Halliford Corporation expects to have earnings this coming year of $3.306 per sh

Question

Halliford Corporation expects to have earnings this coming year of $3.306 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 47% of its earnings. It will retain 19%

of its earnings from that point onward. Eachyear, retained earnings will be invested in new projects with an expected return of 18.7 % 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. IfHalliford's equity cost of capital is 9.2%,

what price would you estimate for Halliford stock?

Explanation / Answer

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 = 18.7%*100% = 18.70% Growth rate for years 4 and 5 = 18.7%*0.47) = 8.79% Perpetual constant growth rate from 65th year = 18.7%*0.19 3.55% 2) Expected EPS, dividends and their PV: Year EPS [$] Growth rate [%] Payout [%] Dividend [$] PVIF at 9.2% PV at 9.2% 1 3.306 0 0 0.91575 $                 -   2 3.924 18.7 0 0 0.83860 $                 -   3 4.658 18.7 53% 2.47 0.76795 $            1.90 4 5.067 8.79 53% 2.69 0.70325 $            1.89 5 5.513 8.79 81% 4.47 0.64400 $            2.88 6 onwards 5.709 3.55 81% 4.62 3) Estimated price of the stock PV of dividends for years 3 to 5 $            6.66 Terminal value of dividends 4.62/(0.092-0.0355) = $      81.77 PV of terminal value = 81.77*0.644 = $          52.66 Estimated price of the stock= 6.66+52.66 = $          59.32

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