Merger Bid Hastings Corporation is interested in acquiring Vandell Corporation.
ID: 2789257 • 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 1.60 (given its target capital structure). Vandell has $11.58 million in debt that trades at par and pays an 7% interest rate. Vandell’s free cash flow (FCF0) is $2 million per year and is expected to grow at a constant rate of 6% a year. Both Vandell and Hastings pay a 35% combined federal and state tax rate. The risk-free rate of interest is 3% and the market risk premium is 8%.
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, $3.3 million, and $3.91 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 6% rate. Hastings plans to assume Vandell’s $11.58 million in debt (which has an 7% interest rate) and raise additional debt financing at the time of the acquisition. Hastings estimates that interest payments will be $1.5 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 $1.405 million, after which the interest and the tax shield will grow at 6%.
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
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Calculation of WACC of V Ke = Rf + (Rm-Rf) x B Ke = 3+ 8 x 1.6 Ke = 15.8 Kd = Interest rate x (1-t) kd= 7 x (1-0.35) Kd = 4.55 WACC = We x Ke + Wd x Kd Wacc = .7 x 15.8 + .3 x 4.55 WACC = 12.425 Value(v) = FCF (1+g)/(WACC-g) = 2 (1.06)/(0.12425 - 0.06) =32.99611 Million This is the total value of firm Value of equity = Total value - debt Value of equity = 32.99611 - 11.58 = 21.41611 No of shares = 1 million Value of 1 share of V = 21.41611/1 = 21.41611 To Calculate Unlevered Cost of capital - Calculate Unlevered beta i.e. Bu Bu = BL 1 + (D(1-t)/E) Bu = 1.6 1 + (0.3(1-0.35)/0.7) Bu = 1.6 1.278571 Bu = 1.251397068 Unlevered COC = Unlevered Ke = Rf + (Rm - Rf) Bu Keu = 3 + 8 x 1.2514 Keu = 13.0112 Tax Shields = Interest x t Year 1 0.525 2 0.525 3 0.525 4 0.91325 Horizon Value = 1.405 x (1.06) Keu - g = 1.4893 .130112-0.06 = 21.24172752 (At 4th year) Horizon value of FCF = 3.91 x 1.06 .130112-0.06 = 59.11399 Year 1 2 3 4 Horizon FCF 3.2 2.8 3.3 3.91 59.11399 Add; Tax shield 0.525 0.525 0.525 0.91325 21.24173 Annual CF 3.725 3.325 3.825 4.82325 80.35572 PVF @ Keu 0.884868048 0.782991 0.692844 0.613076 0.613076 Value of V to H 3.296133481 2.603447 2.650129 2.957017 49.26413 Value of V to H = 60.77086 Less Value of debt assumed -11.58 Value of equity 49.19086 No. of shares 1 Value per share 29.19086 Bid Range 21.4161 to 29.19086