The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividend

Question

The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividends currently and is not expected to for the next 5 years. Its latest EPS was $20, all of which was reinvested in the company. The firm’s expected ROE for the next 5 years is 18% per year, and during this time it is expected to continue to reinvest all of its earnings. Starting in year 6, the firm’s ROE on new investments is expected to fall to 13%, and the company is expected to start paying out 50% of its earnings in cash dividends, which it will continue to do forever after. DEQS’s market capitalization rate is 28% per year.

a.What is your estimate of DEQS’s intrinsic value per share? (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "%" sign in your response.)

Intrinsic Value: $_________

b. The price should _______(click to select: Rise or Fall) by _______%per year until year 6: because there is______ (click to select: No dividend or Dividend) , the entire return must be in______ (click to select: Capital Losses or Capital Gains).

c. The payout ratio would have______ (click to select: No effect or Effect) on intrinsic value because______ (click to select: ROE=k or ROE <k or ROE>k)

Explanation / Answer

b. The price should rise by % per year until year 6 : because there is dividend, the entire return must be is Capital Gains

Note: Consider the formula Price= [Dividend(1+g)]/(required rate of return-g)

c. The Payout ratio would have effect on intrinsic value because ROE<k.

This is because in this case Payout would be more.

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