Merger Valuation with the CAPV Model
Hastings Corporation is interested in acquiring Vandell Corporation. Vandell currently has 1 million shares outstanding and a target capital structure consisting of 30% debt; its current beta is 1.10 (i.e., based on its target capital structure). Vandell's debt interest rate is 7.8%. Assume that the risk-free rate of interest is 5% and the market risk premium is 8%. Both Vandell and Hastings face a 40% tax rate.
Hastings Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandellâs free cash flows to be $2.5 million, $3.1 million, $3.4 million, and $3.73 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 5% rate. Hastings plans to assume Vandellâs $10.61 million in debt (which has an 7.8% interest rate) and raise additional debt financing at the time of the acquisition. Hastings estimates that interest payments will be $1.6 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 $1.408 million, after which the interest and the tax shield will grow at 5%.
What is Vandellâs pre-acquisition levered cost of equity? What is its unlevered cost of equity? Round your answer to two decimal places. Do not round intermediate calculations.
Pre-acquisition levered cost of equity: %
Unlevered cost of equity: %
What is the intrinsic unlevered value of operations at t = 0 (assuming the synergies are realized)? Round your answer to the nearest cent. Do not round intermediate calculations.
$
What is the value of the tax shields at t = 0? Round your answer to two decimal places. Do not round intermediate calculations.
$ million
What is the total intrinsic value of operations at t = 0? What is the intrinsic value of Vandellâs equity to Hastings? What is Vandellâs intrinsic stock price per share? Round your answer to two decimal places. Do not round intermediate calculations.
Value of operations: $ million
Equity value to acquirer: $ million
Intrinsic value per share of existing shares to acquirer: $ /share
Merger Valuation with the CAPV Model
Hastings Corporation is interested in acquiring Vandell Corporation. Vandell currently has 1 million shares outstanding and a target capital structure consisting of 30% debt; its current beta is 1.10 (i.e., based on its target capital structure). Vandell's debt interest rate is 7.8%. Assume that the risk-free rate of interest is 5% and the market risk premium is 8%. Both Vandell and Hastings face a 40% tax rate.
Hastings Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandellâs free cash flows to be $2.5 million, $3.1 million, $3.4 million, and $3.73 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 5% rate. Hastings plans to assume Vandellâs $10.61 million in debt (which has an 7.8% interest rate) and raise additional debt financing at the time of the acquisition. Hastings estimates that interest payments will be $1.6 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 $1.408 million, after which the interest and the tax shield will grow at 5%.
What is Vandellâs pre-acquisition levered cost of equity? What is its unlevered cost of equity? Round your answer to two decimal places. Do not round intermediate calculations.
Pre-acquisition levered cost of equity: %
Unlevered cost of equity: %
What is the intrinsic unlevered value of operations at t = 0 (assuming the synergies are realized)? Round your answer to the nearest cent. Do not round intermediate calculations.
$
What is the value of the tax shields at t = 0? Round your answer to two decimal places. Do not round intermediate calculations.
$ million
What is the total intrinsic value of operations at t = 0? What is the intrinsic value of Vandellâs equity to Hastings? What is Vandellâs intrinsic stock price per share? Round your answer to two decimal places. Do not round intermediate calculations.
Value of operations: $ million
Equity value to acquirer: $ million
Intrinsic value per share of existing shares to acquirer: $ /share
Related questions
Problem 22-05
Merger Analysis
Marston Marble Corporation is considering a merger with theConroy Concrete Company. Conroy is a publicly traded company, andits beta is 1.30. Conroy has been barely profitable, so it has paidan average of only 25% in taxes during the last several years. Inaddition, it uses little debt; its target ratio is just 30%, withthe cost of debt 8%.
If the acquisition were made, Marston would operate Conroy as aseparate, wholly owned subsidiary. Marston would pay taxes on aconsolidated basis, and the tax rate would therefore increase to35%. Marston also would increase the debt capitalization in theConroy subsidiary to wd = 40%, for a total of $18.15 million indebt by the end of Year 4, and pay 11.0% on the debt. Marston'sacquisition department estimates that Conroy, if acquired, wouldgenerate the following free cash flows and interest expenses (inmillions of dollars) in Years 1-5:
| Year | Free CashFlows | InterestExpense |
| 1 | $1.30 | $1.2 |
| 2 | 1.50 | 1.7 |
| 3 | 1.75 | 2.8 |
| 4 | 2.00 | 2.1 |
| 5 | 2.12 | ? |
In Year 5, Conroy's interest expense would be based on itsbeginning-of-year (that is, the end-of-Year-4) debt, and insubsequent years both interest expense and free cash flows areprojected to grow at a rate of 8%.
These cash flows include all acquisition effects. Marston's costof equity is 8.2%, its beta is 1.2, and its cost of debt is 8.0%.The risk-free rate is 4%, and the market risk premium is 3.5%. Usethe compressed APV model to answer the following questions.
What is the value of Conroy's unlevered operations? Do not roundintermediate calculations. Enter your answer in millions. Forexample, an answer of $1.2 million should be entered as 1.2, not1,200,000. Round your answer to two decimal places.
$ million
What is the value of Conroy's tax shields under the proposed mergerand financing arrangements? Do not round intermediate calculations.Enter your answer in millions. For example, an answer of $1.2million should be entered as 1.2, not 1,200,000. Round your answerto two decimal places. Do not round intermediatecalculations.
$ million
What is the dollar value of Conroy's operations? Enter youranswer in millions. For example, an answer of $1.2 million shouldbe entered as 1.2, not 1,200,000. Round your answer to two decimalplaces.
$ million
If Conroy has $8 million in debt outstanding, how much wouldMarston be willing to pay for Conroy? Enter your answer inmillions. For example, an answer of $1.2 million should be enteredas 1.2, not 1,200,000. Round your answer to two decimal places. Donot round intermediate calculations.
$ million
