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dividends. First, Mr. Hitt assumed that an amount of excess
capital, $2,938,280, would be paid out in year 1. Next, he
assumed that FNBW would maintain a capital-to-asset ratio of 8
percent and calculated the minimum equity required to maintain
that ratio. Finally, he assumed that the yearly income would be
used in two ways: Part of it would become retained earnings in
order to maintain the 8-percent capital-to-asset ratio; the
remainder would be distributed to the shareholders. The amount
distributed to shareholders was then discounted to present value
using a capitalization rate of 14.7 percent.
As with JFI, Mr. Hitt used the Capital Asset Pricing Model
to calculate the capitalization rate. His figure for beta, 1.05,
was determined from averages of small publicly traded regional
banks. To calculate the capitalization rate, he began with the
rate for U.S. Government bonds as of the valuation date, which,
according to him, was 7.2 percent, and he added the product of
the beta of 1.05 times 7.2 percent, for a total of 14.7
percent.15 This capitalization rate already took into account
any minority interest discount, so a further such discount was
not applied. Mr. Hitt considered adjusting this rate to a higher
number to reflect the greater risk associated with FNBW’s lack of
geographic diversification; but he felt that this factor was
15 Although 7.2 + (1.05 x 7.2) = 14.76, Mr. Hitt rounded the
figure to 14.7.
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