Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has

Question

Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capital structure consisting of 30% debt. Vandell's debt interest rate is 7.9%. Assume that the risk-free rate of interest is 5% and the market risk premium is 6%. Both Vandell and Hastings face a 40% tax rate.

1. Vandell's free cash flow (FCF0) is $2 million per year and is expected to grow at a constant rate of 4% a year; its beta is 1.35. What is the value of Vandell's operations? (Hint: Use the corporate valuation model.) Round your answer to two decimal places. Do not round intermediate calculations.

2. If Vandell has $11.16 million in debt, what is the current value of Vandell's stock? (Hint: Use the corporate valuation model.) Round your answer to the nearest cent. Do not round intermediate calculations.

Explanation / Answer

cost of equity = risk-free rate + beta * (market risk premium)

= 5 + 1.35*6 = 13.1%

WACC = wd(rd)(1 – T) + wc(rs) = 0.3(7.9)(1 – 0.4) + 0.7(13.1) = 10.592%

Value of firm = FCF* (1 + g) /( WACC - g) = 2* (1 + 0.04) /( .10592- 0.04) = 31.55m

Value of stock = value of firm - value of debt = 31.55 -11.16 = 20.40m

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