Merger Bid Hastings Corporation is interested in acquiring Vandell Corporation.
ID: 2787067 • 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; its beta is 1.40 (given its target capital structure). Vandell has $9.75 million in debt that trades at par and pays an 7.1% interest rate. Vandell’s free cash flow (FCF0) is $2 million per year and is expected to grow at a constant rate of 5% a year. Both Vandell and Hastings pay a 35% combined federal and state tax rate. The risk-free rate of interest is 6% 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, $2.8 million, $3.4 million, and $3.74 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 5% rate. Hastings plans to assume Vandell’s $9.75 million in debt (which has an 7.1% interest rate) and raise additional debt financing at the time of the acquisition. Hastings estimates that interest payments will be $1.6 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 $1.431 million, after which the interest and the tax shield will grow at 5%.
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.
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; its beta is 1.40 (given its target capital structure). Vandell has $9.75 million in debt that trades at par and pays an 7.1% interest rate. Vandell’s free cash flow (FCF0) is $2 million per year and is expected to grow at a constant rate of 5% a year. Both Vandell and Hastings pay a 35% combined federal and state tax rate. The risk-free rate of interest is 6% 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, $2.8 million, $3.4 million, and $3.74 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 5% rate. Hastings plans to assume Vandell’s $9.75 million in debt (which has an 7.1% interest rate) and raise additional debt financing at the time of the acquisition. Hastings estimates that interest payments will be $1.6 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 $1.431 million, after which the interest and the tax shield will grow at 5%.
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
We’ll calculate the free cash flow to the firm for valuing the target company. FCFF includes the cash available to both bondholders and the shareholders. Thus, we’ll need to include the debt cash flows as well.
First, Let’s consider they scenario when the expected synergies are realized.
We need to find the WACC first.
Expected return on Equity = 6 + 1.4*5 ( from CAPM )
Expected return on Equity = 13%
Therefore,
WACC = 0.7*13 + 0.3*7.1 ( using the given capital structure )
WACC = 11.23%
This rate ( WACC ) will be used to discount all the free cash flows.
Now, we have the FCFF = CFO + Int(1-t) – FCinv
Here, FCinv can be considered 0 as no info has been given
FCFF for year 1, FCFF1 = 2.5 + 1.6*(1-0.35) = $3.54 million
Similarly, we can calculate FCFF for first 4 years
We have the following data:
As you can see from the table, Sum of PVs for first 4 years is $12.5637 million
Let’s now calculate the Terminal Value after year 4.
Terminal Value at the end of year 4, TV4, will be:
FCF4(1+g)/(WACCg) = 3.0510*1.05 / (0.1123 – 0.05) = $51.42145172 million
Terminal Value today, TV0, will be TV4/(1+WACC)^4 = $33.5936 million
Therefore, Vandel will be worth: 33.5936 + 12.5637 = $46.1573 million
Similarly, we can do calculations for the case of no synergy realized:
We have the following calculations:
FCFF = 2 + 0.071*9.75*(1-0.35) = 2.4499 million dollars
TV = 2.4499/(WACC – g)
= $39.32524 million.
Thus, we can see that for Hastings, Value of Vandal ranges from 39.32524 to 46.1573 million dollars
As it has one million shares outstanding, This amount comes out to be $39.32524 to $46.1573 per share.
Year FCFO Interest tax rate FCFF Present Value using WACC 1 2.5 1.6 0.35 3.54 3.182594624 2 2.8 1.6 0.35 3.84 3.103754412 3 3.4 1.6 0.35 4.44 3.226392195 4 3.74 1.431 0.35 4.67015 3.051006135