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 1.15 (given its target capital structure). Vandell has $9.21 million in debt that trades at par and pays an 7.3% interest rate. Vandell’s free cash flow (FCF₀) is $1 million per year and is expected to grow at a constant rate of 6% a year. Both Vandell and Hastings pay a 30% combined federal and state tax rate. The risk-free rate of interest is 7% 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 $2.6 million, $3.2 million, $3.5 million, and $3.65 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 $9.21 million in debt (which has an 7.3% 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 $1.459 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

Ans

Calculate cost of Equity

Cost of Equity = Risk free Rate + Beta * Market Risk Premium

= 7% + 1.15 * 8%

= 16.2%

Calculate cost of debt

Cost of Debt = Interest Rate (1 - Tax Rate)

= 7.3% (1 - 30%)

= 5.11%

Calculate Weighted Average Cost of Capital

WACC = Cost of Equity * Weight of Equity + Cost of Debt * Weight of Debt

= 16.2% * 0.7 + 5.11% * 0.3

= 12.873%

Calculate Value of Business of Vandell Corporation

= ($1*1.06) / (12.873% - 6%)

= $15.42 million

Value of Debt = $9.21 million

Therefore, Value of Equity = $6.21 million

Share Price = $6.21

Calculation of Present Value from Given Cash Flows (in millions)

	Year 1	Year 2	Year 3	Year 4
Free Cash Flows	$2.6	$3.2	$3.5	$3.65
PVF @12.873%	0.886	0.785	0.695	0.616
Present value	2.3036	2.512	2.4325	2.2484
Total Present value				$9.4965

Terminal Value = Free cash flows * (1 + Growth rate) / (WACC - Growth Rate)

= $3.65*(1+0.06) / (12.873% - 6%)

= $56.2927

PVF (12.873%, 3 Years) = 0.695

Present Value of Terminal Value = $39.1234

Value of Business = Annual Present Value + Present Value of Terminal Value

= $9.4965 + $39.1234

= $48.6199

Value of Debt = $9.21 million

Therefore, Value of Equity = $39.4099 million

Share Price = $39.41

Hence Share Price ranges between $6.21 and $39.41.