The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividend
ID: 2759310 • Letter: T
Question
The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividends currently and is not expected to for the next 5 years. Its latest EPS was $16, all of which was reinvested in the company. The firm’s expected ROE for the next 5 years is 19% 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 14%, and the company is expected to start paying out 20% of its earnings in cash dividends, which it will continue to do forever after. DEQS’s market capitalization rate is 24% per year.
What is your estimate of DEQS’s intrinsic value per share?
Assuming its current market price is equal to its intrinsic value, by what percentage should the price rise per year by year 6?
Explanation / Answer
Answer: Calculation of the DEQS’s intrinsic value per share:
V5=D6/(Ke-g)
=9.09/(0.24-0.112)
=71.02
V0=V5/(1+K)^5
=71.02/(1.24)5
=24.23
Answer:The price should rise by 19% per year until year 6: because there is no dividend, the entire return must be in capital gains.
Time 0 1 2 3 4 5 6 Et 16.00 19.04 22.66 26.96 32.09 38.18 45.44 Dt 0.00 0.00 0.00 0.00 0.00 0.00 9.09 b 1 1 1 1 1 1 0.8 g 19% 19% 19% 19% 19% 19% 11%Related Questions
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