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Ibm's Stock Price

Step 1:

I used the "U.S. 10-Year Treasury" bond rate from the financial data that was given for this assignment to get the risk free rate which is 4.50%. The market risk premium is assumed at 7.5%.

Step 2:

By using the financial data given for this assignment I completed the subsequent questions (American InterContinental University Online, 2007);

1) IBM's beta (b) = 1.64.
2) IBM's current annual dividend = $ 0.80.
3) IBM's 3-year dividend growth rate (g) = 8.2%.
4) Industry P/E = $23.2.
5) IBM's EPS = $4.87.

Step 3:

With the information I have now from steps 1 and 2 I can calculate the required rate of return for IBM using the Capital Asset Pricing Model (CAPM);
kj = RF + [bj * (km – RF)]
Where:
kj = required return on asset
RF = risk-free rate of return, commonly measured by the return on a U.S. Treasury bill = 4.50% as of September 06, 2007, 8:30pm, CST.
bj = beta coefficient or index of nondiversifiable risk for asset j = 1.64.
km - RF = market return; return on the market portfolio of assets = 7.5%.
Calculation (Gitman, 2006):
Required rate of return = 4.50% + (1.64 * 7.5%) = 4.50% + 12.3 = 19.8%.
Step 4:
Using the Constant-Growth Model (CGM), I have calculated IBM's current stock price;
PO = D1 / ks – g
Where:
D1 = expected dividend per share one period from now = $.87.
ks = required rate of return (CAPM) = 19.8%.
g = growth rate in dividends = 8.2%.
Calculation (Gitman, 2006):
Stock price = $.87 / 19.8% - 8.2% = $.87 / 11.6% = $7.50.
Step 5:
IBM's current stock price as of September 7, 2007 is $115.55, comparing that to $7.50 there is a huge difference. This significant difference could be caused by the assumed market risk premium of 7.5% being to low. The CGM method is at a constant rate and very dependent on growth value. There is no constant in forecasting stocks. Assumption at a constant growth makes more sense for more developed economies that are large and not necessarily for the smaller...