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Risk And Capital

Risk and Capital

A. Find an estimate of the risk free rate of interest.
1. DJIA 10,558.03 -52.07 -0.49%
2. NASDAQ 2,177.91 -13.41 -0.61%
3. S & P 500 1,226.42 -9.44 -0.76%
4. S & P/TSX 10,550.51 -76.20 -0.72%
5. BOVESPA 26,517.92 48.02 0.18%
6. U.S. FED FUNDS 3.50 0.06
7. U.S. FED TARGET 3.25 0.00
8. CANADIAN 10 –YR BOND 4.00 0.07
9. U.S. 10 YR TREASURY 4.39 0.07
10. U.S. GDP 07/29 3.4%
11. U.S. UNEMPLOYMENT 08/05 5.0%
12. CANADIAN UNEMPLOYMENT 08/05 6.8%
13. BRAZILIAN UNEMPLOYMENT 07/21 9.4%

Information regarding the U.S. 10 yr treasury: the risk free rate is 4.39%, market risk premium is 7.5%.
B. Downloading IBM Stock Information:
1. IBM's beta (b) : 1.666 (yahoo finance website)
2. IBM's current annual dividend : year 2004 $0.70 per share (IBM website)
3. IBM's 3 yr dividend growth rate (g) (information on dividend from IBM website)
Dividend Paid
2004 $0.70
2003 $0.63
2002 $0.59
2001 $0.55
Making the average growth rate = ($0.70/$0.55)^(1/3)-1=0.083707 or 8.37%
4. Industry P/E – 20.30 (Yahoo finance website)
5. IBM's EPS
Earnings per share of common stock from continuing operations assuming dilution: 2004 2003 2002
$4.94 $4.34 $3.07
With the information use the CAPM to calculate IBM's required rate of return or ks.
Ks = rf + risk premium *beta
= 4.39% + 7.5%*1.666 = 16.89%
Using the CGM to find the current stock price for IBM.
P0 = D1/(Ks-g)
D1 = Do*(1+g) = $0.70*(1+8.37%) = $0.75859
P0 = $0.75859/ (16.89% - 8.37%) = $8.9096
Using web resources the current IBM's stock quote or P, Compare P0 and P.
The current P is $83.36 per share. Showing a huge difference between P0 and P. This difference is due to the fact that we have used the constant growth formula for calculation of the current price.
IBM is a technology company with high growth. The IT industry is considered quite volatile and full of potential. Every year the development that takes place in the...