9.5 Concept 3 Estimating the Cost of Equity Capital: IBM
Example
As discussed previously in chapters 4 or 5 the most widely used first pass
estimate for the cost of equity capital, ke , is
provided from the Capital Asset Pricing Model (CAPM).
Under CAPM ke is a function of three major
inputs:
i. Risk free rate (Estimated from US Treasury bonds)
ii. Beta (Measures how much volatility the stock contributes to the market as
a whole)
iii. Equity Premium (Excess return expected from stocks over the risk free
rate)
At the time
of this example the 30-year bond rate Rf = 4.19%, IBM’s beta was
around 0.76. The
equity premium, as discussed in chapters 4 or 5, and is
currently estimated to be around 5.1% (Click on Papers & Reports
in Valuation Tutor).
Further, historically it has been around 5.5% relative to the
long term bond rate.
The more conservative estimate of 5.5% is used in the current
example.
Cost of Equity Capital, using CAPM, for IBM
Inputs:
Risk Free Rate = 0.0419
Equity Premium = 0.055
Beta (IBM) = 0.76
ke = rf
+
βi*(E(RM) –
rf) = 0.0419 + 0.76*0.055
= 0.0837
IBM
Summary
Dividend per Share
= Dividends/Shares issued = 2,860/1341 = $2.132 equals the
dividend per share.
Dividend Payout Ratio (Relative to
Comprehensive Earnings) = 2860/10115 = 0.283
Comprehensive Earnings per share
2009 = $10,115/1341 = $7.543
Expected Comprehensive EPS FY 2010
$7.543*1.1255 = $8.49
Expected Comprehensive EPS FY 2011
$8.49*1.094 = $9.288
5-Year
Growth = 0.1043
Normal Growth = 0.045
Projected Dividend Per Share (Next Year) =
$8.49*0.283 = $2.403
Years in Stage 1:
5-years
Inputs for Cost of Equity Capital
(CAPM)
Risk Free Rate = 0.0419
Equity Premium = 0.055
Beta (IBM) = 0.76
Derived:
Cost of Equity Capital (ke) = 0.0837