Merger Valuation Hastings Corporation is interested in acquiring Vandell Corpora
ID: 2719539 • Letter: M
Question
Merger Valuation
Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capital structure consisting of 30% debt. Vandell's debt interest rate is 7.8%. Assume that the risk-free rate of interest is 7% and the market risk premium is 8%. Both Vandell and Hastings face a 35% tax rate.
Hastings estimates that if it acquires Vandell, interest payments will be $1,500,000 per year for 3 years after which the current target capital structure of 30% debt will be maintained. Interest in the fourth year will be $1.461 million after which interest and the tax shield will grow at 5%. Synergies will cause the free cash flows to be $2.6 million, $3.1 million, $3.4 million, and then $3.99 million in Years 1 through 4, respectively, after which the free cash flows will grow at a 5% rate. What is the unlevered value of Vandell? Vandell's beta is 1.10. Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. Do not round intermediate calculations.
$ million
What is the value of its tax shields? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. Do not round intermediate calculations.
$ million
What is the per share value of Vandell to Hastings Corporation? Assume Vandell now has $9.17 million in debt. Round your answer to the nearest cent. Do not round intermediate calculations.
$ per share
Explanation / Answer
FCF1 = $2.5 million, FCF2 = $2.9 million and FCF3 = $3.4 million; g = 4%; b = 1.4; rRF = 5%; RPM = 5%; wd = 30%; T = 35%; rd = 7.3% Vops = ? P0 = ?
Horizon Value3 =
FCF3(1+g)/(WACC g)
=
3.4 (1.04)/(.0908 0.04)
=
$69.60 million
Tax shields in years 1 through 3 are:
TS1 = TS2 = TS3 =
Interest x T
=
1,600,000 x 0.35
=
560,000
FCF + Tax Shield + Horizon Value
Year 1: 2.5 million + 560,000 = 3.06 million
Year 2: 2.9 million + 560,000 = 3.46 million
Year 3: 3.4 million + 560,000 + 69.60 million = 73.56 million
The unlevered cost of equity based on the pre-merger required rate of return and pre-merger capital structure is:
rsU
= wdrd + wsrsL Note: rs was calculated in problem 1 to be 13.4%
=
0.3*(7.3%)+0.7*(10.5%)
=
9.54%
The present value of the FCFs, the tax shields, and the horizon value at the unlevered cost of equity is:
Vops =
3.06
+
3.46
+
73.56
1+0.0954
1+0.0954^2
1+0.0954^3
Tax shields =
$61.64 million
Equity value =
Vops Debt
=
61.64 million - 11.88 million
Equity Value =
49.76 million
or $49.76 per share since there are 1 million shares outstanding
FCF1 = $2.5 million, FCF2 = $2.9 million and FCF3 = $3.4 million; g = 4%; b = 1.4; rRF = 5%; RPM = 5%; wd = 30%; T = 35%; rd = 7.3% Vops = ? P0 = ?
Horizon Value3 =
FCF3(1+g)/(WACC g)
=
3.4 (1.04)/(.0908 0.04)
=
$69.60 million
Tax shields in years 1 through 3 are:
TS1 = TS2 = TS3 =
Interest x T
=
1,600,000 x 0.35
=
560,000
FCF + Tax Shield + Horizon Value
Year 1: 2.5 million + 560,000 = 3.06 million
Year 2: 2.9 million + 560,000 = 3.46 million
Year 3: 3.4 million + 560,000 + 69.60 million = 73.56 million
The unlevered cost of equity based on the pre-merger required rate of return and pre-merger capital structure is:
rsU
= wdrd + wsrsL Note: rs was calculated in problem 1 to be 13.4%
=
0.3*(7.3%)+0.7*(10.5%)
=
9.54%
The present value of the FCFs, the tax shields, and the horizon value at the unlevered cost of equity is:
Vops =
3.06
+
3.46
+
73.56
1+0.0954
1+0.0954^2
1+0.0954^3
Tax shields =
$61.64 million
Equity value =
Vops Debt
=
61.64 million - 11.88 million
Equity Value =
49.76 million
or $49.76 per share since there are 1 million shares outstanding