A Simple Valuation and Reverse Engineering: IBM (Easy)

The following are key numbers from IBM’s financial statements for 2004.

IBM’s shares traded at $95 when 2004 results were announced. Use a required return for operations of 12.3 percent to answer the following questions:

a. Forecast operating income and residual operating income for 2005 if IBM maintains the same core RNOA as in 2004.

b. Calculate the per-share value of the equity if IBM were to maintain this profitability in the future and if residual earnings were to grow at the 2004 sales growth rate. Also calculate the implied forward enterprise P/E ratio and the enterprise P/B ratio.

c. Calculate the expected rate of return on buying IBM’s stock at $95 under the scenario in part

b. Is $95 cheap or expensive?

d. What growth rate in residual operating income would justify the current stock price if you were sure that 12.3 percent was a reasonable required return?

Net operating assets, end of year Net financial obligations, end of year Common shares outstanding, end of year Common equity, end of year Core return on net operating assets Sales growth rate $42,104 million 12,357 million 29,747 million 1,645.6 million 18.8% 8.8%