Problem 22-3 Merger Bid Hastings Corporation is interested in acquiring Vandell

Question

Problem 22-3
Merger Bid

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 5% and the market risk premium is 4%. Both Vandell and Hastings face a 35% tax rate.

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 1.25.

Hastings estimates that if it acquires Vandell, interest payments will be $1,500,000 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 $1.427 million after which interest and the tax shield will grow at 4%. Synergies will cause the free cash flows to be $2.3 million, $3.1 million, $3.5 million, and then $3.69 million, after which the free cash flows will grow at a 4% rate. Assume Vandell now has $11.85 million in debt.

Indicate the range of possible prices that Hastings could bid for each share of Vandell common stock in an acquisition. Round your answers to the nearest cent. Do not round intermediate calculations.

The bid for each share should range between $____    per share and $_____    per share.

Explanation / Answer

Ans:

Calculation of bid for each share:

For Vandell has 1 million 30% Debt = $300,000

Vandel interest rate = $300,000 * 7.2% = $21,600

= Cash flow 2 million / Debt

= $2,000,000 / $300,000

Share per = 6.7

For Hasting $11.85 million 30% Debt = $3,555,000

Interest rate = $1,500,000

= Cash flow / Debt

= $12,590,000 / $3,555,000

= 3.5 share

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