Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capital structure consisting of 30% debt. Vandell's debt interest rate is 7.6%. Assume that the risk-free rate of interest is 6% and the market risk premium is 4%. Both Vandell and Hastings face a 30% tax rate.   Vandell's beta is 1.35. Hastings estimates that if it acquires Vandell, interest payments will be $1,600,000 per year for 3 years. The free cash flows are supposed to be $2.3 million, $2.8 million, $3.3 million, and then $3.70 million in Years 1 through 4, respectively. Suppose Hastings will increase Vandell's level of debt at the end of Year 3 to $34.2 million so that the target capital structure will be 45% debt. Assume that with this higher level of debt the interest rate would be 8.5%, and assume that interest payments in Year 4 are based on the new debt level from the end of Year 3 and new interest rate. Free cash flows and tax shields are projected to grow at 6% after Year 4.   The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.     What is the value of the unlevered firm? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000, not 1.2. Do not round intermediate calculations. Round your answer to two decimal places. $  fill in the blank   What is the value of the tax shield? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000, not 1.2. Do not round intermediate calculations. Round your answer to two decimal places. $  fill in the blank   What is the maximum total price that Hastings would bid for Vandell now? Assume Vandell now has $8.52 million in debt. Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000, not 1.2. Do not round intermediate calculations. Round your answer to two decimal places. $  fill in the blank     Merger Valuation with Change in Capital Structure Current target capital structure: Debt 30.00% Equity 70.00% Number of common shares outstanding 1,000,000 Current debt amount $8,520,000 Debt interest rate 7.60% Risk-free rate 6.00% Market risk premium 4.00% Tax rate 30.00% Beta 1.35 Interest payments, Years 1 - 3 $1,600,000 Growth rate 6.00% Free cash flow, Year 1 $2,300,000 Free cash flow, Year 2 $2,800,000 Free cash flow, Year 3 $3,300,000 Free cash flow, Year 4 $3,700,000 Level of debt, Year 3 $34,200,000 New interest rate at higher debt level 8.50% New target capital structure: Debt 45.00% Equity 55.00%   Calculate target firm's levered cost of equity rsL Calculate target firm's unlevered cost of equity rsU Calculate target firm's unlevered value: Unlevered horizon value of FCF Unlevered value of operations Calculate value of interest tax shields: Tax shield, Year 1 Tax shield, Year 2 Tax shield, Year 3 Tax shield, Year 4 Tax shield, Horizon value Value of tax shields

FINANCIAL ACCOUNTING
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Chapter1: Financial Statements And Business Decisions
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Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capital structure consisting of 30% debt. Vandell's debt interest rate is 7.6%. Assume that the risk-free rate of interest is 6% and the market risk premium is 4%. Both Vandell and Hastings face a 30% tax rate.

 

Vandell's beta is 1.35. Hastings estimates that if it acquires Vandell, interest payments will be $1,600,000 per year for 3 years. The free cash flows are supposed to be $2.3 million, $2.8 million, $3.3 million, and then $3.70 million in Years 1 through 4, respectively. Suppose Hastings will increase Vandell's level of debt at the end of Year 3 to $34.2 million so that the target capital structure will be 45% debt. Assume that with this higher level of debt the interest rate would be 8.5%, and assume that interest payments in Year 4 are based on the new debt level from the end of Year 3 and new interest rate. Free cash flows and tax shields are projected to grow at 6% after Year 4.

 

The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.

 

 

What is the value of the unlevered firm? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000, not 1.2. Do not round intermediate calculations. Round your answer to two decimal places.

$  fill in the blank

 

What is the value of the tax shield? Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000, not 1.2. Do not round intermediate calculations. Round your answer to two decimal places.

$  fill in the blank

 

What is the maximum total price that Hastings would bid for Vandell now? Assume Vandell now has $8.52 million in debt. Enter your answer in dollars. For example, an answer of $1.2 million should be entered as 1,200,000, not 1.2. Do not round intermediate calculations. Round your answer to two decimal places.

$  fill in the blank

 

 

Merger Valuation with Change in Capital Structure

Current target capital structure:

Debt

30.00%

Equity

70.00%

Number of common shares outstanding

1,000,000

Current debt amount

$8,520,000

Debt interest rate

7.60%

Risk-free rate

6.00%

Market risk premium

4.00%

Tax rate

30.00%

Beta

1.35

Interest payments, Years 1 - 3

$1,600,000

Growth rate

6.00%

Free cash flow, Year 1

$2,300,000

Free cash flow, Year 2

$2,800,000

Free cash flow, Year 3

$3,300,000

Free cash flow, Year 4

$3,700,000

Level of debt, Year 3

$34,200,000

New interest rate at higher debt level

8.50%

New target capital structure:

Debt

45.00%

Equity

55.00%

 

Calculate target firm's levered cost of equity

rsL

Calculate target firm's unlevered cost of equity

rsU

Calculate target firm's unlevered value:

Unlevered horizon value of FCF

Unlevered value of operations

Calculate value of interest tax shields:

Tax shield, Year 1

Tax shield, Year 2

Tax shield, Year 3

Tax shield, Year 4

Tax shield, Horizon value

Value of tax shields

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