Hamlin Steel Company wishes to determine the value of Craft Foundry, a firm that it is considering

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-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 5%. The risk-free rate is currently 9%. Craft’s dividend per share for each of the past 6 years is shown in the following table.

Year Dividend per share

2012 ............................ $3.44

2011 ............................ 3.28

2010 ............................ 3.15

2009 ............................ 2.90

2008 ............................ 2.75

2007 ............................ 2.45

a. Given that Craft is expected to pay a dividend of $3.68 next year, determine the maximum cash price that Hamlin should pay for each share of Craft.

b. Describe the effect on the resulting value of Craft of:

(1) A decrease in its dividend growth rate of 2% from that exhibited over the 2007–2012 period.

(2) A decrease in its risk premium to 4%.

Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal... Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their...