Question

Merger Bid 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 1.25 (given its target capital structure). Vandell has $8.79 million in debt that trades at par and pays an 7.5% interest rate. Vandell’s free cash flow (FCF0) is $1 million per year and is expected to grow at a constant rate of 5% a year. Both Vandell and Hastings pay a 30% combined federal and state tax rate. The risk-free rate of interest is 5% and the market risk premium is 7%.

Hastings Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandell’s free cash flows to be $2.3 million, $3.0 million, $3.5 million, and $3.79 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 5% rate. Hastings plans to assume Vandell’s $8.79 million in debt (which has an 7.5% interest rate) and raise additional debt financing at the time of the acquisition. Hastings estimates that interest payments will be $1.5 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 $1.451 million, after which the interest and the tax shield will grow at 5%.

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.

Answer 1

First we shall find   Vandell's cost of Equity, ke ---to discount its FCFs

as per CAPM, ke=RFR+(Beta*Mkt. Risk premium)

ie.5%+(1.25*7%)=

13.75%

Value of Vandell (without considering synergies)

(FCF1/(Cost of equity-Growth Rate of FCFs)

ie.(FCF0*(1+g))/(ke-g)

(1*1.05)/(13.75%-5%)=

12

millions

Value of Vandell 's debt= 8.79 mln

so, value of Vandell's equity= 12 mln-8.79 mln.=ie.3.21 mln

No.of equity shares o/s = 1mln.

Value /share(Without synergies)= 3.21 mln./1 mln.= $ 3.21

Value of Vandell (considering synergies)
Year	0	1	2	3	4
1.FCFs		2.3	3	3.5	3.79
2.Terminal FCF(3.79*1.05)/(13.75%-5%)					45.48
3. Interest Tax shields(int pmt.*30% tax )		0.45	0.45	0.45	0.4353
(1.5*30% for yrs. 1 to 3 & 1.451*30% for yr.4)
4. Terminal value of Tax shilelds discounted at gross cost of debt, ie. 7.5%
(0.4353*1.05)/(7.5%-5%)=					18.2826
Total FCFs(1+2+3+4)		2.75	3.45	3.95	67.9879
PV F at 13.75%	1	0.87912	0.77285	0.67943	0.59730
PV at 13.75%	0	2.417582	2.666345	2.683755	40.6093
NPV of FCFs (Value of Vandell) in mlns.	48.377029
Less:Value of Vandell's Debt(in mlns.)	8.97
Value of Vandell's equity(in mlns.)	39.40703
No.of equity shares o/s(in mlns.)	1
so Value/share(39.40703/1) in $	39.41
So, the answer is:
The bid for each share should range between $ 3.21 per share and $ 39.41 per share.