Excel Online Structured Activity: Merger Valuation with Change in Capital Structure

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 7.8%. Assume that the risk-free rate of interest is 4% and the market risk premium is 7%. Both Vandell and Hastings face a 35% tax rate.

Vandell's beta is 1.30. Hastings estimates that if it acquires Vandell, interest payments will be $1,600,000 per year for 3 years. The free cash flows are supposed to be $2.4 million, $2.9 million, $3.3 million, and then $3.97 million in Years 1 through 4, respectively. Suppose Hastings will increase Vandell's level of debt at the end of Year 3 to $27.3 million so that the target capital structure will be 45% debt. Assume that with this higher level of debt the interest rate would be 8.5%, and assume that interest payments in Year 4 are based on the new debt level from the end of Year 3 and new interest rate. Free cash flows and tax shields are projected to grow at 4% after Year 4.

1. What is the value of the unlevered firm? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000, not 1.2. Do not round intermediate calculations. Round your answer to two decimal places.

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2. What is the value of the tax shield? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000, not 1.2. Do not round intermediate calculations. Round your answer to two decimal places.

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3. What is the maximum total price that Hastings would bid for Vandell now? Assume Vandell now has $10.49 million in debt. Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000, not 1.2. Do not round intermediate calculations. Round your answer to two decimal places.

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