Question

IBM has a stock price of $80 and a dividend of $3. The expected dividend growth rate is 4% per year. The market expected return is 9%. The IBM stock has a beta of 1.

A. What is the expected dividend payment next year?

B. What is the expected return for IBM according to the Capital Asset Pricing Model (CAPM)?

C. What is the intrinsic value of IBM according to the Gordon Growth Model?

D. Is the stock overvalued or undervalued?

E. What dividend growth rate would justify the current stock price of $80?

Answer 1

A) Dividend next year = 3*(1+G) = 3*1.04 = $ 3.12

B) As per CAPM expected return = Rf + beta * Rm - Rf) , here beta is 1 hence expected return will be same as market return. Hence expected return = 9 %

C) Intrinsic Value = Dividend next year / (Return - G) = 3.12 / ( 9% - 4%) = $ 62 40

D) The stock price is $ 80 It is overvalued as its intrinsic value is 62.40 as calculated above

E ) Dividend Growth rate to justify current stock price of $ 80 =

80 = Dividend *(1+G)/ (Ke -G)

80 = 3*1+G/ (0.09 - G)

7.2 - 80 G = 3*(1+G)

7.2 - 80G = 3+3G

7.2-3 = 83G

G = 4.2/83 = 0.0506 = 5. 06 %