Question
The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividends currently and is not expected to for the next 4 years. Its latest earnings
The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividends currently and is not expected to for the next 4 years. Its latest earnings per share were $10, all of which were reinvested in the company. The firms expected ROE for the next 5 years is 20% per year, and during this time it is expected to continue to reinvest all of its earnings. Starting in year 6, the firms ROE on new investments is expected to fall to 15%. At the end of year 5 (start of year 6), the company is expected to start paying out 40% of its earnings in cash dividends, which it will continue to do forever thereafter. DEQSs market capitalization rate is 15% per year.
(a)
Estimate the intrinsic value per share of the DEQS stock.
(b)
Assuming the current market price of the stock is equal to its intrinsic value, what do you expect to happen to its price over the next year? And the year after?
(c)
What effect would it have on your estimate of DEQSs intrinsic value if you expected DEQS to pay out only 20% of earnings starting at the end of year 5?
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