Halliford Corporation expects to have earnings this coming year of $2.607 per sh

Question

Halliford Corporation expects to have earnings this coming year of $2.607 per share. Halliford plans to retain all of its earnings for the next two years. For the subsequent two years, the firm will retain 46% of its earnings. It will then retain 22% of its earnings from that point onward. Each year, retained earnings will be invested in new projects with an expected return of 20.7% 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 10.5%, what price would you estimate for Halliford stock

Explanation / Answer

Calculation of Stock Price:

Year 0

Year 1

Year 2

Year 3

Year 4

Earning Per share (EPS)

$    2.6070

$    2.6070

$                                   2.8552

$                        2.9853

2.607*(1+9.5220%)

2.8552*(1+4.5540%)

Growth rate

9.5220%

4.5540%

(ROE*retention ratio)

(20.7%*46%)

(20.7%*22%)

Dividend

$             -  

$             -  

$                                   1.5418

$                        2.3285

EPS * (1- retention ratio)

2.8552*(1-46%)

2.9853*(1-22%)

Terminal Value at the end of year 3

$                                 39.1608

Div Year 4 / (Required rate - growth rate)

2.3285/ (10.5%-4.5540%)

Net Cash Flows (CF) = Div + Terminal value

$             -  

$             -  

$                                 40.7026

PVF (10.5%)

     1.00000

     0.90498

     0.81898

                                    0.74116

PV = CF*PVF

$             -  

$             -  

$             -  

$                                      30.17

Stock Price today = Sum of PVs

$      30.17

Calculation of Stock Price:

Year 0

Year 1

Year 2

Year 3

Year 4

Earning Per share (EPS)

$    2.6070

$    2.6070

$                                   2.8552

$                        2.9853

2.607*(1+9.5220%)

2.8552*(1+4.5540%)

Growth rate

9.5220%

4.5540%

(ROE*retention ratio)

(20.7%*46%)

(20.7%*22%)

Dividend

$             -  

$             -  

$                                   1.5418

$                        2.3285

EPS * (1- retention ratio)

2.8552*(1-46%)

2.9853*(1-22%)

Terminal Value at the end of year 3

$                                 39.1608

Div Year 4 / (Required rate - growth rate)

2.3285/ (10.5%-4.5540%)

Net Cash Flows (CF) = Div + Terminal value

$             -  

$             -  

$                                 40.7026

PVF (10.5%)

     1.00000

     0.90498

     0.81898

                                    0.74116

PV = CF*PVF

$             -  

$             -  

$             -  

$                                      30.17

Stock Price today = Sum of PVs

$      30.17

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