Low Tech Chip Company is expected to have EPS of $2.50 in the coming year. The expected ROE is 14%. An appropriate required return on the stock is 11%. If the firm has a dividend payout ratio of 40%, the intrinsic value of the stock should be
A) $22.73.
B) $27.50.
C) $28.57.
D) $38.46.

Question

Quizplus · Accepted Answer

The intrinsic value of the stock can be calculated using the Gordon Growth Model: P = D1 / (r - g). First, calculate the growth rate (g) using the formula g = ROE * (1 - payout ratio) = 0.14 * (1 - 0.40) = 0.084 or 8.4%. The dividend next year (D1) is EPS * payout ratio = $2.50 * 0.40 = $1.00. Plug these into the formula: P = $1.00 / (0.11 - 0.084) = $1.00 / 0.026 = $38.46.

Low Tech Chip Company Is Expected to Have EPS of $2.50