Question

The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividends currently and is not expected to for the next five years. Its latest EPS was $20.00, all of which was reinvested in the company. The firm’s expected ROE for the next five years is 18% per year, and during this time it is expected to continue to reinvest all of its earnings. Starting in year 6, the firm’s ROE on new investments is expected to fall to 13%, and the company is expected to start paying out 50% of its earnings in cash dividends, which it will continue to do forever after. DEQS’s market capitalization rate is 28% per year. a. What is your estimate of DEQS’s intrinsic value per share? (Do not round intermediate calculations. Round your answer to 2 decimal places.) b. Assuming its current market price is equal to its intrinsic value, what do you expect to happen to its price over the next year? (Round your dollar value to 2 decimal places.) Because there is (Click to select), the entire return must be in (Click to select). c. What do you expect to happen to the price in the following year? (Round your dollar value to 2 decimal places.) d. What is your estimate of DEQS’s intrinsic value per share if you expected DEQS to pay out only 30% of earnings starting in year 6? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Next Visit question map question 8 of 10 Total8 of 10 Prev

Answer 1

The computation of each parts are shown below:

But before that following calculations need to be done

The Growth rate till 5 years is

= ROE * Retained earnings

= 18% *100%

= 18%

Now

The EPS at year 5 is

= Current EPS * (1 + ROE)^number of years

= 20*(1.18)^5

= $45.76

Now

Growth rate at 6th year is

= Declining ROE * payout

= 13%*50%

= 6.5%

Now

EPS at Year 6 is

= $45.76 *(1 + 0.065)

= 48.73$

So,

Divident 1 = $48.73 *50% = $24.36

Now Price of stock at year 5 = Divident 1 / (r-g)

= $24.36 / (0.28 - 0.065)

= $24.36 / 0.215

= $113.30

(a)

Price of stock today = Future Value / (1+ interest rate)^number of years

= $113.30 / (1 + 0.28)^5

= $32.98

(b).

Price of the stock after one year is

= $32.98 * 1.28

= $42.21

(c)

Price of stock after 2 years is

= $42.21* 1.28

= $54.03

(d) Now the intrinsic value per share is

But before that the calculations are to be done

Growth rate is

= 13% * 0.7

= 9.1%

The EPS at Year 6 is

= $45.76 (1+0.091)

= $49.92

The Divident 1 is

= $49.92 * 30%

= $14.98

Price of stock at year 5 is

= Divident 1 / (r - g)

= $14.98 / (0.28 - 0.091)

= $14.98 / 0.189

= $79.26

And, finally Price of stock today is

= Future value / (1+r)^n

= $79.26 / (1.28)^5

= $23.07