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

Question

The 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 time 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.)

Explanation / Answer

Growth Rate, g = ROE x Retention Ratio = 22% x 100% = 22%

EPS in year 4 = EPS0 x (1 + g)^n = 5.60 x (1 + 22%)^4 = $12.41

In year 5, EPS5 = EPS4 x (1 + g) = 12.41 x (1 + 17%) = 14.51

Stock Price in year 4, P4 = EPS5 / cap rate = 14.51 / 21% = $69.12

Stock Price today, P0 = P4 / (1 + r)^4 = 69.12 / 1.21^4 = $32.24

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