Merger Valuation Harrison Corporation is interested in acquiring Van Buren Corpo
ID: 2802913 • Letter: M
Question
Merger Valuation
Harrison Corporation is interested in acquiring Van Buren Corporation. Assume that the risk-free rate of interest is 4%, and the market risk premium is 5%.
Harrison estimates that if it acquires Van Buren, the year-end dividend will remain at $2.37 a share, but synergies will enable the dividend to grow at a constant rate of 7% a year (instead of current 5%). 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 1.2. What is the per-share value of Van Buren to Harrison Corporation? Do not round intermediate calculations.
$ (to 2 decimals)
Explanation / Answer
Cost of equity, r = Rf + beta x MRP = 4% + 1.2 x 5% = 10%
As the growth rate will increase to g = 7%, using dividend growth model
Value per share = D1 / (r - g) = 2.37 / (10% - 7%) = $79.00