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 8%. Assume that the risk-free rate of interest is 5% and the market risk premium is 6%. Both Vandell and Hasting’s face a 40% tax rate.

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 8%. Assume that the risk-free rate of interest is 5% and the market risk premium is 6%. Both Vandell and Hasting’s face a 40% tax rate.

(Problem 25-1 Valuation) – Vandell’s free cash flow (FCF0) is $2 million per year and is expected to grow at a constant rate of 5% a year; its beta is 1.4. What is the value of Vandell’s operations? If Vandell has $10.82 million in debt, what is the current value of Vandell’s stock? (Hint: Use the corporate valuation model from Chapter 15.)

(Problem 25-2 Merger Valuation) – 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 $1,472 million, after which interest and the tax shield will grow at 5%. Synergies will cause the free cash flows to be $2.5 million, $2.9 million, $3.4 million, and then $3.57 million, in years 1 through 4, after which free cash flows grow at a 5% rate. What is the unlevered value of Vandell and what is the value of its tax shields? What is the per share value of Vandell to Hasting’s Corporation? Assume Vandell now has $10.82 million in debt.

(Problem 25-3 Merger Bid) – On the basis of your answer to problems 25-1 and 25-2, if Hastings were to acquire Vandell, what would be the range of possible prices that it could bid for each share of Vandell common stock?

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