LG 4 LG P7-22 Integrative-Risk and Valuation Hamlin Steel Company wishes to dete
ID: 2780775 • Letter: L
Question
LG 4 LG P7-22 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 similar to Craft that are publicly traded, Hamlin believes that an appropriate risk premium on Craft stock is about 5%. The risk-free rate is currently 9%. Craft's dividend per share for each of the past 6 years is shown in the following table Year 2012 2011 2010 2009 2008 2007 Dividend per share $3.44 3.28 3.15 2.90 2.75 2.45 a. Given that Craft is expected to pay a dividend of $3.68 next year, determine the maximum cash price that Hamlin should pay for each share of Craft. b. Describe the effect on the resulting value of Craft of: (1) A decrease in its dividend growth rate of 2% from that exhibited over the 2007-2012 period. (2) A decrease in its risk premium to 4%Explanation / Answer
Historical growth rate:
2.45*(1 + g)^5 = 3.44
g = (3.44/2.45)^(1/5) – 1 = 0.07023333
Return on stock: r = 9 + 5 = 14%
a:
P0 = D1/(r – g) = 3.68/(0.14 - 0.07023333) = 52.75
Price per share = $52.75
b-1:
g = 0.07023333 – 0.02
P0 = 3.68/(0.14 - 0.07023333 + 0.02) = 41
b-2:
r = 9 + 4 = 13%
P0 = 3.68/(0.13 - 0.07023333) = 61.57
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