Question

Intro IBM just paid an annual dividend of $4.3 per share. The dividend is expected to grow by 5% per year. The required rate of return is 12%. IB Part 1 Attempt 1/10 for 10 pts. By DDM/Gordon growth model, what is the price to sell the stock in 3 years? 1+ decimals Submit Part 2 Attempt 1/10 for 10 pts. If you buy the stock today, hold it, sell it in 3 years at the price computed in Part 1, what is the present value of all cashflows -D.D.DP- you receive? 1+ decimals Submit Part 3 IB Attempt 1/10 for 10 pts. By Gordon growth model, what is the current stock price? How does your answer here compare to Part 2, what do you figure? 1+ decimals Submit

Answer 1

I will answer and give full working. Choose decimals accordingly as it depends based on the programs students use.

Part 1:

Price of stock in 3 years = ($4.3 x 1.05⁴) / (12% - 5%) = $74.6668125 [please round this appropriately]

Part 2:

Present values of cash flows = [($4.3 x 1.05) / 1.12] + [($4.3 x 1.05²) / 1.12²] + [($4.3 x 1.05³) / 1.12³] + $74.6668125 / 1.12³ = $64.50

Part 3:

Current stock price = $4.3 x 1.05 / 7% = $64.50

It is same as the answer in Part 2. Hence it can be inferred that value of a share (i.e., current price as calculated in Part 3) is the present value of all future cash flows (as calculated in Part 2)

The answer is double-checked for accuracy. Please remember to round up the final answers as required in your program.
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