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 1.30 (given its target capital structure). Vandell has $11.78 million in debt that trades at par and pays an 7.8% interest rate. Vandell’s free cash flow (FCF0) is $1 million per year and is expected to grow at a constant rate of 5% a year. Both Vandell and Hastings pay a 40% combined federal and state tax rate. The risk-free rate of interest is 6% 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 $2.3 million, $3.2 million, $3.5 million, and $3.97 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 $11.78 million in debt (which has an 7.8% 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 $1.451 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.

*(Please don't just copy previous responses, because some of the numbers are slightly different. Thank you!)

Answer 1

We can calculate the desired result using the above information as follows

Weighted Cost of Capital for Vandell corporation can be denoted as

= Percentage of Debt * Cost of Debt + Percentage of Equity * Cost of Equity

Percentage of Debt = 30%

Percentage of Equity = 1 - Percentage of Debt

= 1 - 30% = 70%

Cost of Equity = risk-free rate + (beta*market risk premium)

= 6% + (1.30*8%) = 16.40%

Cost of Debt = Interest rate * ( 1-Tax rate )

= 7.8% ( 1 - 40% )

= 4.68%

Weighted Cost of Capital = Percentage of Debt * Cost of Debt + Percentage of Equity * Cost of Equity

= 30% * 4.68% + 70% * 16.40%

= .30 * 4.68% + .70 * 16.40% = 1.404 + 11.48

= 12.88%

Now the given Free cash flows = $ 1 Million and Growth rate is 5%

Value of the firm = Free cash flows * ( 1+growth rate ) / ( Weighted Cost of Capital - growth rate )

= 1 * (1+5%) / (12.88 - 5)

= 1 * (1.05) / 7.88% = $ 13.32 Million

Debt of the Company = $ 11.78 Million

Equity of Company = Value of Firm - Debt of Company

= 13.32 - 11.78 = $ 1.55 Million

Price per share = Value of Equity / No of outstanding shares

= 1,550,000 / 1,000,000 = $ 1.55 per share

Now as the given cashflows for each period, we can calculate the value of shares using excel sheet as follows

Formulas Used in excel are

Total PV = $ 42.01 Million

PV of Tax shield = $ 2.15 Million

Total Value of PV = 42.01 + 2.15

= $ 44.16 Million

Current Debt = 11.78 Million

Equity value = $ 32.38 Million

Shares Outstanding = 1 Million

Price per share = Value of Equity / No of outstanding shares

= 32.38 / 1 = $ 32.38

So, the bid for each share should range between $ 1.55 per share and $ 32.38 per share.

Hope I was able to solve your concern. If you are satisfied hit a thumbs up !!