Question

Chiptech, Inc., is an established computer chip firm with several profitable existing products as well as some promising new products in development. The company earned $1.60 a share last year, and just paid out a dividend of $0.80 per share. Investors believe the company plans to maintain its dividend payout ratio at 50%. ROE equals 26%. Everyone in the market expects this situation to persist indefinitely.

a. What is your estimate of Chiptech's intrinsic value per share? The required return for the computer chip industry is 17%, and the company has just paid dividend (i.e., the next dividend will be paid a year from now, at t = 1). (Do not round intermediate calculations. Round your answers to 2 decimal places.)

intrinsic value of stock

b. Suppose you discover that Chiptech’s competitor has developed a new chip that will eliminate Chiptech’s current technological advantage in this market. This new product, which will be ready to come to the market in two years, will force Chiptech to reduce the prices of its chips to remain competitive. This will decrease ROE to 17%, and, because of falling demand for its product, Chiptech will decrease the plowback ratio to 0.4. The plowback ratio will be decreased at the end of the second year, at t = 2: that is, the annual year-end dividend for the second year (paid at t = 2) will be 60% of that year’s earnings. What is your revised estimate of Chiptech’s intrinsic value per share?

(Hint: Carefully prepare a table of Chiptech’s earnings and dividends for each of the next three years. Pay close attention to the change in the payout ratio in t = 2.) (Round your answers to 2 decimal places.)

revised intrinsic value of stock ?

Answer 1

In the revised intrinsic value the same formula is used using T=2 values.