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IBM's stock price

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By walking you through a set of real-time financial data for IBM, this assignment will help you better understand how theoretical stock prices are calculated; and how prices may react to market forces such as risk and interest rates. You will use both the CAPM and the Constant Growth Model (CGM) to arrive at IBM's stock price. To get started, complete the following steps.

First, find an estimate of the risk-free rate of interest, krf. To calcuate this rate, first go to Bloomberg.com: Market Data [http://www.bloomberg.com/markets/index.html], to find the 10-year Treasury bond rate. Use this interest rate as the risk-free rate. In addition, you also need a value for the market risk premium. Use an assumed market risk premium of 7.0%.

Download this IBM Stock Information document (.doc file). This document was generated from recent financial data for IBM. Using this document, find an estimate of IBM's beta (β). Also find IBM's current annual dividend and its 3-year growth rate, or g.

With the information you now have, use the CAPM to calculate IBM's required rate of return or ks.

Use the CGM to find the current stock price for IBM. We will call this the theoretical price or Po.

Now use appropriate Web resources to find IBM's current stock quote, or P. Compare Po and P. Do you see any differences? Can you explain what factors may be at work for such a difference in the two prices? This section is especially important-with more weight in grading-so you may want to do some study before answering such a question. Explain your thoughts clearly.

Now assume the market risk premium has increased from 7.0% to 10%; and this increase is due only to the increased risk in the market. In other words, assume krf and stock's beta remains the same for this exercise. What will the new price be? Explain what happened?

Recalculate IBM's stock using the P/E ratio model (pp. 350-1) and the needed info found on the Web. Explain why the present stock price is different from the price arrived at using CGM.

Please show all work, including formulae and calculations used to arrive at financial values.

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Solution Summary

The solution calculates theoretical stock price of IBM and compares it with the actual price and explains why they are different.

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