Question

Integrativelong dashRisk 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 8 %. The risk-free rate is currently 6 %. Craft's dividend per share for each of the past 6 years is shown in the following table: LOADING.... a. Given that Craft is expected to pay a dividend of $3.25 next year, determine the maximum cash price that Hamlin should pay for each share of Craft. (Hint: Round 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 2014 -2019 period. (2) A decrease in its risk premium to 7 %. a. The required return on Craft's stock is nothing %. (Round to the nearest whole percentage.) Year Dividend per Share 2019 $3.01 2018 $2.79 2017 $2.58 2016 $2.39 2015 $2.21 2014 $2.05

Answer 1

required return on stock = risk free rate + risk premium = 6 + 8 =14%

Annual average growth rate

=((last value/First value)^(1/Time between 1st and last value)-1)*100

=((3.01/2.05)^(1/5)-1)*100

Annual Growth rate% = 7.98

As per DDM

Price = Dividend in 1 year/(cost of equity - growth rate)

Price = 3.25/ (0.14 - 0.0798)

Price = 53.99

decrease in growth rate by 2%

As per DDM

Price = Dividend in 1 year/(cost of equity - growth rate)

Price = 3.25/ (0.14 - 0.0598)

Price = 40.52

decrease in risk premium to 7%

required return on stock = risk free rate + risk premium = 6 + 8 =13%

As per DDM

Price = Dividend in 1 year/(cost of equity - growth rate)

Price = 3.25/ (0.13 - 0.0798)

Price = 64.74