Reference no: EM132443426

Problem: In this chapter our textbook authors demonstrate two methods for computing the value of a stock, the dividend discount model (DDM) and the P/E model. In this assignment you will be applying these models to IBM, Inc.

1. Let's assume that IBM is a constant-growth firm with its quarterly dividends paid as an annual dividend at the end of each year; i.e., find total dividends paid in the previous year and assume they were paid in one lump sum at the end of the previous year. Assume that the dividend paid during the past year grows at a rate of g, and g = 5%. The price estimate of IBM stock would be using the dividend discount model. Let's assume R is calculated using the Capital Asset Pricing Model (CAPM), where the risk-free rate of return is 3% and the market rate of return is 10%. You can find IBM's price history and beta at https://finance.yahoo.com/. Compute the value of IBM stock given this information.
2. Now let's assume the P/E (price-earnings ratio) model gives us a better estimate of IBM stock value. In 2011, IBM's P/E range was 13.19-13.43 and its 12/31/11 EPS was $13.06. You should assume that EPS will grow by an annual rate of g% (see part 1). Analyst estimates on 12/31/11 are that the P/E will rise by 12-13.5% in the next several years. Find the price range estimated for the stock at the end of the current year using the P/E model. Find the present value of the expected prices using your CAPM R (from part 1) as the discount rate.
3. Compare the two estimates of stock price to IBM's stock price at the end of the most recent year. Discuss your findings in a 1-page essay. If one of the valuation methods does not work well, be sure to discuss why that may be true. No references are required.

Complete your work in a Word or Excel document. Show your work wherever possible. If you use a financial calculator to solve these problems, note your keystrokes. If you use the spreadsheet to solve these problems, leave your commands in the spreadsheet cells.