Hastings 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.

Hastings 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. 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 $1.472 million after which the interest and tax shield will grow at 5%. As described in problem 22-1, Vendell 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 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 previously if you worked Problem 22-1.)

b. What is the intrinsic unlevered value of operations at t 0 (assuming the synergies are realized)?

C. What is the value of the tax shields at t 0? d what is the total intrinsic value of operations at t = 0?

d. What is the intrinsic value of Vandell's equity to Hastings? What is Vandell's intrinsic stock price per share?

Problem 22-1: Valuation Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and target capital structure consisting of 30% debt; it s beta is 1.4 (given its target capital structure). Vandell has $10.82 million in debt that trades at par and pays an 8% interest rate. Vandell s free cash flow (FCFO) is $2 million per year and is expected to grow at a constant rate of 5% a year. Vandell pays a 40% combined federal and state tax rate. The risk-free rate of interest is 5% and the market risk premium is 6%. Hastings s first step is to estimate the intrinsic value of Vandell. Data Risk Free Rate Market Risk Premium Debt in Capital Strcuture Interest Rate FCF Growth Tax Beta Item Debt Equity 5.00% 6.00% $10,820,000 $2,000,000 8% a. What are Vandell s cost of equity and weighted average cost of capital? Cost of Equity Risk-Free Rate+ (Beta Market Risk Premium) = 5% +(1.4*6%) 13.4% 5% 40% 1.40 Weight Cost Weight Cost 30% 4.8% 70% 13.4% WACC Current Value of stock = 1.44% 9.38% 10.82% b. What is Vandell s intrinsic value of operation? Intrinsic value of operation FCF 0* (1+g) (WACC-g) = 2,000,000*(1+0.05)/0.1082 -0.05 = 36,082,474 c. What is the current intrinsic value of Vandell s stock? Current Instrinsic Stock Value = Vops - debt = $36,082,474 -10,820,000 = 25,262,474 $25.26 Problem 22-3 On the basis of your answers to Problems 22-1 and 22-2, indicate the range of possible prices that Hastings could bid for each share of Vendell Common Stock in an acquisition.