Question

3) IBM's stock is currently trading at $133 per share. The EPS for 2018 was $15.00 and the dividend was $5.00 The beta of IBM is 1.2 The risk-free rate is 2% and the market risk premium is 7% 1) What is the intrinsic value of the stock if you forecast the company to grow at 20% for the next 2 years, then 5% thereafter, assuming that the payout ratio remains constant at current levels? 2) What is the intrinsic value if we presume that the company grows at 20% for the next 2 years but that the company increases (immediately) the payout ratio to 50% where it will remain forever? Assume 5% growth in perpetuity (forever) 3) Identify 3 items that will increase the valuation of IBM - think about the constant growth formula and intuitively what would make the stock worth more (good things) Hint - when we reference a company growing at a certain rate ay 10% - this implies that the EPS (earnings) will also grow at 10% - assumes constant expense, margins. So to calculate dividends you have Earnings X Payout Ratio - Dividends or EPS X POR = DPS

Answer 1

Given Beta Rp Solution: Step 1: Calculated discount rate / required rate of return Ri We know that Expected return for a security using CAPM (capital asset pricing model) theory, = Rf + Bi X Rp Where, Cost of common stock Risk free rate Beta of Security Risk Premium = 10.40% Hence, Required return is 10.40% Part 1) Growth Rate (G) 1st Year 2nd Year Thereafter Rate 20% 20% Symbol G1 5% Gn DO (Current Dividend) $ 5 As we know, that current value of stock is present vaule of future cash flow Current Price D1 1+R - + D2 (1+R)^2 (1+R)^2 Where D1 = DO(1+G1) D2 = D1(1+G2) Dividend at end of 1st year Dividend at end of 2nd year D2(1+Gn) (R-Gn) P (Price of Stock) Hence Using above formula Current Price ($) = 6:00 + + - 17:20 + + 7.20 1.219 5.91 - 6.00 1.104 5.43 + 126.21 110:00 140.00 1.219 114.87 + = Hence, intrinsic value shall be 126.21 $

Part 2) Rate 20% Growth Rate (G) 1st Year 2nd Year Thereafter Symbol G1 G2 Gn 20% 5% DO (Current Dividend) = EPS X Payout rate = 15 X 50% = 7.5 As we know, that current value of stock is present vaule of future cash flow 01 D2 Current Price he + Theo 2 + 12 ARAZ + 1+R (1+R)^2 (1+R)^2 Where D1 = DO(1+G1) D2 = D1(1+G2) Dividend at end of 1st year Dividend at end of 2nd year D2(1+Gn) (R - Gn) P (Price of Stock) Hence Using above formula Current Price ($) Current Price (s) = 29,0 + 10,89 10.80 1.219 8.86 9.00 1.104 8.15 + 189.31 + 210.00 210.00 1.219 172.30 + Hence, intrinsic value shall be 189.31 $ *Note : Assumed dividend payout chage have immediate effect. Part 3) Three factors that shall increase the stock worth are:- 1. Growth rate - Increase in growth shall increase the worth of stock. 2. Dividend - Increase in dividend payout ratio shall increase the worth of stock. 3. EPS - Increase in EPS whill inturn increase dividend ratio which shall increase the worth of stock.