Merger Bid (PLEASE NOTE THAT NUMBERS ARE DIFFERENT THATN IN TEXTBOOK) Hastings C
ID: 2762455 • Letter: M
Question
Merger Bid (PLEASE NOTE THAT NUMBERS ARE DIFFERENT THATN IN TEXTBOOK)
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 7.7%. Assume that the risk-free rate of interest is 6% and the market risk premium is 7%. Both Vandell and Hastings face a 30% tax rate.
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Vandell's free cash flow (FCF0) is $1 million per year and is expected to grow at a constant rate of 6% a year; its beta is 1.25.
Hastings estimates that if it acquires Vandell, interest payments will be $1,600,000 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 $1.412 million after which interest and the tax shield will grow at 6%. Synergies will cause the free cash flows to be $2.4 million, $2.7 million, $3.4 million, and then $3.56 million, after which the free cash flows will grow at a 6% rate. Assume Vandell now has $11.72 million in debt.
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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.
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The bid for each share should range between $ ________ per share and $ ________ per share.
Explanation / Answer
Part A FCF0 $1 millions Growth Rate (g) 6.00% Risk Free Rate (Rf) 6.00% Market Risk Premium MRP 7.00% Beta 1.25 Cost of Debt RD 7.70% Tax Rate 30.00% Debt's Weight WD 30.00% Equity's Weight (1-30%) WE 70.00% Cost of equity RE = Rf + Beta x MRP ; 6%+1.25 x 7% 14.75% WACC = WE x RE + WD x RD x(1-Tax) WACC = 70% x 14.75% + 30% x 7.70% x (1-30%) 11.94% Value of Operation = FCF x (1+ g)/WACC -g Value of Operation = $1,000,000 x (1+6%)/(11.94% - 6%) $17.84 millions Debt (Given) $11.72 millions Value of equity = Value of Operation - Value of Debt;($19.09-$11.81) $6.12 millions Shares Outstanding 1 millions Price = $6.12 million / 1 million shares $6.12 per share Part B In millions FCF1 $2.4 FCF2 $2.7 FCF3 $3.4 FCF4 $3.56 Growth Rate 6.00% WACC (calculated above) 11.94% Horizon Value = FCF3 x (1+g)/WACC -g) Horizon Value = $3.56 x (1+6%)/(11.94% -6%) $63.51 Millions Debt Interest $1,600,000 Debt Interest tax Shield = $1,600,000 x 30% $480,000 Horizon value of Interest tax shield= Debt interest 4yr x(1+g)/WACC-g) Horizon value of Interest tax shield = ($1.412 x 30% x (1+6%))/(11.94%-6%) $7.56 millions Year FCF Tax Shield FCF + Tax shield PV @ 11.94% Present Value 1 $2.4 $0.48 $2.88 0.893335716 $2.57 Millions 2 $2.7 $0.48 $3.18 0.798048701 $2.54 Millions 3 $3.4 $0.48 $3.88 0.712925407 $2.77 Millions 4 $3.56 $0.42 $3.98 0.636881729 $2.54 Millions Horizon Value $63.51 $7.56 $71.06 0.636881729 $45.26 Millions Value of Operations $55.67 Millions Value of equity = Value of Operation - Value of Debt;($55.67- $11.72) $43.95 millions Shares Outstanding 1 Millions Price = $43.95 million / 1 million shares $43.95 per share The bid for each share should range between $6.12 and $43.95