he Generic Genetic (GG) Corporation pays no cash dividends currently and is not

Question

he Generic Genetic (GG) Corporation pays no cash dividends currently and is not expected to for the next four years. Its latest EPS was $5.60, all of which was reinvested in the company. The firm's expected ROE for the next four years is 22% per year, during which ime it is expected to continue to reinvest all of its earnings. Starting in year 5, the firm's ROE on new investments is expected to fall to 17% per year. GG's market capitalization rate is 21% per year. a. What is your estimate of GG's intrinsic value per share? (Round your answer to 2 decimal places.) GG's intrinsic value b. Assuming its current market price is equal to its intrinsic value, what do you expect to happen to its price over the next year? Price should at a rate of % over the next year

Explanation / Answer

a) Dividends for the next four years = 0 so (100% plowback ratio) Year EPS DPS 0 $5.60 0 1 $6.83 0 2 $8.34 0 3 $10.17 0 4 $12.41 0 5 $15.14 $15.14 Price @ 4 year =$15.14 /21% $72.07 Intrinsic value = $72.07/(1+21%)^4 $33.62 b) Its price should increase at a rate of 21% over the next year, so that the Holding period return will equal to cost of capital

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