1. IBM Corp. expects to earn $8.40 per share in the next year. IBM follows a policy of paying out 60% of all earnings as dividends, and reinvesting the rest. IBM’s dividends and earnings are expected to grow at a constant rate of 4% in the future. You require a 9% rate of return on stock investments of similar risk. What is your estimate of the market value of IBM stock?
2. Based on the information in problem #2, what will the value of IBM stock be if their payout rate changes to 70% next year, and the return on new investment (ROE*) is 10%? (Hint: you must compute a new value for D1 and g.)