Problem 18-14 The Digital Electronic Quotation System (DEQS) Corporation pays no
ID: 2819838 • Letter: P
Question
Problem 18-14
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 $11.00, all of which was reinvested in the company. The firm’s expected ROE for the next five years is 15% 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 30% of its earnings in cash dividends, which it will continue to do forever after. DEQS’s market capitalization rate is 15% 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.)
PRICE WILL RISE/FALL (SELECT) BY ___________% EACH YEAR
Because there is (Click to select) no dividend a dividend , the entire return must be in (Click to select) capital gains capital losses .
WHAT IS THE PRICE IN ONE YEAR?
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 10% of earnings starting in year 6? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Explanation / Answer
(a) Computation of the estimate of DEQS’s intrinsic value per share.We have,
Since,the dividend payout is for forever.So, we apply perpetual formula for calculated intrinsic value per share.
V5 = D6 / Ke - g
V5 = 6.64 / ( 0.15 - 0.098) = 6.64 / 0.052 = $ 127.69
V0 = V5 /(1+Ke)5 = 127.69 / (1.15)5 = $ 63.48
Hence,the estimated of DEQS’s intrinsic value per share shall be $ 63.48.
(b) Computation of the price in one year.We have,
The price will rise by 15% each year because there is no dividend and entire return is in capital gain.
Price in one year = Current price(1+ROE)
Price in one year = 63.48(1.15) = $ 73.00
(C) Price in the following year = 73(1.15) = $ 83.95
(d) Computation of the estimate of DEQS’s intrinsic value per share if you expected DEQS to pay out only 10% of earnings starting in year 6.We have,
Since,the dividend payout is for forever.So, we apply perpetual formula for calculated intrinsic value per share.
V5 = D6 / Ke - g
V5 = 2.21 / ( 0.15 - 0.126) = 2.21 / 0.024 = $ 92.08
V0 = V5 /(1+Ke)5 = 92.08 / (1.15)5 = $ 45.78
Hence,the estimated of DEQS’s intrinsic value per share shall be $ 45.78
Year 1 2 3 4 5 6 EPS 11.00 12.65 14.55 16.73 19.24 22.13 Dividend 0 0 0 0 0 6.64 Retention Ratio 1.00 1.00 1.00 1.00 1.00 0.70 Growth rate 15.0% 15.0% 15.0% 15.0% 15.0% 9.8 %