Question

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 1.45 (given its target capital structure). Vandell has $8.61 million in debt that trades at par and pays an 7.7% 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. Vandell pays a 30% combined federal and state tax rate. The risk-free rate of interest is 5% and the market risk premium is 8%. Hastings' first step is to estimate the current intrinsic value of Vandell.

Cost of equity 16.61% WACC 13.24%

Question: What is Vandell's intrinsic value of operations? (Hint: Use the free cash flow corporate valuation model.) Round your answer to two decimal places. Do not round intermediate calculations.

Answer 1

Given

Weighted average cost of capital (r) = 13.24%

Growth rate (g) = 5% pa

Free cash flow now = 2million for every year

Intrinsic value = explicit value + present value of terminal value

Terminal value using Gordans Growth model

= FCFF0*(1+g)/(r-g)

= 2000000*(1+0.05)/(0.134-0.05)

= 25,000,000 dollars

Here since there is one cash flow in year 0 is 2 million dollars it is the explicit value of the enterprise

Terminal value is also calculated in year 0 that is 25 million dollars

INTRINSIC VALUE OF ENTERPRISE

= 2,000,000+25,000,000

= 27,000,000 dollars

Therefore intrinsic value of entity = 27 million dollars.