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 1.45 (given its target capital structure). Vandell has $10.12 million in debt that trades at par and pays an 7.2% interest rate. Vandell’s free cash flow (FCF₀) is $2 million per year and is expected to grow at a constant rate of 6% a year. Both Vandell and Hastings pay a 40% combined federal and state tax rate. The risk-free rate of interest is 4% and the market risk premium is 8%.

Hastings Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandell’s free cash flows to be $2.4 million, $2.9 million, $3.5 million, and $3.73 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 6% rate. Hastings plans to assume Vandell’s $10.12 million in debt (which has an 7.2% 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 $1.445 million, after which the interest and the tax shield will grow at 6%.

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

Free Cash Flows (FCF) = $ 2 million per year

cost of equity (r_e) = risk free rate + ( beta * risk premium)

= 0.04 + (1.45 * 0.08)

= 0.156 (or) 15.6%

Weighted Average Cost of Capital (WACC) = [ E/ (E+D) * r_e ] + [ D/(E+D) * {r_d (1-t) } ]

E = market value of equity

D = Market value of debt

r_d = cost of debt   

t = corporate tax

WACC = ( 0.7 * 0.156 ) + [0.3 * { 0.072 (1-0.4)}]

= 12.22%

Value of Firm = FCF( 1+g) / (WACC-g)

= 2000000 ( 1+0.06) / ( 0.1222- 0.06)

= $ 34083601

Value of equity = Value of firm - debt

= $34083601 - 10120000

= $ 23963601

number of Equity shares = 1 million shares

Equity Share Price = $ 23.9636

Year	FCF	PVF @ WACC	Discounted Value
1	2.4	0.8911	2.1387
2	2.9	0.7941	2.3028
3	3.5	0.7076	2.4766
4	3.73	0.6305	2.3519
4	63.5659	0.6305	40.0814
			$49.3514 million

Terminal Value = FCF₄ (1+g) / (WACC -g)

= 3.73 (1.06)  / (0.1222 - 0.06)

= $ 63.5659 m

Free Cash flow of equity = FCFE + Debt

= 49.3514 + 10.12

= 59.4714

Value of equity share = 59.4714