Caledonia Minerals has an estimated beta of 1.6. The company is considering the acquisition of another firm that has a beta of 1.2. Both companies are exactly the same size.

a. What is the expected new beta value for the combined firm?

b. The risk-free rate of return is estimated at 7 percent and the market return is estimated as 12 percent. What is your estimate of the required return of investors in Caledonia before and after the merger?

Caledonia Minerals is expected to pay a $1 dividend next year (D1 ¼ $1). This dividend is expected to grow at a rate of 6 percent per year for the foreseeable future if the merger is not completed. The merger is not expected to change the current dividend rate, but future dividends are expected to grow at a 7 percent rate as a result of the merger.

c. What is the value of a share of stock in Caledonia Minerals prior to the merger?

d. What is the new value of a share of stock, assuming that the merger is completed?

e. Would you recommend that Caledonia go ahead with the merger?