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 7.5%. Assume that the risk-free rate of interest is 3% and the market risk premium is 5%. Both Vandell and Hastings face a 35% tax rate. Vandell's free cash flow (FCF0) is $1 million per year and is expected to grow at a constant rate of 5% a year; its beta is 1.20. 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. If Vandell has $8.05 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.

Explanation / Answer

Cost of equity = Rf + Beta x Risk premium

= 3 + 1.20x5

= 9%

WACC = [Cost of debt (1-tax rate) x Debt%] + [Cost of equity x Equity%]

= [7.5(1-0.35)x30%] + [9x70%]

= 7.7625%

Value of operations at t-0 = FCFO(1+g) / (WACC-g)

= 1000000(1.05) / (0.07625-0.05)

= $40,000,000

= $40 million

If Vandell has $8.05 million in debt, current value of Vandell's stock = 40 million - 8.05 million = $31.95 million

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