Assignment Instructions

1. Assignment Instructions • Find an estimate of the risk-free rate of interest, krf. To obtain this value, go to Bloomberg.com: Market Data [http://www.bloomberg.com/markets/index.html] and use the "U.S. 10-year Treasury“ 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 7.5%. NOTE Today: September 9, 2009 the US 10-year Treasury = 3.49

2. Assignment Instructions • 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. NOTE: Please see attached document “IBM Stock Document U3 Assignment. PDF” for updated IBM stock information as of September 9, 2009.

3. Assignment Instructions • IBM's beta (ß) • IBM's current annual dividend • IBM's 3-year dividend growth rate (g) • Industry P/E • IBM's EPS • *NOTE: all of the information you need for this IP can be found on the pdf file with the exception of IBM’s current stock price and the risk-free rate (Bloomberg site)

4. Assignment Instructions • With the information you now have, use the CAPM to calculate IBM's required rate of return or ks (also called Kj). See next Slide • Use the CGM to find the current stock price for IBM. We will call this the theoretical price or Po. (See CGM example on slide: 6) • 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.

5. Key things to keep in mind for this IP: The formula for CAPM can be found on page 254 of your textbook:Kj= RF+ [bj x (km-RF)]Hint:  Think of CAPM as three separate components:  "RF" = risk-free rate, "(km-RF)" = market risk premium, and "bj" = beta.  Therefore, you should only "plug" three figures into your equation.The formula for the Gordon Model (Constant-Growth Model) can be found on page 513 of your textbook.  Please be sure to refer to my previous announcement regarding this model.The final question of the IP asks you to recalculate IBM's stock price using something called the "P/E ratio model."   This is the equation you should follow in your recalculation:  Stock price = Industry PE x EPS  Make sure you are using the 60-month beta figure in your calculations for CAPM.

6. The CGM (Constant Growth Model) is also called the Gordon Model.  Stock Value (PO) = D1/ kS -G Where: D1 = D * (1+G)kS = Required rate of return (this is your CAPM)G = Growth rate in dividends (in perpetuity).  This figure is the 3-year dividend growth rate.

7. Assignment Instructions • Step 3: Calculate IBM’s rate of return using CAPM • Step 4: Calculate IBM’s theoretical stock price using the Gordon Model (Constant Growth Model)

8. Assignment Instructions • Step 5: Compare the theoretical stock price and IBM’s actual stock price (Po with P)

9. Assignment Instructions Now assume the market risk premium has increased from 7.5% 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.

10. Assignment Instructions Recalculate IBM's stock using the P/E ratio model and the needed info found in the IBM pdf file. Explain why the present stock price is different from the price arrived at using CGM (Constant Growth Model). Formula you will use to calculate: Stock price = Industry PE x EPS

11. Assignment Instructions • To receive full credit on this assignment, please show all work, including formulae and calculations used to arrive at financial values.