Question

You’ve collected the following information from your favorite financial website.

52-Week Price		Stock (Div)	Div Yld %	PE Ratio	Close Price	Net Chg
Hi	Lo
64.60	47.80	Abbott 1.12	1.9	235.6	62.91	−.05
145.94	70.28	Ralph Lauren 2.50	1.8	70.9	139.71	.62
171.13	139.13	IBM 6.30	4.3	23.8	145.39	.19
91.80	71.96	Duke Energy 3.56	4.9	17.6	74.30	.84
113.19	96.20	Disney 1.68	1.7	15.5	??	.10

According to your research, the growth rate in dividends for IBM for the next 5 years is expected to be 5 percent. Suppose IBM meets this growth rate in dividends for the next five years and then the dividend growth rate falls to 3.5 percent indefinitely. Assume investors require a return of 10 percent on IBM stock.

a.	According to the dividend growth model, what should the stock price be today? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b.	Based on these assumptions, is the stock currently overvalued, undervalued, or correctly valued?

Answer 1

Dividend Year 0 =6.30
D1=6.30*1.05
D2=6.30*1.05^2
D3=6.30*1.05^3
D4=6.30*1.05^4
D5=6.30*1.05^5
Terminal Value =D5*(1+indefinite growth)/(Required Rate-growth) =6.30*1.05^5*1.035/(10%-3.5%) =128.0307

Stock Price today =D1/(1+r)+D2/(1+r)^2+D3/(1+r)^3+D4/(1+r)^4+D5/(1+r)^5+Terminal Value/(1+r)^5
=6.30*1.05/1.10+6.30*1.05^2/1.10^2+6.30*1.05^3/1.10^3+6.30*1.05^4/1.10^4+6.30*1.05^5/1.10^5+128.0307/1.10^5= 106.95

b. Based on these assumptions IBM is overvalued because Stock Price of IBM is greater than intrinsic value.