Problem 22-2 Merger Valuation Hastings Corporation is interested in acquiring Va

Question

Problem 22-2
Merger Valuation

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 7.5%. Assume that the risk-free rate of interest is 3% and the market risk premium is 6%. 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 $1.402 million after which interest and the tax shield will grow at 5%. Synergies will cause the free cash flows to be $2.3 million, $2.7 million, $3.5 million, and then $3.77 million in Years 1 through 4, respectively, after which the free cash flows will grow at a 5% rate. What is the unlevered value of Vandell? Vandell's beta is 1.60. 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.
$   million

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.
$   million

What is the per share value of Vandell to Hastings Corporation? Assume Vandell now has $8.18 million in debt. Round your answer to the nearest cent. Do not round intermediate calculations.
$   per share

Explanation / Answer

Answer:

rsL=Rf+Beta*market risk premium

=3%+1.6*6%=12.6%

rsU = wd*rd + ws*rsL

= 0.30(7.5%) + 0.70(12.6%) = 11.07%

WACC = wdrd(1-T) + wsrs

= 0.30(7.5%)(0.70) + 0.70(12.6%) = 10.395%

Tax shields are TS1 = TS2 = TS3 = Interest x T = $1,600,000(0.30) = $480,000, and TS4 = $1,402,000 (0.30) = $420,600.

Tax shield horizon value = TS4(1+g)/(rsU-g)

= 420600 (1.05)/(0.1107-0.05)

=421630/0.0607

= 6946128.50

Value of tax shields=

Unlevered horizon value = FCF4(1+g)/(rsU-g)

= 3.77(1.05)/(0.1107-0.05) = 65.21417

Unlevered Vops

Value of operations = unlevered Vops + value of tax shields

= 52141281.23+6012026.96

=$58153308.19

Equity value to Harrison = Vops – Debt

= $58153308.19-8180000 = 49973308.19

or $49.97 per share since there are 1 million shares outstanding.

Year cash Flow P.V.F (11.07%) PV 1 480000 0.90033 432159.90 2 480000 0.81060 389087.87 3 480000 0.72981 350308.70 4 7366728.5 0.65707 4840470.49 Value of tax shields 6012026.96

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