Question

Q2 (20 points): Hasting Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandell's free cash flows to be $2.5 million, $2.9 million, $3.4 million, and $3.57 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 5% rate. Hasting plans to assume Vandell's $10.82 million in debt (which has an 8% interest rate) and raise additional debt financing at the time of the acquisition. Hasting estimates that interest payments will be $1.5 million each year for Years 1, 2, and 3. After Year 3, a target capital structure of 30% debt will be maintained. Interest at Year 4 will be $1.472 million, after which the interest and the tax shield will grow at 5%. As described in previous question of Q1, Vandell currently has 1 million shares outstanding and a target capital structure consisting of 30% debt; its current beta is 1.4 (i.e., based on its target capital structure). a (3 points). What is Vandell's pre-acquisition levered cost of equity? What is its unlevered cost of equity? (Hint: You can use the pre-acquisition levered cost of equity you determined in Q1.) b (6 points). What is the intrinsic unlevered value of operations at t= 0 (assuming the synergies are realized)? c (6 points). What is the value of the tax shields at t=0? d (5 points). What is the total intrinsic value of operations at t = 0? What is the intrinsic value of Vandell's equity to Hasting? What is Vandell’s intrinsic stock price per share?

Answer 1

Solution:

a) Vandell's pre-acquisition levered cost of equity=5+1.4*6=13.40
rSU=8.0*0.3+13.40*0.7=11.78%
b) Intrinsic unlevered value of operations(with synergy):
	1	2	3	4
FCF ($ million)	2500000	2900000	3400000	3570000
pvif at 11.78%	0.89461	0.80033	0.71599	0.64054
PV of horizon FCF	2236536	2320971	2434370	2286714
Cummulative Pv of Horizon FCF	9278591
Terminal value of FCF=3570000*1.05/(0.1178-0.05)				55287611
PV of Terminal FCF=55287611*0.64054	35413708
Intrinsic unlevered value of operations	44692299
c) CValue of tax shields
Interest	1500000	1500000	1500000	1472000
tax shield at 40%	600000	600000	600000	588800
pvif at 11.78%	0.89461	0.80033	0.71599	0.64054
PV of Horizon tax shields	536769	480201	429595	377148
Cummulative Pv of Horizon tax shields	1823712
Terminal value of tax shield 588800*1.05/(0.1178-0.05)				9118584
Pv of terminal tax shield=9118584*0.60621=	5840782
value of tax shields at t=0	7664494
d) Total intrinsic value of operations	52356793
(44692299+7664494)
value of debt	10820000
Equity value to acquirer	41536793
Number of shares	1000000
Intrinsic Value per share of existing shares	$41.54