Question

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 8​%. The​ risk-free rate is currently 4​%.​ Craft's dividend per share for each of the past 6 years is shown in the following​ table:

Year	Dividend per Share
2019	​$2.37
2018	​$2.19
2017	​$2.03
2016	​$1.88
2015	​$1.74
2014	​$1.61

a. Given that Craft is expected to pay a dividend of ​$2.56 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 _____​%.​(Round to the nearest whole​ percentage.)

The maximum cash price that Hamlin should pay for each share of Craft is ​$________. ​(Round to the nearest​ cent.)

b.​ (1) If the dividend growth rate decreases by​ 2%, the maximum cash price that Hamlin should pay for each share of Craft is ​$________. ​(Round to the nearest​ cent.)

​(2) If the risk premium decreases to 7​%, the required return on​ Craft's stock is _____​%. ​(Round to the nearest whole​ percentage.)

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

​(Round to the nearest​ cent.)

Price is a function of the current​ dividend, (1) _________ ​, and the​ risk-free rate, and the​ company-specific (2)

_________. For​ Craft, the lowering of the dividend growth rate (3) ________ future cash flows resulting in (4)

________ in share price. The decrease in the risk premium reflected (5) _________ in risk leading to (6) ___________

in share price.  ​(Select the best answers from the​ drop-down menus.)

(1)

expected dividend growth rate

expected risk-free growth rate

expected risk premium growth rate

(2)

risk premium

risk discount

risk-free rate

(3)

increased

reduced

(4)

an increase

a reduction

(5)

an increase

a reduction

(6)

an increase

a reduction

Answer 1

Calculation is given in the below attached images