Question

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 1.20 (given its target capital structure). Vandell has $12.00 million in debt that trades at par and pays an 7.3% 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 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 $2.5 million, $2.8 million, $3.3 million, and $3.75 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 $12.00 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 $1.6 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 $1.447 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

Given Details as Follows

1. Risk Free Interest rate; 7 %

2. Company beta: 1.2

3. Risk Premium rate: 8%

So Rate of Equity is = Risk free rate of interest + (Beta * Risk premium rate)

= 7%+(1.2*8%)=16.6%

Based on given data post merger the Vandell’s free cash flows due to synergies as follows for first four years

Particulars	Y1	Y2	Y3	Y4
FCFO to Be	2500000	2800000	3300000	3750000
Interest Payments to be	1600000	1600000	1600000	1470000
Net Cash Flows	900000	1200000	1700000	2280000
Present value @ 16.6 %	771869	883002	1072555	1233766

Terminal cash Flows ( due to having FCFO with growth rate)

TV4= 2280000 *(1+0.06)/(1.166-0.05) [ PV* (1+g)/(ke-g)]

So, TV4 is 2400505

Present value of terminal value year 4 (i.e is 2400505)= 1298975

Present Value of Cash Flows for All four years with Terminal cash flows: 52,60,167

Equity Value = Pv of FCFO/Ke

i.e 52,60,167/16.6% =  $ 31,687,753

per share value= $ 32/ share ( 31,687,753/1000,000)