Integrative Risk and Valuation Hamlin Steel Company wishes to determine the valu

Question

Integrative Risk and Valuation Hamlin Steel Company wishes to determine the value of Craft Foundry, a firm that it is considering acquiring for cash. Hamlin wishes to determine the applicable discount rate to use as an input to the constant-growth valuation model. Craft's stock is not publicly traded. After studying the required returns of firms si mlar to Craft that are publicly traded Hamlin believes that an appropriate risk premum on Craft stock is about 5%. The risk-ee rate is currently 9%. Craft's dividend per share for each of the past 6 years is shown in the following table: a. Given that Craft is expected to pay a dividend of $3.72 next year, determine the maximum cash price that Hamlin should pay for each share of Craft. (Hint: Roun the growth rate to the nearest whole percent.) b. Describe the effect on the resulting value of Craft from: (1) A decrease in its dividend growth rate of 2% from that exhibited over the 2010-2015 period. (2) A decrease in its risk premium to 4% The required retum on Calts sook a. The required return on Craft's stock is %. (Round to the nearest whole percentage.) The maximum cash price that Hamlin should pay for each share of Craft is s(Round to the nearest cent.) b. (1) If the dividend growth rate decreases by 2%, the maximum cash price that Hamlin should pay for each share of Craft is S . (Round to the nearest cent.) (2) If the risk premium decreases to 4%, the required return on Crars stock is L %. (Round to the nearest whole percentage.) With a 13% required return, the maximum cash price that Hamlin should pay for each share of Craft is S Round to the nearest cent. hould pay for each share of Crat i sRound to the nearest cent)

Explanation / Answer

Rate of growth in dividends:

$ 3.32

Average growth rate in dividends = 20.04% / 5 = 4%

If Craft is expected to pay a dividend of $ 3.73 next year (D1), then the price of the stock = D1/ ( r - g) = 3.73 / ( 0.10 - 0.04) = $ 62.17

b. 1. If dividend growth rate decreases by 2%, revised stock price = 3.73 / ( 0.10 - 0.02) = $ 46.63

2. If risk premium decreases to 3%, revised stock price = 3.73 / ( 0.09 - 0.04) = $ 74.60

Year Dividend per share Growth in dividends 2010 $ 2.95 - 2011 $ 3.07 4.07% 2012 $ 3.19 3.91% 2013

$ 3.32

4.08% 2014 $ 3.45 3.92% 2015 $ 3.59 4.06% 20.04%

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