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 $1.4 a share last year, and just paid out a dividend of $0.63 per share. Investors believe the company plans to maintain its dividend payout ratio at 45%. ROE equals 24%. Everyone in the market expects this situation to persist indefinitely.

a.

What is the market price of Chiptech stock? The required return for the computer chip industry is 15%, and the company has just gone ex-dividend (i.e., the next dividend will be paid a year from now, at t = 1). b. Suppose you discover that Chiptechs competitor has developed a new chip that will eliminate Chiptechs current technological advantage in this market. This new product, which will be ready to come to the market in 2 years, will force Chiptech to reduce the prices of its chips to remain competitive. This will decrease ROE to 15%, 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: The annual year-end dividend for the second year (paid at t = 2) will be 55% of that years earnings. What is your estimate of Chiptechs intrinsic value per share? ( Hint: Carefully prepare a table of Chiptechs earnings and dividends for each of the next 3 years. Pay close attention to the change in the payout ratio in t = 2.)