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 7.2%. Assume that the risk-free rate of interest is 4% and the market risk premium is 5%. Both Vandell and Hastings face a 35% 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. ANSWER: $ million

2) If Vandell has $10.43 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. ANSWER: $ /share

Explanation / Answer

1)

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

=4+1.35*5

=10.75%

WACC = wd(rd)(1 – T) + wc(rs) =                     

=0.3*7.2*(1-0.35)+(1-0.3)*10.75

=8.93%

Value of ops = FCF* ( 1 + growth rate )/( WACC - growth rate)

=2*(1+0.04)/(0.0893-.04)

=42.19m

2)

Value of stock = (Value of ops-debt)/number of shares o/s

=(42.19-10.43)/1 = 31.76

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