Capital Asset Pricing Model IBM paid dollar 1.50 per share in dividends this yea

Question

Capital Asset Pricing Model

IBM paid dollar 1.50 per share in dividends this year. Analyst expects that the market return and the risk free rate would be 8 percentage and 3 percentage, respectively, for next two centuries. Also, the earnings growth rate, the payout ratio and the beta of IBM are expected to change in the following way; Using the given information, answer the following questions. What is the expected dividend at year 10? By using CAPM. calculate the appropriate required rate of return of IBM(/UU?) at year 21. The equation of an expected RRR is RRR = R_f + beta^astir (R_m - R_f). where R_f, beta, and R_m represent risk free rate, beta, and the market rate of return, respectively. Find the present value of dividend that will be paid at year 25 What is the cumulative present value of dividends at year 16? What is the expected price of IBM stock now?

Explanation / Answer

a. Expected Dividend at the end of year 5 = $1.50(1.12)5

= 2.64

Expected dividend at the end of year 10 = 2.64(1.11)5

= 4.45

b. RRR = Rf + beta*(Rm - Rf)

= 3% + 0.60*(8% - 3%)

= 6%

c. Dividend at th end of year 15 = 4.45(1.09)5

= 6.85

Dividend at the end of year 20 = 6.85(1.05)5

= 8.74

Dividend at the end of year 25 = 8.74(1.02)5

= 9.65

Present value = 9.65 x 1/(1.06)25

= 9.65 x 0.2330

= 2.25

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