Problem 18-17
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 $19.00, all of which was reinvested
in the company. The firm’s expected ROE for the next five years is
17% 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 12%, and the company is
expected to start paying out 40% of its earnings in cash dividends,
which it will continue to do forever after. DEQS’s market
capitalization rate is 25% 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 Correct, the entire return
must be in capital gains Correct.
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 20% of earnings
starting in year 6? (Do not round intermediate
calculations. Round your answer to 2 decimal
places.)
Calculation is given in the below attached images
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