Hasting Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vanell’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 $10.82 million in debt (which has an 8% interest rate) and raise additional debt financing at the time of the acquisition. Hasting 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 26-1, Vandell 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?

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? What is the intrinsic value of Vandell’s equity to Hasting? What is Vandell’s intrinsic stock price per share?

Problem 26-1

Hasting Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capital structure consisting of 30% debt; its 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 (FCF0) 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%. Hasting’s first step is to estimate the current intrinsic value of Vandell.