1) Harrison Corporation is interested in acquiring Van BurenCorporation. Assume

Question

1) Harrison Corporation is interested in acquiring Van BurenCorporation. Assume that the risk-free rate of interest is 5percent and the market risk premium is 6 percent.

Harrison estimates that if it acquires Van Buren, the year-enddividend will remain at $2.00 a share, but synergies will enablethe dividend to grow at a constant rate of 7 percent a year(instead of the current 5 percent). Harrison also plans to increasethe debt ratio of what would be its Van Buren subsidiary-the effectof this would be to raise Van Buren’s beta to 1.1. What isthe per-share of Van Buren to Harrison Corporation?

Explanation / Answer

$46.52 capital asset pricing model yields a discount rate of 11.6% Kc = Rf + beta x ( Km - Rf) where Kc is the risk-adjusted discount rate (alsoknown as the Cost of Capital); Rf is the rate of a "risk-free" investment, i.e.cash; Km is the return rate of a market benchmark, like theS&P 500. Dividend of $2 with a growth rate of 7 percent for perpetuity,discounted by 11.6% is $46.52

Related Questions

Navigate

• Browse (All)
• Browse 1
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.