Question

QUESTION 4 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 $13, all of which was reinvested in the company. The firm's expected ROE for the next 5 years is 17% 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 12%, and the company is expected to start paying out 35% of its earnings in cash dividends, which it will continue to do forever after. DEQS's market capitalization rate is 20% per year. Instructions What is your estimate of DEQS's intrinsic value per share?

Answer 1

Ans.

Growth Rate from Year 1 to 5 = g = b * r = 100 % * 0.17 = 17%

Expected EPS for next years

EPS 1 = $ 13 ( 1 + 0.17) = $ 15.21

EPS 2 = $ 15.21 ( 1 + 0.17) = $ 17.7957

EPS 3 = $ 17.7957 ( 1+ 0.17) = $ 20.820969

EPS 4 = $ 20.820969 ( 1 + 0.17) = $ 24.36053373

EPS 5 = $24.36053373 ( 1 + 0.17 ) = $ 28.50182446

EPS 6 = $ 28.50182446 ( 1 + 0.078) = $ 30.72496676 [ Note : g for 6th Year = 0.65 * 0.12 = 7.8 % ]

D 6 = 0.35 *  $ 30.72496676 = $ 10.753738

Hence value of DESC's share 5 years from now =

P5 = D6 / Ke - g = $ 10.753738 / 20% - 7.8% = $ 88.145396

So the value of DESC's share today is $ 88.145396 / ( 1+ 0.20)5 = $ 35.42365 or $ 35.42