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 1.30 (given its target capital structure). Vandell has $9.30 million in debt that trades at par and pays an 7.8% interest rate. Vandell’s free cash flow (FCF0) is $1 million per year and is expected to grow at a constant rate of 5% a year. Both Vandell and Hastings pay a 30% combined federal and state tax rate. The risk-free rate of interest is 6% and the market risk premium is 7%.

Hastings Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandell’s free cash flows to be $2.6 million, $3.1 million, $3.4 million, and $3.92 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 $9.30 million in debt (which has an 7.8% 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 $1.431 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.

Answer 1

WACC of Vandell to discount FCFs

Cost of Equity as per CAPM:

Ke=RFR+(beta*MRP)

ie.6%+(1.3*7%)=

15.10%

After-tax Cost of debt:

7.8%*(1-30%)=

5.46%

WACC=(Wt.d*kd)+(wt.e*ke)

ie.(30%*5.46%)+(70%*15.10%)=

12.21%

Now, discounting the FCF s using Gordon's Dividend discount model:

for PV of constant growth FCFs

PV of FCFs=FCF1/(Reqd. return-g)

ie. (FCF0*(1+g))/(WACC-g)

ie. (1000000*(1+0.05))/(0.1221-0.05)=

14563107

PV of FCFs =Value of Firm=	14563107
Less:MV of Debt=	9300000
Market Value of equity	5263107
No.of common shares o/s	1000000
Price/share=	5.26

Year	0	1	2	3	4
FCF		2600000	3100000	3400000	3920000
Terminal FCF					57087379
(3920000*(1+0.05))/(0.1221-0.05)=
Interest tax shields		450000	450000	450000	429300
1500000*30% &
1431000*30%
Terminal value of Int. tax shields					6251942
(429300*1.05)/(12.21%-5%)
Total annual FCF		3050000	3550000	3850000	67688620
PV F at 12.21%(1/1.1221^Yr.n)		0.89119	0.79421	0.70779	0.63077
PV at 12.21%		2718118	2819455	2724997	42696219
NPV/Value of firm	50958789
MV of Debt	9300000
MV of equity	41658789
No.of common shares o/s	1000000
Price/share=	41.66

SO,
The bid for each share should range between $ 5.26 per share and $ 41.66 per share.