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 1.45 (given its target capital structure). Vandell has $8.29 million in debt that trades at par and pays an 7.5% interest rate. Vandell’s free cash flow (FCF₀) is $2 million per year and is expected to grow at a constant rate of 5% 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 5%.

Hastings Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandell’s free cash flows to be $2.3 million, $2.9 million, $3.5 million, and $3.61 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 $8.29 million in debt (which has an 7.5% 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 $1.439 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.

Answer 1

The risk-free rate of interest = 7%

Beta = 1.45

Market risk premium = 5%

Using CAPM model, required rate of return on equity = Rf + Beta*(Market risk premium)

The required rate of return on equity = 7% + 1.45*(5%) = 14.25%

Post-merger, the Vandella's free cash flows due to synergies will be

Year	1	2	3	4
Free Cash Flows	2300000	2900000	3500000	3610000
Interest payments	1500000	1500000	1500000	1439000
Net cash flows	800000	1400000	2000000	2171000
PV at a discount rate 14.25%	700219	1072545	1341101	1274192

Terminal cash flows due to free cash flows

where g is the growth rate= 5%

r is the required rate of return = 14.25%

TV4 =  2171000*(1.05) /(0.1425-0.05) = 24,643,784

PV of terminal value at year 4 = 24643784 / (1.1425^4) = 14,463,805

PV of net cash-flows from year 1-4 = 4,388,057

Total PV = 18,851,862

Present value of equity =

Total equity value = 18851862 / 0.1425 = 132,293,768

Total shares outstanding = 1,000,000

Equity value per share = 132,293,768 / 1,000,000

Equity value per share = $132.293

Hence, the bid can range between $132 and $133.