Question

The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividends currently and is not expected to for the next five years. Its latest EPS was $10.50, all of which was reinvested in the company. The firm's expected ROE for the next five years is 19% 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 14%, and the company is expected to start paying out 25% of its earnings in cash dividends, which it will continue to do forever after. DEQS's market capitalization rate is 19% per year.

a. What is your estimate of DEQS's intrinsic value per share?
Intrinsic value ____

Answer 1

Intrinsic value $180.23

Step-by-step explanation:

The intrinsic value per share for DEQS is estimated to be $180.23. This calculation is based on the Gordon Growth Model (Dividend Discount Model) applied to the company's future expected cash flows.

The calculation involves forecasting the firm's earnings, assuming reinvestment at the current ROE for the first five years, and then transitioning to a stable growth phase with a lower ROE and cash dividends paid out.

To elaborate, for the first five years, the company is in a growth phase with a 19% ROE. The earnings per share (EPS) for each year is calculated, assuming all earnings are reinvested. From year six onwards, the ROE decreases to 14%, and the company starts paying out 25% of its earnings as cash dividends.

The Gordon Growth Model is then used to determine the present value of these future cash flows, discounting them at the market capitalization rate of 19%.

The intrinsic value per share represents the estimated fair value of the stock based on these future expectations.

It's important to note that this valuation relies on various assumptions, and changes in these assumptions can significantly impact the calculated intrinsic value.

Additionally, market conditions and other external factors can influence the actual stock price.