Cotton Bowl enterprises is considering expansion in to overseas operations. Curr
ID: 2800989 • Letter: C
Question
Cotton Bowl enterprises is considering expansion in to overseas operations. Currently the stock’s
beta is +1.25, the Risk free rate of return is 2% and the going rate on the market is 10%. Cotton
Bowl has a constant dividend growth rate of 4%. Post the expansion, Cotton Bowl’s beta value is
expected to increase to +2.75 and the dividend growth rate will increase to 6%. The company’s last
paid dividend was $3.00 per share.
a. Does the expansion make sense for Cotton Bowl? (Make sure to evaluate the impact on a preand
post-expansion basis and show all work).
Explanation / Answer
Current beta of stock = 1.25
Risk free rate, Rf = 2%
Market rate , Rm = 10%
Cost of equity, Ke = Rf + Beta*(Rm - Rf)
= 2% + 1.25 *(10% - 2%)
= 12%
Growth rate,g = 4%
Current paid dividend, D0 = $3
D1 = D0*(1 + g) = $3*(1 + 4%) = $3.12
Current price of stock, P0 = D1 / (Ke - g)
= $3.12 / (12% - 4%)
= $39 Per share
If expansion makes :
Growth rate, g = 6%
Beta = 2.75
Cost of equity, Ke = 2% + 2.75 *(10% - 2%)
= 24%
D1 = $3*(1 + 6%) = $3.18
P0 = $3.18 / ( 24% - 6%)
= $17.667 Per share
Due to expansion stock price decreased, hence expansion doesn't make any sense for Cotton Bowl.