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 $16.50, all of which was reinvested in the company. The firm’s expected ROE for the next five years is 20% 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 15%, and the company is expected to start paying out 30% of its earnings in cash dividends, which it will continue to do forever after. DEQS’s market capitalization rate is 23% 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 (no dividend/a dividend), the entire return must be in (capital gains/capital losses). The price in one year would be?

c. What do you expect to happen to 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 10% of earnings starting in year 6? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

The formula for Intrinsic value basically represents the net present value of all the future free cash flows to equity (FCFE) of a company during the entire course of its existence. It is the reflection of the actual worth of the business underlying the stock i.e. the amount of money that can be received if the whole business and all of its assets are sold off today.

1. EPS of current year= 16.5

Dividend payout ratio= 30%

ROE is 15 %

Dividend growth rate = retention ratio X ROE= 70%X15%= 10.5 %

Share Value = Dividend / ( ROE- Dividend Growth rate )= 16.5*30%/ ( 15%-10.5%)= 110

2. No change in share value, because the 5 years growth rate is consider in prices calculation ( the CAGR and discounting factors are same).

3.No change in share value, because the 5 years growth rate is consider in prices calculation ( the CAGR and discounting factors are same).

4.if Dividend payout ratio is 10 %

EPS of current year= 16.5

Dividend payout ratio= 10%

ROE is 15 %

Dividend growth rate = retention ratio X ROE= 90%X15%= 13.5 %

Share Value = Dividend / ( ROE- Dividend Growth rate )= 16.5*10%/ ( 15%-13.5%)= 110

* So No change in value of share if the ROE is same ( because the we just changing composition of retain earning and cash out not the value of business.