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 $1.50,(given its target capital structure). Bendel has $9.6 million in debt that trades at par and pays and 7.9% interest rate. Caseload free cash flow is $1 million per year and is expected to grow at a constant rate of 6% a year. Both Vandell and Hastings pay 35% combined federal and state tax. The risk-free rate of interest is 3% and the market risk premium is 8%.

Hastings corporation estimates that if it requires Vadells corporation , synergist will cause Bendel’s recapped close to be 2.5 million dollars , 2.7 million dollars , 3.4 million dollars , and 3.68 million dollars at years one through year for respectively. After which the free cash flow’s will grow at a constant 6%rate . Hastings plans to assume the vadells 9.6 million dollars in debt ( at a rate of 7.9%) interest) and raise additional debt financing at the time of the acquisition. Hastings estimates that the interest payments will be $1.5 million each year for years one, two, and three. After your three, a target capital structure of 30% debt will be maintained. Interest at year for will be $1.407 million, After which the interest and tax shield will grow at 6%.

Indicate the range of possible prices that Hastings could bid for each share of Vandell common stock in the acquisition. Round your answer to the nearest cent do not round immediate calculations.

The bid for each share should range between $___________ per share and

$__________per share

Answer 1

Weight of debt	30%
Weight of equity	70%
debt interest rate	7.90%
tax rate	35.00%
cost of debt	5.14%	=7.9%*(1-35%)
Risk free rate	3.00%
Market risk premium	8.00%
Beta	1.5
Cost of equity	15.00%	=3%+1.5*8%
WACC	12.04%	=30%*5.14%+70%*15%
Growth rate	6.00%
Amount of debt	9,600,000
No of shares outstanding	1,000,000

FCFE projections-
case 1- no synergy
Year	Formula	1	2	3	4	5
FCFF	=1,000,000*(1+6%)	1,000,000	1,060,000	1,123,600	1,191,016	1,262,477
Interest payment	=7.9%*9,600,000	758,400	758,400	758,400	758,400	758,400
Tax shield	=7.9%*9,600,000*35%	265,440	265,440	265,440	265,440	265,440
Net interest payment	=7.9%*9,600,000*(1-35%)	492,960	492,960	492,960	492,960	492,960
FCFE	=FCFF- net interest payment	507,040	567,040	630,640	698,056	769,517
V- equity	= FCFE*(1+g)/ (r - g)= 567,040*(1+6%)/(15%-6%)	6,300,444
Price per share	=6,300,444/1,000,000	6.30

Case 2- 100% synergy
Year	Formula	1	2	3	4	5
FCFF	=1,000,000*(1+6%)	1,000,000	1,060,000	1,123,600	1,191,016	1,262,477
Additional debt		2,500,000	2,700,000	3,400,000	3,680,000	-
Interest payment	=7.9%*9,600,000 for year 5 onwards	1,500,000	1,500,000	1,500,000	1,407,000	758,400
Tax shield	=Interest payment*35%	525,000	525,000	525,000	492,450	265,440
Net interest payment	=Interest payment*(1-35%)	975,000	975,000	975,000	914,550	492,960
FCFE	=FCFF- net interest payment	25,000	85,000	148,600	276,466	769,517
PV of FCFE	=FCFE/(1+r)^t = 25,000/(1+15%)^1	21,739	64,272	97,707	158,070	382,586
V- equity (year 5 onwards)	= FCFE*(1+g)/ (r - g)= 138,939*(1+6%)/(15%-6%)	9,063,200
PV of V- equity at year 1	=1,636,392/(1+6%)^5	6,772,550
Total value of equity	=1,636,392+1,222,807	15,835,750
Price per share	=15,835,750/1,000,000	15.84

The bid for each share should range between $6.30 per share and $15.84 per share

Note- here discount rate for FCFE is cost of equity and not WACC since FCFE has only equity component and no debt component