Question

Low Tech Chip Company is expected to have EPS of $2.50 in the coming year. The expected ROE is 14%. An appropriate required return on the stock is 11%. If the firm has a dividend payout ratio of 40%, the intrinsic value of the stock should be:

• $22.73.

• $27.50.

• $38.46.

• $28.57.

Answer 1

Answer is $38.46

Payout Ratio = 40%

Retention Ratio = 1 - Payout Ratio
Retention Ratio = 1 - 0.40
Retention Ratio = 0.60

Growth Rate, g = ROE * Retention Ratio
Growth Rate, g = 14.00% * 0.60
Growth Rate, g = 8.40%

Expected EPS = $2.50

Expected Dividend, D1 = Expected EPS * Payout Ratio
Expected Dividend, D1 = $2.50 * 0.40
Expected Dividend, D1 = $1.00

Required Return, rs = 11.00%

Intrinsic Value, P0 = D1 / (rs - g)
Intrinsic Value, P0 = $1.00 / (0.11 - 0.0840)
Intrinsic Value, P0 = $1.00 / 0.026
Intrinsic Value, P0 = $38.46