Suppose you discover that Chiptech’s competitor has developed a new chip that will eliminate Chiptech’s current technological advantage in this market. This new product, which will be ready to come to the market in two years, will force Chiptech to reduce the prices of its chips to remain competitive. This will decrease ROE to 15%, and, because of falling demand for its product, Chiptech will decrease the plowback ratio to .40. The plowback ratio will be decreased at the end of the second year, at t = 2: The annual year-end dividend for the second year (paid at t = 2) will be 60% of that year’s earnings. What is your estimate of Chiptech’s intrinsic value per share? (Hint: Carefully prepare a table of Chiptech’s earnings and dividends for each of the next three years. Pay close attention to the change in the payout ratio in t = 2.) (Round your answer to 2 decimal places.)
Book value per share $
No one else in the market perceives the threat to Chiptech’s market. In fact, you are confident that no one else will become aware of the change in Chiptech’s competitive status until the competitor firm publicly announces its discovery near the end of year 2. (Hint: Pay attention to when the market catches on to the new situation. A table of dividends and market prices over time might help.)
c-1. What will be the rate of return on Chiptech stock in the coming year (i.e., between t = 0 and t = 1)? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Rate of return %
c-2. What will be the rate of return on Chiptech stock in the second year (i.e., between t = 1 and t = 2)?(Negative value should be indicated by a minus sign. Do not round intermediate calculate.