The Generic Genetic (GG) Corporation pays no cash dividends currently and is not
ID: 2720118 • Letter: T
Question
The Generic Genetic (GG) Corporation pays no cash dividends currently and is not expected to for the next 4 years. Its latest EPS was $5.2, all of which was reinvested in the company. The firm’s expected ROE for the next 4 years is 18% per year, during which time it is expected to continue to reinvest all of its earnings. Starting in year 5, the firm will payout all of its earnings as dividend and the firm’s ROE on new investments is expected to fall to 13% per year. GG’s market capitalization rate is 17% per year.
What is your estimate of GG’s intrinsic value per share? (Round your answer to 2 decimal places.)
What is your estimate of GG’s intrinsic value per share? (Round your answer to 2 decimal places.)
Explanation / Answer
First four years
Growth rate g = ROE x b
= 18% x 100%
= 18%
EPS after 4 years = EPSo x (1+g)^4
= 5.20 x(1+0.18)^4
= 10.082
10.082 will be paid as dividend on the 5th year.
Now ROE will fall to 13%.
G = ROE x b
= 13% x 0
=0%
Price at the end of fourth year = D5/(Ke-g)
= 10.082/(0.17-0)
=59.306
Now to compute intrinsic value of the stock that is value of stock today, we need to discount f for four years:
Intrinsic value = Price at the end of fourth year/(1+Ke)^4
= 59.306 /(1+0.17)^4
= 31.65
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