Question

10 Problem 18-18 The Generic Genetic (GG) Corporation pays no cash dividends currently and is not expected to for the next four years. Its latest EPS was $5.50, all of which was reinvested in the company. The firm's expected ROE for the next four years is 21% per year, during which time it is expected to continue to reinvest all of its earnings Starting in year 5. the firm's ROF on new investments is expected to fall to 20% per year. GG's market capitalization rate is 20% per year. shipped a. What is your estimate of GG's intrinsic value per share? (Round your answer to 2 decimal places.) Book 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 over the next year.

Answer 1

In year 4, Growth rate (g) = ROE*reinvestment rate
= 21% * 100% = 21%
EPS = EPS0*(1+g)
= $5.50 * (1+21%)^4
= 11.79%

In year 5, ROE = market capitalization rate(K)
So, EPS = EPS4*(1+ROE)
= 11.79 * (1+20%) = 14.15

Terminal value = EPS5/k
= 14.15 / 20%
= 70.74

Intrinsic value today = Terminal value/(1+k)^4
= 70.74/(1+20%)^4
= 34.11

b)

Price should increase at a rate of 20% over the next year.