Hilal Steel Company wishes to determine the value of Craft Foundry, a firm that it is considering acquiring for cash. Hilal wishes to use the capital asset pricing model (CAPM) 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 betas of firms similar to Craft that are publicly traded, Hilal believes that an appropriate beta for Craft's stock would be 1.25. The risk-free rate is currently 9 percent, and the market return is 13 percent. Craft's dividend per share for each of the past 6 years is shown in the following table.
Year.............................Dividend per share
2012.........................................US$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 US$3.68 next year, determine the maximum cash price that Hilal should pay for each share of Craft.
b. Discuss the use of the CAPM for estimating the value of common stock, and describe the effect on the resulting value of Craft of:
(1) A decrease in its dividend growth rate of 2 percent from that exhibited over the 2007-2012 period.
(2) A decrease in its beta to 1.