Question

Hastings Corporation is interested in acquiring Vandell Corporation. Vandell currently has 1 million shares outstanding and a target capital structure consisting of 30% debt; its current beta is 1.10 (i.e., based on its target capital structure). Vandell's debt interest rate is 8%. Assume that the risk-free rate of interest is 7% and the market risk premium is 6%. Both Vandell and Hastings face a 30% tax rate. 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, $3.4 million, and $3.56 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 $9.12 million in debt (which has an 8% 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 $1.441 million, after which the interest and the tax shield will grow at 6%.

a. What is Vandell’s pre-acquisition levered cost of equity? What is its unlevered cost of equity? Round your answer to two decimal places. Do not round intermediate calculations.
Pre-acquisition levered cost of equity= ____%

Unlevered cost of equity = _____%

b. What is the intrinsic unlevered value of operations at t = 0 (assuming the synergies are realized)? Round your answer to the nearest cent. Do not round intermediate calculations.

c. What is the value of the tax shields at t = 0? Round your answer to two decimal places. Do not round intermediate calculations.

d. What is the total intrinsic value of operations at t = 0? What is the intrinsic value of Vandell’s equity to Hastings? What is Vandell’s intrinsic stock price per share? Round your answer to two decimal places. Do not round intermediate calculations.
Value of operations: $
million
Equity value to acquirer: $
million
Intrinsic value per share of existing shares to acquirer: $
/share

Answer 1

Solution

Part A : Risk free rate = 7%, beta = 1.1, Risk premium = 6%

Cost of equity (levered) = Rf + beta (levered) * Risk premium

= 7%, + 1.1 * 6% = 13.6%

Beta unlevered

Cost of equity un-levered = 7%, + .85 * 6% = 12.08%

Detailed calculation is provided in the excel

Part B ) Unlevered cash flow is calculated using discounted CF method and given in excel with all the formula

Value of firm = 56.68 million

Part C ) Tax shield = interest * tax rate ... Future tax shield is discounted by interest rate to get PV of tax shield

PV of tax shield = 18.40

Part D)

What is the total intrinsic value of operations at t = 0 , = 75.07 million

the intrinsic value of Vandell’s equity to Hastings = 65.95 million

What is Vandell’s intrinsic stock price per share = 65.95