Problem 2201 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 1.55 (given its target capital structure). Vandell has $8.11 million in debt that trades at par and pays an 7.3% interest rate. Vandell’s free cash flow (FCF_{0}) is $2 million per year and is expected to grow at a constant rate of 4% a year. Vandell pays a 30% combined federal and state tax rate. The riskfree rate of interest is 6% and the market risk premium is 4%. Hastings’ first step is to estimate the current intrinsic value of Vandell.

a. Cost of equity as per CAPM = risk free rate + market risk premium * beta
= 6 + 4 *1.55 =12.2 %
weighted average cost of capital = weight of equity * cost of equity + weight of debt * after tax cost of debt
= 0.7 * 12.2 + 0.3 *7.3 ( 1  0.3)
= 10.07%
b.
Vandell's intrinsic value of operations = FCF0 ( 1 + Growth rate ) / ( wacc  growth rate)
= 2 *1.04 / ( 0.107  0.04 )
= 34.27 Million
c. Equity value = Firm value  value of debt = 34.27  8.11 = 26.16 million
Intrinsic value per share = 26.16 / 1 = $26.16
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