Question

**Valuation of Merger Target**

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 $10.91 million in debt that trades at par and pays an 7.1% interest rate. Vandell’s free cash flow (FCF0) is $1 million per year and is expected to grow at a constant rate of 6% a year. Vandell pays a 35% combined federal and state tax rate. The risk-free rate of interest is 4% and the market risk premium is 4%. Hastings’ first step is to estimate the current intrinsic value of Vandell.

**A)** What are Vandell’s cost of equity and
weighted average cost of capital? Round your answer to two decimal
places. Do not round intermediate calculations.

**1)** Cost of equity________%

**2)** WACC:___________%

**B)** 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.

**1)** $____________ million

**C)** What is the current intrinsic value of
Vandell's stock? Round your answer to the nearest cent. Do not
round intermediate calculations.

**1)** $ ________ /share

Answer #1

A) | |||

1) | Cost of equity per CAPM = 4%+1.6*4% = | 10.40% | |

After tax cost of debt = 7.1%*(1-35%) = | 4.62% | ||

2) | WACC = 4.62%*30%+10.40%*70% = | 8.67% | |

B) | Intinsic value of operations = 1*1.06/(0.0867-0.06) = | $ 39.70 | million |

C) | Value of debt | $ 10.91 | million |

Value of common equity = 39.70-10.91 = | $ 28.79 | million | |

Number of shares | 1 | million | |

Current intinsic valueof Vandell's stock |
$
28.79 |
per share |

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