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Halliford Corporation expects to have earnings this coming year of $ 3.357$3.357

ID: 2792035 • Letter: H

Question

Halliford Corporation expects to have earnings this coming year of

$ 3.357$3.357

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

53 %53%

of its earnings. It will retain

18 %18%

of its earnings from that point onward. Each year, retained earnings will be invested in new projects with an expected return of

18.6 %18.6%

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

10.9 %10.9%,

Halliford Corporation expects to have earnings this coming year of $3.357 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 53% of its earnings. It will retain 18% of its earnings from that point onward. Each year, retained earnings will be invested in new projects with an expected return of 18.6% 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 10.9%, what price would you estimate for Halliford stock? The stock price will be S. (Round to the nearest cent.)

Explanation / Answer

See the Spreadsheet For Halliford's Dividend forecast ( g = retention rate x return on new investment ) :-

FROM YEAR 5 ON , DIVIDENDS GROW AT CONSTANT RATE OF 3% .THEREFORE,

P(5) = $ 4.777 / (10.9 % - 3% ) = $ $ 4.777 / 0.079 = $ 60.47

THEN P(0) = 2.197 / (1.109 ) ^ 3 + 2.417 / (1.109 ) ^ 4 + ( 4.637 +60.47) / 1.109 ^ 5

= 2.197/1.3640 + 2.417 /1.5127 + 65.107/1.6776

= 1.61+ 1.60+ 38.81 = $ 42.02

EARNINGS YEAR 0 1 2 3 4 5 6 EPS GROWTH RATE(VS PRIOR YRS) 18% 18% 10% 10% 3% EPS 3.357 3.961 4.674 5.141 5.655 5.825 DIVIDENDS RETENTION RATIO 100% 100% 53% 53% 18% 18% DIVIDEND PAY OUT RATIO 0 % 0% 47% 47% 82% 82% DIV $ 0 $ 0 2.197 2.417 4.637 4.777