Question
Hamlin Steel Company wishes to determine the value of Craft Foundry, a firm that it is considering acquiring for cash.Hamlin wishes to use the capital
Hamlin Steel Company wishes to determine the value of Craft Foundry, a firm that it is considering acquiring for cash.Hamlin wishes to use the capital asset pricing model (CAPM) to determine theapplicable discount rate to use as an input to the constant-growth valuationmodel. Crafts stock is not publicly traded. After studying the betas of firms similar to Craft that are publicly traded, Hamlin believes that an appropriate betafor Crafts stock would be 3.25. The risk-free rate is currently 10%, and the market return is 20%. Crafts dividend per share for each of the past 5 years isshown in the following table. Year 2003: $5 2002: $4 2001: $3 2000: $2 and 1999: $1. Given that Craft is expected to pay a dividend of $10 next year, determinethe maximum cash price that Hamlin should pay for each share of Craft.b. Discuss the use of the CAPM for estimating the value of common stock, anddescribe the effect on the resulting value of Craft of:(1) A decrease in its dividend growth rate of 3% from that exhibited over the19992003 period.(2) A decrease in its beta to 1.
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