QUESTION 17

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 a share last year, and just paid out a dividend of $.50 per share. Investors believe the company plans to maintain its dividend payout ratio at 50%. ROE equals 20%. Everyone in the market expects this situation to persist indefinitely. 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). Given this information, the estimated stock price is $11.

However, suppose you discover that Chiptech's competitor has developed a new chip that will eliminate Chiptech's 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 .40. 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 60% of that year's earnings. What is your current estimate of Chiptech's share price?

	A.	$18.493
	B.	$6.493
	C.	$12.493
	D.	$7.493
	E.	$11.493