Question

Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capital structure consisting of 30% debt; its beta is 1.45 . Vandell has $11.90 million in debt that trades at par and pays an 7.9% interest rate. Vandell’s free cash flow (FCF0) is $1 million per year and is expected to grow at a constant rate of 4% a year. Both Vandell and Hastings pay a 30% combined federal and state tax rate. The risk-free rate of interest is 6% and the market risk premium is 4%. Hastings Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandell’s free cash flows to be $2.6 million, $2.8 million, $3.5 million, and $3.78 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 4% rate. Hastings plans to assume Vandell’s $11.90 million in debt (which has an 7.9% interest rate) and raise additional debt financing at the time of the acquisition. Hastings 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 $1.446 million, after which the interest and the tax shield will grow at 4%. 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.

Answer 1

Details	Without Synergy in Mn	With Synergy In mn
FCFE ( Refer Workings)	5.93	39.35
No of Equity Shares	1.00	1.00
FCFE per Share	5.93	39.35
Floor Price which can be offered	5.93
Ceiling Price which can be offered	39.35

Workings
Value of Vendel under FCFE Pre Merger
	In Mn
FCFO	1.00
Less Interest net off tax [11.90*7.9%*(1-.30)]	0.66
FCFE( Free Cash flow from Equity)	0.34
Value of Equity =(FCFE*1+g)/(r-g)
r= Cost of Equity = RF Interest rate + Market Premium	0.10
g= Growth Rate	0.04
FCFE at year 1= .34193*1.04	0.36
Value of Equity at year 0= .355607/10%-4%	5.93

Workings
Value of Vendel under FCFE Post Merger with Synergy
FCFO	In Mn	Less Interest Net off tax	FCFE	PVF 10% { Cost of Equity)	Discounted FCFF upto year 4
Year 1	2.60	1.05	1.55	0.909091	1.41
Year 2	2.80	1.05	1.75	0.826446	1.45
Year 3	3.50	1.05	2.45	0.751315	1.84
Year 4	3.78	1.0122	2.77	0.683013	1.89
Year 5= Year 4 * Constant Growth rate of 4%	3.93	1.052688	2.88
Discounted FCFF upto year 4 (a)	6.59
Terminal Value at the end of year 4 = (FCFE at year 4 *1+Growth rate)/r-g	47.98
2.88/.10-.04
Terminal Value Discounted back to year 0 = TV * PVDF for year 4 (b)	32.77
Value of Equity of Vendel under FCFE (a+b)	39.35