Posted: July 12th, 2016
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.
1. Use the two-stage dividend discount model to determine the current intrinsic value for IBM given these assumptions. Is the stock overvalued or undervalued? Briefly explain the possible reasons for your response.
3. Reset the long term dividend growth rate to 6%. What required rate of return would provide an intrinsic value similar to the current market price? (Leave all other assumptions in place.)
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