Milton Corporation recently paid a dividend of $1.70 per share, is currently exp
ID: 2708193 • Letter: M
Question
Milton Corporation recently paid a dividend of $1.70 per share, is currently expected to grow at a constant rate of 5%, and has a required return of 11%. Milton Corporation has been approached to buy a new company. Milton estimates if it buys the company, their constant growth rate would increase to 6.5%, but the firm would also be riskier, therefore increasing the required return of the company to 12%. Should Milton go ahead with the purchase of the new company?
No, because the value of the Milton Co. should decrease $3.17 per share.Explanation / Answer
Current share price = 1.7*(1+5%)/(11%-5%) = 29.75
New share price after acquisition = 1.7*(1+6.5%)/(12%-6.5%) = 32.92
So the value of Milton Co has increased by 32.92-29.75 = 3.17 per share
Answer is: Yes, because the value of the Milton Co. should increase $3.17 per share.
Hope this helped ! Let me know in case of any queries.