend [$]	PVIF at 8.5%	PV at 8.58%
	1	2.85		0	0	0.92166	$                 -
	2	3.429	20.33	0	0	0.84946	$                 -
	3	4.127	20.33	53%	2.19	0.78291	$            1.71
	4	4.521	9.56	53%	2.40	0.72157	$            1.73
	5	4.953	9.56	77%	3.81	0.66504	$            2.53
	6 onwards	5.185	4.68	77%	3.99
3)	Estimated price of the stock			PV of dividends for years 3 to 5			$ 5.97
				Terminal value of dividends 3.99/(0.085-0.0468) =				$ 104.45
				PV of terminal value = 104.45*0.665 =			$ 69.46
				Estimated price of the stock= 5.97+69.46 =			$ 75.43