Carem Industries was formed in 1985 producing specialized valves and pumps. Carem employed approximately 100 employees in

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Carem Industries was formed in 1985 producing specialized valves and pumps. Carem employed approximately 100 employees in two plants and generated sales of $35.83 million in 2019 (Exhibit 2A). Mr.Carem, CEO, started the firm with 12 employees by manufacturing one specialized valve for the military, and Carem grew as more military contracts were awarded. However, reductions in military spending forced a change in strategy. It was Ms.Raymar, Mr.Carem?s likely successor, who encouraged revamping the product line for civilian use and helped diversify the company?s client base. The turnaround was successful and the company has seen revenues grow steadily since, averaging 16.5% during the last two years.

Ms.Raymar has long recognized that a crucial element in maintaining the steady growth of the company is the availability of sufficient long-term funding. Ms.Raymar wants Carem to raise an additional $5 million through a combination of debt and equity(stock) issues. Of the $5 million raised, $1 million will be used to retire short-term debt, $1 million to support Carem?s growing working capital requirements and $3 million for strategic acquisitions. Mr. Carem has approved the plan.

Ms.Raymar relayed some information given to her by Carem?s bankers over the past week. Based on the company?s financial information, she wanted them to answer:

What price can Carem expect for issuing new shares? Ms.Raymar is comfortable with using constant-growth DDM/DGM, but wants ?r? (required return/cost of equity) to be estimated using DDM/DGM and CAPM (i.e. somewhere in the range established by the two alternative methods, and support your selection). (Note: For purposes of calculating ?r? using DDM/DGM, year 1 is 2020. For purposes of calculating share price using DDM/DGM, year 1 is 2021. The reason is that the recent share price is based on 2020 dividends, but prospective share price will be based on 2021 dividends.)

EXHIBIT 1: Report prepared by Mr.Marty Reynolds of Western Bank for Ms.Michelle Raymar of Carem Industries on March 31, 2020, summarizing major points discussed over the past week.

Carem could issue new bonds for proceeds up to $2 million without any risk of losing its current BBB credit rating.
Current YTM on BBB bonds is 10.5% for 5-year bonds and 11% for 10-year bonds.
A yield premium of 2% must be offered to issue zero coupon bonds.
Carem could issue up to 3 million of new shares without any risk of a drop in credit ratings or dilution of its shares.
If Carem increases its annual dividends it could fetch a higher price for new shares, but the exact trade-off is not clear.
The current interest rate on 3-month Treasury bills is 2%, the market risk premium (MRP) is 10%, and the beta on Carem stock is 1.5.