Harrison Corporation is interested in acquiring Van Buren Corporation. Assume th

Question

Harrison Corporation is interested in acquiring Van Buren Corporation. Assume that the risk-free rate of interest is 4% and the market risk premium is 5%.

Van Buren currently expects to pay a year-end dividend of $2.40 a share (D1 = $2.40). Van Buren's dividend is expected to grow at a constant rate of 6% a year, and its beta is 0.8.

Harrison estimates that if it acquires Van Buren, the year-end dividend will remain at $2.40 a share, but synergies will enable the dividend to grow at a constant rate of 10% a year (instead of the current 6%). Harrison also plans to increase the debt ratio of what would be its Van Buren subsidiary-the effect of this would be to raise Van Buren's beta to 1.4.

If Harrison were to acquire Van Buren, what would be the range of possible prices that it could bid for each share of Van Buren common stock?
Round your answers to the nearest cent.
a. Low bound $  
b. High bound $  

.

Explanation / Answer

Cost of equity :Rf +risk premium *beta

If beta = .8 , 4 + (5 *.8 )

                = 4 +4

                 = 8%

If beta = 1.4 , 4 +(5*1.4)

                 = 4 + 7

                = 11 %

2.40/(.08-.06)

2.40/ .02

2.40/(.08-.10)

2.40 / - .02

2.40 /(.11-.06)

2.40/ .05

2.40/ (.11-.10)

=2.40/.01

a)low bound =$ 48 per share

b)high bound =$ 240 per share

when Beta = .80 ,cost of equity = 8% when Beta = 1.40 ,cost of equity = 115 case 1 2 3 4 Growth (g) 6% 10% 6% 10% Current price = D1/(cost of equity -growth)

2.40/(.08-.06)

2.40/ .02

2.40/(.08-.10)

2.40 / - .02

2.40 /(.11-.06)

2.40/ .05

2.40/ (.11-.10)

=2.40/.01

proce of share $ 120 per share not possible $48per share $240 per share

Related Questions

Navigate

• Browse (All)
• Browse H
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.