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# Dividend Discount Model

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I would like to get some help with this problem . I have 4 more similar to it and I would like to get some guidance as to what I'm supposed to be doing here. Please provide all calculations and formulas used as well as explanations where possible. Information needed to complete this problem is provided in the attachments. However, there is on web site, which is provided, that must be used to complete the problem. This is an on-line course and basically self-taught. I would really appreciate any and all help that is provided. Your team of experts have kept me afloat over the past 7 months with there advise and expertise in several subjects.

#### Solution Preview

What this question requirs you to do is to use the Constant Growth Model to find the stock price. Compare the price to the current market price and see why the two are different

1. Find an estimate of the risk-free rate of interest, krf.

The US 10 year treasury rate is 4.54% from Bloomberg ( found from the website given)

2. Download this IBM Stock Information document (.pdf file). Please note that the following information contained in this document must be used to complete the subsequent questions.
1. IBM's beta (à?) = 1.64
2. IBM's current annual dividend = \$0.80 per share
3. IBM's 3-year dividend growth rate (g) = 8.20 %
4. Industry P/E = 23.2
5. IBM's EPS = \$4.87

3. With the information you now have, use the CAPM to calculate IBM's required rate of return or ks.
Using CAPM, the required rate of return is given as
Ks = Risk Free Rate + ( Risk Premium ) X beta
Ks = 4.54 % + 7.5% X 1.64
Ks= ...

#### Solution Summary

The solution explains the use of dividend discount model to calculate the stock price using the example of IBM

\$2.19
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## The Dividend Discount Model and the CAPM

CAPM and Cost of Equity Estimation

1) What is your opinion to the questions below?

The Capital Asset Pricing Model (CAPM) is a linear model that can be used to estimate a company's cost of equity and determine a stock's required rate of return. The required rate of return is one input into the Dividend Discount Model, a model used to determine the value of a company's common stock. There are a several varieties of the Dividend Discount Model including the zero growth model, the constant growth model, and the differential growth model. An analyst needs to use his or her best judgment to determine which model variety should be used to value a company's common stock. For example, if the analysts forecasts that the company's dividends will grow at a fixed rate of 5% per year forever, then the constant growth model should be used. If, on the other hand, the analyst forecasts that the company's dividends will grow at a 15% growth rate for the next three years and then growth at a constant rate of 7% per year, then the differential growth model should be used. As you can see, there's a lot of estimation involved in applying the Dividend Discount Model. Because of this situation, it's useful to conduct a sensitivity analysis.

References:

Penman, S.H. (1997, November 5). A synthesis of equity valuation techniques and the terminal value calculation for the dividend discount model. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=38720

Womack, K.L, & Zhang, Y. (2003, December 19). Understanding risk and return, the capm, and the fama-french three-factor model. Retrieved from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=481881

Required:

Below are some questions for discussion.

1. Please apply the Dividend Discount Model to the common stock of a publicly-traded company of your choosing. Based off your results from the model, state whether you believe that the company's common stock is currently overvalued, overvalued, or fully valued. Please be sure to state your assumptions and justify your results.

2. Beta is one of the inputs into the CAPM. How's a stock's beta determined? Is beta a good measure of risk? Why or why not?

3. What are some competing models to the CAPM to determine a company's cost of equity? Compare and contrast them to the CAPM.

You must answer one of the above questions. You do not need to answer all three questions. You must also respond to at least two peers' posts over two separate days. Please try to add information not previously discussed by others. Please provide factual information (not merely opinions) backed up by details or examples. Your comments should be in your own words and include references in APA format.

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