Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has
ID: 2712493 • Letter: H
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 8%. Assume that the risk-free rate of interest is 4% and the market risk premium is 6%. Both Vandell and Hastings face a 30% tax 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; its beta is 1.50. 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.
$ million
If Vandell has $9.06 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.
$ /share
Explanation / Answer
Value of Vandell’s operations = $ 18.17 Millions
Current value of Vandell’s stock = $ 9.11
Risk-free rate of interest = 4%
Market risk premium = 6%
Beta of Vandell = 1.5
Expected return of Vandel based on CAPM = 4% + 1.5 * 6% = 4% + 9% = 13%
Pre-tax cost of debt = 8%
Tax rate = 30%
Weight of debt in capital structure = 30% or 0.30
Weight of equity in capital structure = 100%-30% = 70% or 0.70
WACC of Vandell = 0.3 * 8% *(1-0.30) + 0.7 * 13%
= 0.3 * 8% * 0.7 + 0.7 * 13%
= 1.68% + 9.10%
= 10.78%
Free Cash flow FCF0 = $ 1 Million
Free cash flow growth rate = 5%
Expected Free Cash Flow next year FCF1 = $ 1 Million * 1.05 = $ 1.05 Million
Total Business Value = Free cash flow next year (FCF1) / WACC – growth rate
= $ 1.05 Million / (0.1078 – 0.05)
= $ 1.05 Million / 0.0578
= $ 18.1660 or $ 18.17 Million
Total value of Debt of Vandell = $9.06 Million
Total Value of Equity = Total Business Value - Total Value of Debt = $ 18.17 Million - $ 9.06 Million
= $ 9.11 Million
Total number of shares outstanding = 1 Million
Current Value of Vandell’s stock = $9.11 Million / 1 Million = $ 9.11
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