Mahlo is planing to diversify into the bakery industry. As a result, its beta should drop from 1.4 to 1.2 and the expected long-term growth rate of dividends will drop from 12% to 9%. The risk-free rate is 4%, the expected market risk premium is 9%, and the current dividend per share paid by Mahlo is $2.10. Should Mahlo complete the diversification into the bakery industry?

Question

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Solution: Current k? = 0.04 + 1.4(0.09) = 0.166 or 16.6% P₀ = $2.10(1.12) / (0.166 - 0.12) = $51.13 New k_e = 0.04 + 1.2(0.09) = 0.148 or 14.8% New P₀ = $2.10(1.09) / (0.148 - 0.09) = $39.47

Mahlo Is Planing to Diversify into the Bakery Industry