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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

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Capricious23

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:

Calculation of the price of a share of IBM's stock      

Price of a share of IBM's stock = Sum of Present values of all future dividends discounted at cost of capital i.e.12%

Working          

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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