Question

Problem 22-03
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 1.15 (given its target capital structure). Vandell has $10.32 million in debt that trades at par and pays an 7.5% interest rate. Vandell’s free cash flow (FCF₀) is $2 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 6% and the market risk premium is 6%.

Hastings Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandell’s free cash flows to be $2.6 million, $3.1 million, $3.3 million, and $3.85 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 $10.32 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 $1.434 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

We need to calculate the Intrinsic Enterprise Value of the firm by discounting the Free Cash Flow to present value then by subtracting the Net Debt we will get the Equity Value of the firm and then dividing by the no, of shares outstanding to get the per share intrinsic value.

Enterprise Value = Equity Value + Net Debt

Acquirer	Hasting Corporation
Target	Vandell Corporation
Financial Information of Vandell Corporation
o/s Shares (mn)	1.00
Debt	30%
Equity	70%	Equity Weight will be (1 - Debt weight)
Beta	1.15
Market Value of Debt (mn)	$   10.32
Cost of Debt	7.50%
Free Cash Flow at T=0 (mn)	$     2.00
Constant Growth Rate	5%
Tax Rate	30%
Risk free Rate	6%
Market Risk Premium	6%
Cost of Equity	12.90%	(Cost of Equity will be calculated through CAPM)
		CAPM = Risk free rate + Beta * (Market Risk Premium)
		CAPM - 6% + (1.15 *6%)
Weighted Avg. Cost of Capital (WACC)	10.61%	WACC = (Cost of Debt * Weight of Debt * (1 - tax rate)) + (Cost of Equity * Weight of Equity)
		WACC = (7.5% * 30% * (1 - 30%)) + (12.9% *70%)
	Year 1	Year 2	Year 3	Year 4
Free Cash Flow (mn)	$     2.60	$     3.10	$     3.30	$        3.85
Interest Payment	$     1.50	$     1.50	$     1.50	$     1.434
Terminal Value at the end of 4th Year				$     72.12	(3.85 * (1+5%))/(10.61% - 5%)
Terminal Value will be calculated throught Gordon Growth Model
Gordon Growth Model Terminal Value = (Cash flow *(1 + Growth Rate))/ ( WACC - growth rate)
Calculating the Finite free cash flows
Projection Year	1	2	3	4
Discounting Rate (WACC)	10.61%	10.61%	10.61%	10.61%
Discounting Factor ( 1/ (1+WACC)^projection year	0.904	0.817	0.739	0.668
Value of Finite Free Cash Flows (Discounting Factor * Free Cash Flow)	$     2.35	$     2.53	$     2.44	$        2.57
Sum of Present Value of Finite Free Cash Flows	$     9.90
Present Value of Terminal Value	$   48.19	(72.12 * 0.668)
(here the Terminal Value will be discounted to 4 years ,thus a Discounting Facto of 4 year will be taken)
Enterprise Value (sum of finite and infinte free cash flows)	$   58.09	(9.9 + 48.19)
Net Debt	$   10.32
Equity Value = Enterprise Value - Net Debt	$   47.77	(58.09-10.32)
Intrinsic Price per Share	$   47.77	(Equity Value / No of O/s Shares)
		(47.77 / 1)

The bid for each share should range between $47 and $48.