Question

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-growthvaluation model. ​Craft'sstock 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 9​%.The​ risk-freerate is currently 3​%.

​Craft's dividend per share for each of the past 6 years is shown in the following​table:

2019   $2.42
2018   $2.26
2017   $2.11
2016   $1.98
2015   $1.85
2014   $1.73

.

a. Given that Craft is expected to pay a dividend of ​$2.59

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​-2019period.

​(2)A decrease in its risk premium to 8​%.

(3)With a 11​% required​ return, the maximum cash price that Hamlin should pay for each share of Craft is $.

Price is a function of the current​dividend,

▼

​,

and the​risk-freerate, and the​company-specific

▼

risk premium

risk discount

risk-free rate

.

For​Craft,the lowering of the dividend growth rate

▼

increased

reduced

future cash flows resulting in

▼

an increase

a reduction

in share price. The decrease in the risk premium reflected

▼

an increase

a reduction

in risk leading to

▼

an increase

a reduction

in share price

Answer 1

A. if expected dividend next year is 2.59, then net present value = 9.44, DISCOUNTRATE = 9+3= 12%

	Y1	Y2	Y3	Y4	Y5	Y6	Y7
CASH FLOW	1.73	1.85	1.98	2.11	2.26	2.42	2.51
PV OF CASH FLOW	1.544643	1.474809	1.409325	1.340943	1.282385	1.226047	1.171584
TOTAL NPV	9.449736

B. 1) Average growth rate in dividend eachyear is 7%, so 2% decrease will be 5% growth next year. So, Dividned on year 7 = 2,42*(1.05)= 2.54

so,

	Y1	Y2	Y3	Y4	Y5	Y6	Y7
CASH FLOW	1.73	1.85	1.98	2.11	2.26	2.42	2.54
PV OF CASH FLOW	1.544643	1.474809	1.409325	1.340943	1.282385	1.226047	1.149419
TOTAL NPV	9.427571

2) a decrease in risk premium to 8% means discount rate is 8+3=11% a decrease in discount rate increases the present value of cash flow.