Cascade Mining ($28Mil Assets) has an estimated beta of 1.6. The company is considering the acquisition of Hanson Welding ($42 Mil assets) that has a beta of 1.2.
Cascade last paid a dividend of $1 per share 2010. In 2007, the Cascade paid a dividend of $0.89. 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.
What is the expected new beta of cascade after the acquisition?
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 Cascade before and after the acquisition?
What is the value of a share of Cascade prior to the acquisition?
What is the new value of a share of stock in Cascade, assuming the acquisition is completed?
Would you recommend that Cascade go ahead with the acquisition? Please support your answer.
To find the expected new beta of Cascade after the acquisition, we need to use the formula for weighted average beta.
Beta is a measure of a stock's systematic risk relative to the market. It measures the sensitivity of the stock's returns to changes in the overall market returns.
The formula for weighted average beta is:
New Beta = W1 * Beta1 + W2 * Beta2
Where:
W1 = the weight of the first stock in the portfolio (Cascade in this case)
W2 = the weight of the second stock in the portfolio (Hanson Welding in this case)
Beta1 = the beta of the first stock (Cascade's beta of 1.6)
Beta2 = the beta of the second stock (Hanson Welding's beta of 1.2)
Given that Cascade Mining has $28 million in assets and Hanson Welding has $42 million in assets, we can calculate the weights as follows:
W1 = $28 million / ($28 million + $42 million) = 0.4
W2 = $42 million / ($28 million + $42 million) = 0.6
Plugging in the values, we get:
New Beta = 0.4 * 1.6 + 0.6 * 1.2
= 0.64 + 0.72
= 1.36
Therefore, the expected new beta of Cascade after the acquisition is 1.36.
Now, let's calculate the required return of investors in Cascade before and after the acquisition using the Capital Asset Pricing Model (CAPM).
The CAPM formula is:
Required Return = Risk-free Rate + Beta * (Market Return - Risk-free Rate)
Assuming a risk-free rate of 7% and a market return of 12%, we can calculate the required return for Cascade before and after the acquisition.
For Cascade before the acquisition:
Required Return (before) = 7% + 1.6 * (12% - 7%)
= 7% + 1.6 * 5%
= 7% + 8%
= 15%
For Cascade after the acquisition:
Required Return (after) = 7% + 1.36 * (12% - 7%)
= 7% + 1.36 * 5%
= 7% + 6.8%
= 13.8%
Therefore, the estimated required return of investors in Cascade before the acquisition is 15%, and after the acquisition is 13.8%.
To calculate the value of a share of Cascade prior to the acquisition, we can use the dividend discount model (DDM). The DDM formula is:
Value = D1 / (Required Return - Growth Rate)
Given that Cascade paid a dividend of $1 per share in 2010 and the dividend growth rate is expected to be constant, we can use the 2010 dividend as D1. The growth rate is not given in the question. However, since the merger is not completed, we can assume the same growth rate as before, which is the growth rate from 2007 to 2010.
Dividend growth rate = (Dividend in 2010 - Dividend in 2007) / Dividend in 2007
= ($1 - $0.89) / $0.89
= $0.11 / $0.89
= 0.1236 (12.36%)
Plugging in the values, we get:
Value = $1 / (0.15 - 0.1236)
= $1 / 0.0264
≈ $37.88
Therefore, the value of a share of Cascade prior to the acquisition is approximately $37.88.
To calculate the new value of a share of stock in Cascade assuming the acquisition is completed, we need to use the new dividend and growth rate. Given that the expected dividend for next year (D1) is $1.03 and the new long-term growth rate is 7.5%, we can use the DDM formula again.
Plugging in the values, we get:
Value = $1.03 / (0.138 - 0.075)
= $1.03 / 0.063
≈ $16.35
Therefore, the new value of a share of stock in Cascade, assuming the acquisition is completed, is approximately $16.35.
Finally, regarding the recommendation for Cascade to go ahead with the acquisition, we need to compare the values before and after the acquisition.
Before the acquisition, the value of a share of Cascade is $37.88. After the acquisition, the value decreases to $16.35.
Considering that the value dropped significantly after the acquisition, it suggests that the merger may pose some risks or challenges. It would be prudent to conduct a more detailed analysis of the potential benefits and risks associated with the acquisition before making a recommendation.
Please note that this is a simplified analysis based on the information provided, and it is important to consider other factors and conduct a comprehensive evaluation before making any investment decisions.