Question

Answer 1

a) Market Price of Chiptech

Given:

Earnings Per Share = $1.70

Dividend Per Share = = $0.68

Dividend Payout ratio = 40% or 0.4

Return on equity (r) = 27%

Return for Industry = 18%

We can find out the current market price of Chiptech stock using the formula given below:

p0 = EPS (1-b) / Ke -g

Where,

p0 = current market price of share

EPS = Earnings Per Share

b = Retention ratio

Ke = Return for shareholders

g = growth rate

First we need to find out the retention ratio (b)

We know that Dividend payout ratio + retention ratio = 1

hence, by putting the figures 0.4 + b = 1

Hence b (retention ratio) = 0.6

Next we need to find out the growth rate using the following formula

g = b x r

putting the values we have,

g = 0.6 x 0.27

g = 0.162 or 16.2%

Now we will find out the market price of Chiptech

p0 = 1.7 (1-0.6) / 0.27 - 0.162

p0 = 0.68/0.108

p0 = $6.30

b) Intrinsic Value per share at year end 2

First we need to estimate the Dividend payout ratio in the second year

Year	Dividend per share	Earnings per share	Dividend payout ratio
0	0.68	1.70	0.4
1	0.68	1.70	0.4
2	0.85	1.70	0.5

Given:

Earnings Per Share = $1.70

Dividend Per Share = = $0.85

Dividend Payout ratio = 50% or 0.5

Return on equity (r) = 18%

We can find out the current market price of chiptech stock using the formula given below:

p0 = EPS (1-b) / Ke -g

Where,

p0 = current market price of share

EPS = Earnings Per Share

b = Retention ratio

Ke = Return for shareholders

g = growth rate

First we need to find out the retention ratio (b)

We know that Dividend payout ratio + retention ratio = 1

hence, by putting the figures 0.5 + b = 1

Hence b (retention ratio) = 0.5

Next we need to find out the growth rate using the following formula

g = b x r

putting the values we have,

g = 0.5 x 0.18

g = 0.09 or 9%

Now we will find out the market price of Chiptech

p0 = 1.7 (1-0.5) / 0.18 - 0.09

p0 = 0.85/0.09

p0 = $9.44

Assumption: We have assumed Earnings per share in the subsequent years to be $1.70 only as given in the question in the absence of adequate information.

c) The rate of return on Chiptech stock will be same as the Dividend payout ratio will be same in the Zero and 1st year that is 27%.

d) The rate of return on Chiptech stock will be same as the Dividend payout ratio will be same in the 1st year and 2nd year that is 27%.

e) The rate of return on Chiptech stock will be reduced as the Dividend payout ratio will be increased from 40% to 50% and therefore the investor's return will be reduced.