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 $11.50, 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 35% of its earnings in cash dividends, which it will continue to do forever after. DEQS’s market capitalization rate is 19% 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.)

Intrinsic value___

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.)

The price will rise by____% per year until year 6

Because there is no dividend, the entire return must be in capital gains.

price in one-year ___

c. What do you expect to happen to the price in the following year? (Round your dollar value to 2 decimal places.)

Price in two years___

d. What is your estimate of DEQS’s intrinsic value per share if you expected DEQS to pay out only 15% of earnings starting in year 6? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Intrinsic value____

Answer 1