Question

8. Chiptech Inc. is an established computer chip Örm with several proÖtable existing products as well as some promising new products in development. The company earned $1 a share last year and just paid out a dividend of $0.50 per share. Investors believe the company plans to maintain its dividend payout ratio at 50%. ROE of the company equals 20%. Everyone in the market expects this situation to continue indeÖnitely.

(a) What is the market price of Chiptech stock? The required rate of return for the computer chip industry is 15% and the company has just gone ex-dividend (i.e., the next dividend will be paid a year from now at t = 1).

(b) Suppose you discover that Chiptechís competitor has developed a new chip that will eliminate Chiptechís current technology advantage in this market. This new product, which will be ready to come to the market in 2 years, will force Chiptech to reduce the prices of its chips to remain competitive. This will decrease Chiptechís ROE to 15%. The company then will reduce the plowback ratio to 0.4. The plowback ratios will be decreased at the end of the second year, at t = 2: The annual year-end dividend for the second year (paid at t = 2) will be 60% of that yearís earnings. What is your estimate of Chiptechís intrinsic value per share? (Hint: Carefully prepare a table of Chiptechís earnings and dividends for each of the next 3 years. Pay close attention to the change in the payout ratio in t = 2.)

(c) No one else in the market perceive the threat to Chiptechís market. In fact, you are conÖdent that no one else will become aware of the change in Chiptechís competitive status until the competitor Örm publicly announces its discovery near the end of year 2. What will be the rate of return on Chiptech stock in the coming year (between t = 0 and t = 1)? In the second year (between t = 1 and t = 2)? The third year (between t = 2 and t = 3)? (Hint: Pay attention to when the market catches on to the new situation.)

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

no intermediate rounding is done. I have done this sum regularly and observed that sometimes dividend is rounded and sometimes not. I have not rounded any figure. so if you find price at t=2 and t=0 not matching, let me know we have to round it, but as per the textbook, no rounding is to be done.

If we do rounding, answer will definitely change. if i round dividend to 0.80, price at t=2 will be 8.89 and so on.