Principles of Managerial Finance

348 PART 2 Important Financial Concepts

LG4 LG6 7–23 Integrative—Valuation and CAPM Hamlin Steel Company wishes to deter-

mine 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 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 sim-

ilar to Craft that are publicly traded, Hamlin believes that an appropriate beta

for Craft’s stock would be 1.25. The risk-free rate is currently 9%, and the mar-

ket return is 13%. Craft’s dividend per share for each of the past 6 years is

shown in the following table.

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. 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% from that exhibited over the

1998–2003 period.

(2) A decrease in its beta to 1.

CHAPTER 7 CASE Assessing the Impact of Suarez Manufacturing’s

Proposed Risky Investment on Its Stock Value

E

arly in 2004, Inez Marcus, the chief financial officer for Suarez Manufactur-

ing, was given the task of assessing the impact of a proposed risky investment

on the firm’s stock value. To perform the necessary analysis, Inez gathered the fol-

lowing information on the firm’s stock.

During the immediate past 5 years (1999–2003), the annual dividends paid

on the firm’s common stock were as follows:

The firm expects that without the proposed investment, the dividend in 2004

will be $2.09 per share and the historical annual rate of growth (rounded to the

nearest whole percent) will continue in the future. Currently, the required return

on the common stock is 14%. Inez’s research indicates that if the proposed

Year Dividend per share

2003 $1.90

2002 1.70

2001 1.55

2000 1.40

1999 1.30

Year Dividend per share

2003 $3.44

2002 3.28

2001 3.15

2000 2.90

1999 2.75

1998 2.45