E6.9. Residual Earnings and Abnormal Earnings Growth: IBM (Medium)

Consider the following pro forma for International (IBM) based on analysts forecasts in early 2011. Business Machines Corp.

2011 2012 Next Three Years

Earnings per share 13.22 14.61 Growth at 11%

Dividends per share 3.00 3.30 Growth at 11%

The book value of IBMs common equity at the end of 2010 was $23.0 billion, or $18.77 per share. Use a required return for equity of 10 percent in calculations.

a. Forecast residual earnings for each of the years 2011 2015.

b. Forecast abnormal earnings growth (in dollars) for each of the years 2012-2015.

c. Show that abnormal earnings growth is equal to the change in residual earnings for every year.

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