Merger Bid Hastings Corporation is interested in acquiring Vandell Corporation.
ID: 2763193 • Letter: M
Question
Merger Bid 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 7.4%. Assume that the risk-free rate of interest is 4% and the market risk premium is 8%. Both Vandell and Hastings face a 40% tax rate. Vandell's free cash flow (FCF_0) 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 $1,500,000 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 $1,459 million after which interest and the tax shield will grow at 6%. Synergies will cause the free cash flows to be $2.5 million, $3.1 million, $3.4 million, and then $3.70 million, after which the free cash flows will grow at a 6% rate. Assume Vandell now has $10.13 million in debt. 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.Explanation / Answer
Answer: The bid for each share should range between $9.36 per share and $21.05 per share.
1) The lowest price could be the one derived from the cash flows without synergy; ie: without merger.
Calculation of WACC:
cost of debt = 7.4(1-0.4) = 4.44%
cost of equity = 4 + 1.25*8 = 14% (as per CAPM)
WACC = 4.44*0.3 + 14*0.7 = 11.13%
Valuation of Vandell:
Free cash flow for Firm = $1 million growing at 6% perpetually.
PV = 1/0.1113-0.06 = 1/0.0513 = $19.493177m = value of the firm
Vaue of Debt (as given) = $10.13 m
Value of equity = 19.493177 - 10.13 = 9.363177
No of shares = 1 m
Value of one share = $9.36
2) Value of Vandell with synergy.
figures in millions of $ 1 2 3 4 free cash flows to firm - $ millions 2.500 3.100 3.400 3.700 interest on debt 1.500 1.500 1.500 1.459 tax shield on interest at 40% 0.600 0.600 0.600 0.584 free cash flows to equity 1.600 2.200 2.500 2.825 (FCFE - Int + tax shield on debt) PVIF @ 10% - cost of equity 0.9091 0.8264 0.7513 0.6830 1.455 1.818 1.878 1.929 Sum of PVs from year 1 to 4 7.080 PV of terminal cash flows at t = 4 = {1.929(1.06)/0.10}*.6830 =13.97 Value of total equity = 13.97 + 7.08 = $21.05 million Value of one share $21.05