IBM has generated annual dividend growth of 15.1% over the past 3 years. IBM\'s
ID: 2760750 • Letter: I
Question
IBM has generated annual dividend growth of 15.1% over the past 3 years. IBM's most recent annual dividend is $2.90. Assume IBM will continue to increase dividends at 15.1 % for the next 5 years before reducing its dividend growth to 6% for the long term. Also assume that the required return for IBM stock is 9.5%. It is currently trading for $179.90. Using two stage dividend discount model to determine the current intrinsic value for IBM given these assumptions. 1- is the stock overvalued or undervalued? Explain 2- how long dividend growth rate will provide an intrinsic value similar to the current market price? 3- what required rate of return would provide an intrinsic value similar to the current market price? IBM has generated annual dividend growth of 15.1% over the past 3 years. IBM's most recent annual dividend is $2.90. Assume IBM will continue to increase dividends at 15.1 % for the next 5 years before reducing its dividend growth to 6% for the long term. Also assume that the required return for IBM stock is 9.5%. It is currently trading for $179.90. Using two stage dividend discount model to determine the current intrinsic value for IBM given these assumptions. 1- is the stock overvalued or undervalued? Explain 2- how long dividend growth rate will provide an intrinsic value similar to the current market price? 3- what required rate of return would provide an intrinsic value similar to the current market price? Using two stage dividend discount model to determine the current intrinsic value for IBM given these assumptions. 1- is the stock overvalued or undervalued? Explain 2- how long dividend growth rate will provide an intrinsic value similar to the current market price? 3- what required rate of return would provide an intrinsic value similar to the current market price?Explanation / Answer
Year 0 Year 1 Year 2 Year 3 Year 5 Year 6 Dividend 2.90 3.34 3.84 4.42 5.86 6.21 Terminal Value of stock at Yr 6 end=6.21*1.06/(0.095-0.06)= 188.07 Total Cash Flow 3.34 3.84 4.42 5.86 194.28 PV factor @9.5% 1 0.913 0.834 0.762 0.635 0.580 PV of Cash flows 3.05 3.20 3.37 3.72 112.70 Total Intrinsic value = $ 129.59 Current IBM share value= $ 179.90 1 So the stock is overvalued as the current price is more than intrinsic value 2 Year 0 Year 1 Year 2 Year 3 Year 5 Year 6 Dividend 2.90 3.34 3.84 4.42 5.86 6.27 (assuming 7.03% dividend growth rate) Terminal Value of stock at Yr 6 at 7.03% growth rate 274.16 Total Cash Flow 3.34 3.84 4.42 5.86 280.43 PV factor @9.5% 1 0.913 0.834 0.762 0.635 0.580 PV of Cash flows 3.05 3.20 3.37 3.72 162.68 Total Intrinsic value = $ 179.57 Current IBM share value= $ 179.90 At 7.03% dividend growth rate continuously from year 6 will provide same intrinsic value as of share value today. 3 Year 0 Year 1 Year 2 Year 3 Year 5 Year 6 Dividend 2.90 3.34 3.84 4.42 5.86 6.21 Terminal Value of stock at Yr 6 end=6.21*1.06/(0.0854-0.06)= 259.15 Total Cash Flow 3.34 3.84 4.42 5.86 265.36 PV factor @8.54% 1 0.921 0.849 0.782 0.664 0.612 PV of Cash flows 3.08 3.26 3.46 3.89 162.29 Total Intrinsic value = $ 179.64 Current IBM share value= $ 179.90 So at approx 8.54% required return rate the intrinsic and current stock value are same