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 $9.12 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 6% a year. Both Vandell and Hastings pay a 35% 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 $2.5 million, $3.0 million, $3.4 million, and $3.90 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 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 $1.441 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

This question is related to the valuation of shares of unlisted companies. When a company is unlisted, there is no data related to their financials. This can only be done by estimation of the data given using formula, justification, approximation, so the value we get can only be subjective and in practice can be discussed upon.

There are basically four method of valuation :-

1. Dividend Yield Method:- unlisted companies do not publish their dividend yield or any data related to it. so in that case the dividend yield of the similar company is to be taken for reference. Dividend yield is nothing but the shareholder receive in form of return. Formula for the same is "Ordinary dividend per share/Adjusted dividend yield". The dividend yield needs to be adjusted as an unlisted ordinary shares are not very marketable or there are multiple factors such as risk, transferability restriction etc.
2. Earning Method:- just like in the case of dividend yield method, we have to take the reference of the similar company in the industry to compare the financials. We will consider the Price Earning ratio to get the desired result. Formula for same will be "Earning per share*adjusted price earning ratio".
3. Net asset method:- This method can be considered as the easiest way to get the value of an unlisted company. Formula for the same are:
   • Net Asset= Total asset - Total Liabilities = Total equity and reserves
   • Prices of the share= Net asset/No. of ordinary share issued
4. Discounted Cash Flow Method:- This method requires estimation of future cash flow of the unlisted company. The cash flows are those used for after debt finance payments but before the dividend gets paid.Cost of equity can be calculate by CAPM method.
   • price of a share= Total discounted cash flow/no. of ordinary share to issue.
   • CAPM:- Expected rate of return= risk free rate of return+beta*(risk premium)

From above explanation we will consider 4th method to get the value of the share. so the derived financial from the above question are:-

Vandell Figures
Shares Outstanding	1000000
beta	1.45
debt	$9,120,000	@7.80%
FCFO	$1,000,000	6%
tax	35%
Risk free rate	7%
market premium	5%
total Capital	$30,400,000	debt/0.3
CAPM Return	14.25%	Formula applied

Cash flow Structure:-

years	1	2	3	4	5	6	7
FCFO	$2,500,000	$3,000,000	$3,400,000	$3,900,000	$4,134,000	$4,382,040	$4,644,962
Discount Rate	14.25%	14.25%	14.25%	14.25%	14.25%	14.25%	14.25%
Interest payment	$1,500,000	$1,500,000	$1,500,000	$1,441,000	$1,441,000	$1,441,000	$1,441,000
Net Cash Flow	$1,000,000	$1,500,000	$1,900,000	$2,459,000	$2,693,000	$2,941,040	$3,203,962
After Tax Cash Flow	$650,000	$975,000	$1,235,000	$1,598,350	$1,750,450	$1,911,676	$2,082,576
PV	$568,928	$746,951	$828,130	$938,095	$899,226	$859,562	$819,610
Expected Share Price	$0.57	$0.75	$0.83	$0.94	$0.90	$0.86	$0.82