Hastings HMO is interested in acquiring Vandell, a smaller HMO in its service ar

ID: 2698995 • Letter: H

Question

Hastings HMO is interested in acquiring Vandell, a smaller HMO in its service area. Vandell has

1 million shares outstanding and a target capital structure consisting of 30 percent debt. Vandell's

debt interest rate is 8 percent. Assume that the risk-free rate of interest is 5 percent and the market

risk premium is 6 percent. Both Vandell and Hastings face a 40 percent tax rate.

Vandell's Free Operating Cash Flow is $2 million per year and is expected to grow at a constant

rate of 5 percent a year; its beta is 1.4. If Vandell has $10.82 million in debt, what is the current

value of Vandell's stock? What price per share should Hastings bid for each share of Vandell

common stock?

WACC = Krf + beta*(MRP) = 5% + 1.4*6% =13.40%

Value of the firm = FCF1/(WACC-g)

Where:FCF1 = operating free cash flow of Y1

WACC = discount rate (in this case WACC)=13.40%

g = expected growth rate in OFCF=5%

MV of firm = PV of FCF = 2000000/(13.4%-5%) = $23,809,524

= 23.81M approx

MV of equity = MV of firm %u2013 MV of debt

= 23.81M - 10.82M = 12.99M

So Share price = 12.99M/No of shares = 12.99M/1M

= $12.99

So Max Bid price should be $12.99

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