You expect that IBM will have earnings per share of $2.50 for the coming year. IBM plans to retain all of its earnings for years
1-3. For the subsequent two years (years 4 and 5), the firm plans on retaining 40% of its earnings. It will then retain only 10% of its earnings from that point forward. Retained earnings will be invested in projects with an expected return of 15% per year. If IBM's equity cost of capital is 12%, then what is the the price of a share of IBM's stock
1 answer:
Answer:
what is the the price of a share of IBM's stock?
Price of a share of IBM's stock = $8.90 per share
Explanation:
<u>Calculation of the price of a share of IBM's stock</u>
<em>Price of a share of IBM's stock = Sum of Present values of all future dividends discounted at cost of capital i.e.12%</em>
<u>Working</u>
Per Year Dividend from 3rd Year on-wards = Earnings per share x (1 - retention %) = $2.5 x (1 - 0.40) = $1.50
Value of perpetual dividend = Dividend payable / equity cost of capital = $1.5 / 12% = $12.50
Calculations are attached:
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