Question

Integrativelong dash—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 88​%. The​ risk-free rate is currently 55​%. 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 ​$2.92 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%.

Year	Dividend per Share
2019	$2.73
2018	$2.55
2017	$2.38
2016	$2.23
2015	$2.08
2014	$1.95

Answer 1

a

Required rate = risk free rate+ risk premium

=5+8=13%

Annual average growth rate

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

=((2.73/1.95)^(1/5)-1)*100

Annual Growth rate% = 7

As per DDM

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

Price = 2.92/ (0.13 - 0.07)

Price = 48.67

b

1)

As per DDM

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

Price = 2.92/ (0.13 - 0.05)

Price = 36.5

2)

As per DDM

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

Price = 2.92/ (0.12 - 0.07)

Price = 58.4