Question

Problem 22-01 Valuation of Merger Target Hastings Corporation s interested in acquiring Vandell Corporation. Vandell has 1 1 on shares out tanto anat get capital s ture consisting of 30 % d t: ts jeta 05 given sane apa structure Vandell has S9.89 million in debt that trades at par and pays an 7,7% interest rate. Vandell s free cash flo FCFc is S2 million per year and is expected to go ata constant rate of 5% a year var del pa sa 40% combined federal and state tax rate. The risk-free rate of interest is 4% and the market risk p em um is 7% Hastings first step s to estimate the current intrinsic value of Vandell a. What are Vandell's cost of equity and weighted average cost of capital? Round your answer to two decimal places. Do not round intermediate calculations. Cost of equity: t is Vandell's intrinsic value of operations? (Hint: Use the free cash flow corporate valuation model.) Round your answer to two decimal places million c. What is the current intrinsic value of Vandell's stock? Round your answer to the nearest cent. Do not round intermediate calculations /share

Answer 1

(a) Risk-Free Rate = Rf = 4 %, Beta = 1.35 and Market Risk Premium = MRP = 7 %

Cost of Equity = Rf + Beta x MRP = 4 + 1.35 x 7 = 13.45 %

Target Capital Structure: 30 % Debt 70 % Equity, Tax Rate = 40 % and Cost of Debt = Interest Rate = 7.7 %

WACC = (1-0.4) x 7.7 x 0.3 + 13.45 x 0.7 = 10.801 %

(b) FCF0 = $ 2 million and perpetual constant growth rate = g = 5 %

FCF1 = FCF0 x (1+g) = 2 x 1.05 = $ 2.1 million

Value of Operations = FCF1 / (WACC - g) = 2.1 / (0.1345 - 0.05) = $ 24.8521 million ~ $ 24.85 million

(c) Market Value of Debt = $ 9.89 million

Value of Equity = 24.85 - 9.89 = $ 14.96 million and Number of Shares Outstanding = 1 million

Price per Share = 14.96 / 1 = $ 14.96