Caledonia last paid a dividend of $1 per share 2010. In 2007, the Caledonia paid a dividend of $0.84. This dividend growth rate is expected to be constant for the foreseeable future if the merger is not completed. If the merger is successful, the expected dividend for next year, that is, D1 is expected to be $1.03 and the new long-term growth rate will be 7.5% as a result of the merger.
14. What is the expected new beta value for the combined firm?
15. The risk-free rate is 7% and the market return is estimated as 12%. What is your estimate of the required return of investors in Caledonia before and after the merger?
16. What is the value of a share of Caledonia prior to the merger?
17. What is the new value of a share of stock in Caledonia, assuming the merger is completed?
18. Would you recommend that Caledonia go ahead with the merger?
To answer these questions, we need to use the Dividend Discount Model (DDM) and the Capital Asset Pricing Model (CAPM).
14. To find the expected new beta value for the combined firm, we need the beta value of Caledonia and the beta value of the acquisition target (if available). If the beta value of the acquisition target is not provided, we can assume that the beta value of Caledonia will remain the same. Let's assume the beta value of Caledonia is 1.2.
15. Before the merger, the required return can be calculated using the CAPM formula:
Required Return = Risk-free rate + Beta * (Market return - Risk-free rate)
Assuming the risk-free rate is 7% and the market return is 12%:
Required Return before the merger = 7% + 1.2 * (12% - 7%)
To calculate the required return after the merger, we need to use the new beta value of the combined firm, which we'll calculate later.
16. The value of a share of Caledonia prior to the merger can be calculated using the DDM:
Value of Share = D1 / (Required Return - Growth Rate)
Given that D1 (expected dividend for next year) is $1 and the dividend growth rate is expected to be constant at 0.84 for the foreseeable future:
Value of Share before the merger = 1 / (Required Return before the merger - 0.084)
17. To calculate the new value of a share of stock in Caledonia after the merger, assuming the constant growth rate is 7.5%, we can use the DDM with the new growth rate:
Value of Share after the merger = D1 / (Required Return after the merger - Growth Rate)
Given that D1 is $1.03 and the new long-term growth rate is 7.5%:
Value of Share after the merger = 1.03 / (Required Return after the merger - 0.075)
18. To determine whether Caledonia should go ahead with the merger, we'll compare the value of a share before and after the merger. If the new value of a share after the merger is higher than the value before the merger, it may be favorable to proceed with the merger.
Now, let's calculate the required return before the merger and the new beta value for the combined firm.
To answer these questions, we need to calculate various values using the given information. Let's go step by step:
14. To calculate the expected new beta value for the combined firm, we need the beta value of Caledonia and the beta value of the merger. Unfortunately, the provided information does not include the beta values. Thus, we cannot calculate the expected new beta.
15. To estimate the required return of investors before and after the merger, we can use the Capital Asset Pricing Model (CAPM):
Before the merger:
Required return = Risk-free rate + Beta * (Market return - Risk-free rate)
After the merger:
Required return = Risk-free rate + Beta_new * (Market return - Risk-free rate)
Since we do not have the beta values, we cannot calculate the required return.
16. To calculate the value of a share of Caledonia prior to the merger, we can use the Dividend Discount Model (DDM):
Value of a share of Caledonia = Dividend / (Required return - Dividend growth rate)
Given that the dividend last year was $1 and the dividend growth rate is expected to be constant at the rate of 7.5%, we can calculate the value of a share of Caledonia prior to the merger once we have the required return.
17. To calculate the new value of a share of stock in Caledonia after the merger, we can use the DDM again:
New value of a share of Caledonia = Dividend_next_year / (Required return - Long-term growth rate)
Given that the expected dividend for next year (D1) is $1.03 and the new long-term growth rate after the merger is 7.5%, we can calculate the new value of a share of Caledonia once we have the required return.
18. To determine whether Caledonia should go ahead with the merger, we need to consider various factors such as the expected benefits of the merger, potential risks, market conditions, and financial implications. The decision should be made based on a thorough analysis of the available information and careful consideration of the company's objectives and strategic plans.