Merger Valuation (PLEASE NOTE THAT NUMBERS ARE DIFFERENT THAN IN TEXTBOOK) Hasti
ID: 2763707 • Letter: M
Question
Merger Valuation (PLEASE NOTE THAT NUMBERS ARE DIFFERENT THAN 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 7.2%. Assume that the risk-free rate of interest is 7% and the market risk premium is 6%. 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 $1.438 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 $3.69 million in Years 1 through 4, respectively, after which the free cash flows will grow at a 6% rate. What is the unlevered value of Vandell? Vandell's beta is 1.60. 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 $8.35 million in debt. Round your answer to the nearest cent. Do not round intermediate calculations.
$ ________ per share
Explanation / Answer
1) Unlevered Value of Vandell = $35.34 millions.
Note: The discount rate to be used is the cost of unlevered equity.
Calculations of Cost of unlevered equity of Vandell.
Vandell's unlevered beta = BL /[(1+(1-t)(D/E)] = 1.6/[1+0.65*30/70] = 1.6/1.28 = 1.25
Where:
BL is the firm's beta with leverage.
T is the corporate tax rate.
D/E is the company's debt/equity ratio.
Ungeared cost of equity = 7 + 1.25*6 = 14.5%
2) Value of Vandell's tax shields = $35.20 millions.
Calculations:
Note: the discount rate used is the cost of debt (before tax), as it is the tax shields have the same risk as the debt.
3) Per share value of Vandell's share to Hastings = $
Value of Vandell to Hastings = Unlevered value + pv of tax shields = 35.34+35.20 = $70.54 m
Value of Vandell's equity = Value of firm - Value of debt = 70.54 - 8.35 = $62.19m
Value per share = 62.19/1 = $62.19
figures in millions 1 2 3 4 FCF to Firm-$ 2.4 2.7 3.4 3.69 terminal value 46.02 (3.69*1.06)/(0.145 - .06) Free cash flow 2.4 2.7 3.4 49.71 pvif @14.5% 0.8734 0.7628 0.6662 0.5818 pv 2.10 2.06 2.26 28.92 Total PV 35.34