Merger valuation Harrison Corporation is interested in acquiring Van Buren Corpo
ID: 2652972 • Letter: M
Question
Merger valuation
Harrison Corporation is interested in acquiring Van Buren Corporation. Assume that the risk-free rate of interest is 3% and the market risk premium is 8%.
Harrison estimates that if it acquires Van Buren, the year-end dividend will remain at $2.00 a share, but synergies will enable the dividend to grow at a constant rate of 9% a year (instead of the current 4%). Harrison also plans to increase the debt ratio of what would be its Van Buren subsidiary - the effect of this would be to raise Van Buren's beta to 1.3. What is the per-share value of Van Buren to Harrison Corporation? Round your answer to the nearest cent.
$
Explanation / Answer
Market Risk Premium = Expected Market Return – Risk-Free Rate
8% = Expected Market Return - 3%
Expected Market Return = 11%
Cost of Equity = Risk Free Rate + Beta of the Security (Expected Market Return – Risk Free rate)
= 3% + 1.3*(11% - 3%)
= 3% + 10.4%
= 13.4%
Per Share Value = Dividend/Cost of Equity – Growth rate
Per Share Value = 2/13.4%-9%
= 2/4.4% = $ 45.45