1. Here is some information about the world: the risk free rate is currently 2%, the expected return on the market is currently 7%.

Over the last year, each share of IBM has paid $5.98 in dividends. I got this from Yahoo Finance, just as you did when you did the project.

Go to Yahoo Finance and find (a) the price of IBM shares and (b) the beta of IBM. For the beta, instead of going to Historical Data as you did in the project, go to Statistics.

Assume that IBMs dividends grow at 1% per year forever. Assume that IBM pays dividends annually. If you buy the stock, the first dividend you receive will be one year from now, and its value will be 5.98(1 + .01).

Is IBM stock overpriced or underpriced?

To answer this question, follow these steps: start by finding how much you would be willing to pay for the stock (i.e., its fair value). How do you find fair value? The rule says to take the PV of the expected cashflows at the OCC.

(a) What are the expected cashflows? If you bought this stock and held it forever, how much cash would you get one year from now? In two years? In three years?

(b) Then find the OCC. Use the SML: E(Ri) = Rf + i(E(RM) Rf ) to get what the CAPM says this stock should be paying.

(c) Then find the PV of the expected cashflows with the OCC as the interest rate. The expected cashflows are just a growing perpetuity. Use the formula you learned for a growing perpetuity.