In: Finance
Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capital structure consisting of 30% debt; its beta is 1.60 (given its target capital structure). Vandell has $8.12 million in debt that trades at par and pays an 7.8% interest rate. Vandell’s free cash flow (FCF0) is $1 million per year and is expected to grow at a constant rate of 4% a year. Both Vandell and Hastings pay a 35% combined federal and state tax rate. The risk-free rate of interest is 4% and the market risk premium is 4%. Hastings Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandell’s free cash flows to be $2.6 million, $2.9 million, $3.5 million, and $3.74 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 4% rate. Hastings plans to assume Vandell’s $8.12 million in debt (which has an 7.8% interest rate) and raise additional debt financing at the time of the acquisition. Hastings estimates that interest payments will be $1.6 million each year for Years 1, 2, and 3. After Year 3, a target capital structure of 30% debt will be maintained. Interest at Year 4 will be $1.490 million, after which the interest and the tax shield will grow at 4%. Indicate the range of possible prices that Hastings could bid for each share of Vandell common stock in an acquisition. Round your answers to the nearest cent. Do not round intermediate calculations. The bid for each share should range between $ per share and $ per share.
First,We can calculate the expected return by using given information
Expected return = Risk free return + Beta * Risk premiun
= 4%+ 1.6 (4%)
Expected return = 10.4%
Now we will calculate the discounted cash flows to acquiring company if it acquired vendells
Year | Cash Inflows | Cash Outflows | Net Cash Inflows | Discount [email protected]% | Discounted Cash Inflows(in Million $) |
1 | 2.6 | 1.04 | 1.56 | 0.906 | 1.41336 |
2 | 2.9 | 1.04 | 1.86 | 0.820 | 1.5252 |
3 | 3.5 | 1.04 | 1.82778 | 0.743 | 1.358 |
4 | 3.74 | 1.04 | 2.7 | 0.673 | 1.8171 |
TV | 37.4 | 10.4 | 27 | 0.673 | 18.171 |
Total Cash Flows | 24.28466 |
[Cash Out flows is Interest after tax shield for 1 year to 4 th year is 1.6*0.65 = 1.04
Terminal Value of Outflows = (1.04*104%)/0.104 = $10.4 million
Terminal Value of Inflows = (3.74*104%) / 0.104 = $37.4 million]
Now will calculate the cash flows in Vendells Cash flows individually
Cash Flows Per Year = $ 1 million
Growth rate annually = 4%
So Present value of individual firm is = (1*1.04) /10.4 = $10 million
Conclusion :
If the Hastings acquired Vendells Value is $24.28446 Million
Value per share is $ 24.28
Individual Value of Vendells is $ 10 million
Value per share is $ 10
There fore price range is $10 - $24.28