Hasting 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. Hasting plans to assume Vandell’s $10.19 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 eachyear 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 the tax shield will grow at 5%. As described in Problem 22-4, Vandell currently has 1.5 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). Vandell and Hastings each have a 25% combined federal-plus-state tax rate. The risk-free rate is 5% and themarket risk premium is 6%.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 at t = 0? What is the intrinsic value of Vandell’s equity to Hasting? What is the maximum price per share that Hasting’s should offer Vandell’s shareholders?

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter26: Mergers And Corporate Control

Section: Chapter Questions

Problem 2P

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Hasting 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. Hasting plans to assume Vandell’s $10.19 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 the tax shield will grow at 5%. As described in Problem 22-4, Vandell currently has 1.5 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). Vandell and Hastings each have a 25% combined federal-plus-state tax rate. The risk-free rate is 5% and the
market risk premium is 6%.
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 at t = 0? What is the intrinsic value of Vandell’s equity to Hasting? What is the maximum price per share that Hasting’s should offer Vandell’s shareholders?

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