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 7.3%. Assume that the risk-free rate of interest is 4% and the market risk premium is 7%. Both Vandell and Hastings face a 40% 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 $1.465 million after which interest and the tax shield will grow at 6%. Synergies will cause the free cash flows to be $2.4 million, $2.9 million, $3.5 million, and then $3.65 million in Years 1 through 4, respectively, after which the free cash flows will grow at a 6% 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 $9.30 million in debt. Round your answer to the nearest cent. Do not round intermediate calculations.
$   per share

Explanation / Answer

FCF1 = $2.5 million, FCF2 = $2.9 million and FCF3 = $3.4 million; g = 4%; b = 1.4; rRF = 5%; RPM = 5%; wd = 30%; T = 35%; rd = 7.3% Vops = ? P0 = ? Horizon Value3 = FCF3(1+g)/(WACC g) = 3.4 (1.04)/(.0908 0.04) = $69.60 million Tax shields in years 1 through 3 are: TS1 = TS2 = TS3 = Interest x T = 1,600,000 x 0.35 = 560,000 FCF + Tax Shield + Horizon Value Year 1: 2.5 million + 560,000 = 3.06 million Year 2: 2.9 million + 560,000 = 3.46 million Year 3: 3.4 million + 560,000 + 69.60 million = 73.56 million The unlevered cost of equity based on the pre-merger required rate of return and pre-merger capital structure is: rsU = wdrd + wsrsL Note: rs was calculated in problem 1 to be 13.4% = 0.3*(7.3%)+0.7*(10.5%) = 9.54% The present value of the FCFs, the tax shields, and the horizon value at the unlevered cost of equity is: Vops = 3.06 + 3.46 + 73.56 1+0.0954 1+0.0954^2 1+0.0954^3 Tax shields = $61.64 million Equity value = Vops Debt = 61.64 million - 11.88 million Equity Value = 49.76 million or $49.76 per share since there are 1 million shares outstanding

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