Chiptech Inc. is an established computer chip firm with several profitable existing products as well as some new products in development. The company earned $4.00 (i.e., EPS(0) = $4.00 at time period 0), and just paid a dividend of $1.80 (dividend is paid at t=0). Investors believe the company plans to maintain its current dividend payout ratio of 45% (earnings retention is 55%). You may assume that dividend are paid once per year. The return on equity, ROE, is 20%.

Everyone in the market expects the situation described above to persist indefinitely.

You should think about this problem using a time line.

Today is time period t = 0

One year from now is time period t = 1; and so on

Please answer b, c, i, ii, iii.

a What is the market price of the common stock of Chiptech? The required return for the computer chip industry is 15%. Chiptech will pay its next dividend at time period t=1 (today is time period t=0). $49.95

b You are a very diligent research analyst. Suppose you discover that one of Chiptech's competitors has developed a new chip that will eliminate Chiptech's technological advantage in the chip market. The new product will be ready in two years. You forecast that Chiptech's ROE will be reduced to 10% and that they will decrease their plowback (earning retention) to 30% (assume that this reduction in plowback and ROE happens at t = 2). Consequently, the dividend at t= 2 will be 70% of earnings at t=2.

What is your estimate of Chiptech's intrinsic value per share (at t=0)?

c No one else in the market realizes the competitors new development. In fact, you are confident that no one else will become aware of the change in Chiptech's competitive status until the competitor firm publicly announces its discovery at year 2 (i.e., at t= 2).

i. Calculate the holding period return on Chiptech stock in the coming year (i.e., from t = 0 to t = 1)? Explain your answer.

Ii. Calculate the holding period return on Chiptech stock in the second year (i.e., from t = 1 to t =2)? Also provide some explanation.

iii. Calculate the holding period return on Chiptech stock in the third year (i.e., from t = 2 to t = 3)? Also provide some explanation.