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 7.7%. Assume that the risk-free rate of interest is 5% and the market risk premium is 8%. Both Vandell and Hastings face a 30% tax rate. Hastings estimates that if it acquires Vandell, interest payments will be $1,600,000 per year for 3 years after which the current target capital structure of 30% debt will be maintained. Interest in the fourth year will be $1.401 million after which interest and the tax shield will grow at 4%. Synergies will cause the free cash flows to be $2.4 million, $3.2 million, $3.5 million, and then $3.71 million in Years 1 through 4, respectively, after which the free cash flows will grow at a 4% rate.

a) What is the unlevered value of Vandell? Vandell's beta is 1.10. Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. Do not round intermediate calculations.

b) What is the value of its tax shields? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. Do not round intermediate calculations.

c) What is the per share value of Vandell to Hastings Corporation? Assume Vandell now has $11.62 million in debt. Round your answer to the nearest cent. Do not round intermediate calculations.

Explanation / Answer

year 1 2 3 4 Free cash flows 2.4 3.2 3.5 3.71 grwoth rate of free cash flows after year 4 4% Beta of Vandell 1.1 risk-free rate 5% Market risk premium 8% Expected return on equity =risk-free rate + beta * market risk premium = 5%+1.1*8% 13.80% Calculation of unlevered value of Vandell year 1 2 3 4 5 Free cash flows 2.4 3.2 3.5 3.71 3.8584 Cost of equity = 13.8% Present value of flows 1-4 2.108963 2.470959 2.374878 2.212101 Present value = FCF/(1+cost of Equity)^n Total Present value of flows yr1-4 9.1669 value of flows yr 4 onwards = FCF in year 5/(cost of equity - growth rate) 39.37143 Present value of flows year 4 onwards = Value of flows/(1+cost of equity)^4 23.47535 Unlevered value of Vandell =Present value of cash flows for years 1-4 + present value of flows year 4 onwards 32.64 Calculation of interst tax-shield growth rate of interest and tax shiled after 4th year 4% Tax rate 30% year 1 2 3 4 5 interest expense 1.6 1.6 1.6 1.401 1.45704 Tax Shield = int *tax rate 0.48 0.48 0.48 0.4203 0.437112 Growth rate of interest and tax shield from 5th year onwards is 4% Calculation of per share value of Vandell Free Cash Flow = Net Profit + Interest Expense + Net Capex - Net change in WC - Tax shield on interest expense Other things being equal, Net Profit = Free cash flow + tax shield on interest expense -interest expense Given FCF year 1 2 3 4 5 FCF 2.4 3.2 3.5 3.71 3.8584 Interest 1.6 1.6 1.6 1.401 1.45704 Interest Tax Shield 0.48 0.48 0.48 0.4203 0.437112 EBIT * (1-Tax rate) or Op Cash Flow 1.28 2.08 2.38 2.7293 2.838472 weight of debt 30% Debt interest rate 7.70% After tax cost of debt 0.0539 or 5.39% Weight of Equity = 1- weight of debt =1-0.30 70% Cost of Equity 13.80% WACC = weight of debt * after tax cost of debt + weight of equity * cost of equity = 0.3 * 5.39% + 0.7*13.8% 11.2770% or 11.28% rounded off year 1 2 3 4 Operating Cash Flows 1.28 2.08 2.38 2.7293 Discount factor at 11.28% 0.898634 0.807543 0.725686 0.652126 = 1/(1+wacc)^n Present Value of Operating Flows 1.150252 1.67969 1.727132 1.779848 = ocf *discount factor Total present value of OCF for yr1-4 6.336921 =sum of present value of flows year1-4 OCF in year 5 2.838472 wacc 11.28% growth rate of flows 4% value of OCF after 4 years in year 4 = OCF in year 5/(wacc - growth rate) 38.99 Present value of the value after 4 years = Value of OCF after 4 years in year 4 / (1+wacc)^4 = 38.99/(1+11.28%)^4 25.42639 Total Present Value = Total present value of OCF for year 1-4 + Present value of value after 4 years = 6.336921 + 25.42639 31.76332 Million Total number of shares outstanding 1 Million Value per share of Vandell = Total Present Value / Total number of shares outstanding $31.76

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