Problem 21-1 Valuation Harrison Corporation is interested in acquiring Van Buren

Question

Problem 21-1
Valuation

Harrison Corporation is interested in acquiring Van Buren Corporation. Assume that the risk-free rate of interest is 3% and the market risk premium is 6%.

Van Buren currently expects to pay a year-end dividend of $2.70 a share (D1 = $2.70). Van Buren's dividend is expected to grow at a constant rate of 6% a year, and its beta is 0.6. What is the current price of Van Buren's stock? Round your answer to the nearest cent.

$  

Problem 21-2
Merger valuation

Harrison Corporation is interested in acquiring Van Buren Corporation. Assume that the risk-free rate of interest is 5% and the market risk premium is 7%.

Harrison estimates that if it acquires Van Buren, the year-end dividend will remain at $2.15 a share, but synergies will enable the dividend to grow at a constant rate of 7% a year (instead of the current 5%). 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 1.2. What is the per-share value of Van Buren to Harrison Corporation? Round your answer to the nearest cent.

$  

Problem 21-3
Merger bid

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 6%.

Van Buren currently expects to pay a year-end dividend of $2.60 a share (D1 = $2.60). Van Buren's dividend is expected to grow at a constant rate of 4% a year, and its beta is 0.9.

Harrison estimates that if it acquires Van Buren, the year-end dividend will remain at $2.60 a share, but synergies will enable the dividend to grow at a constant rate of 7% a year (instead of the current 4%). 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 1.2.

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

21-1 rate of return= Riskfree+beta(risk premium) 6.60% (3%+0.6*(6%)) value of stock= D1/(k-g) D1= dividend k= rate of return g= growth rate 450 (2.7/(6.6%-6%)) 21-2 rate of return= Riskfree+beta(risk premium) 13.40% (5%+01.2*(7%)) value of stock= D1/(k-g) D1= dividend k= rate of return g= growth rate 33.59 (2.15/(13.4%-7%)) 21-3 rate of return= Riskfree+beta(risk premium) 9.40% (4%+.9*(6%)) value of stock= D1/(k-g) D1= dividend k= rate of return g= growth rate 48.15 (2.6/(9.4%-4%)) rate of return= Riskfree+beta(risk premium) 11.20% (4%+1.2*(6%)) value of stock= D1/(k-g) D1= dividend k= rate of return g= growth rate 61.90 (2.6/(11.2%-7%)) a. lowbound= $ 48.15 h. Highbound= $ 61.90

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