Managerial Finance

a

Chapter

Wn 2)-l ? )2'2,- t', &o k903t22 Mergers and Corporate Control

(sr-1) Valuation

Red Valley is considering an acquisition of Flagg Markets' Fiagg currently has a cost

of equity of 10%; of its financing is in the form of and the rest is in common

equity. Its federal-plus: tax rate is 407o. uisition, Red Vailey expects Flagg to

have the following FCFs the next 3 years (in millions):

Year 2 Year 3 $10.00 $20.00 $2s.00

24.00 20.28

Year 1

exPense

After the free cash flows are expected to at a constant rate of 5D/a, and the capital

will stabilize at 35o/o debt with an rate of 7o/o. 'u. Wtrut is Flagg's unlevered cost of equity? What its levered cost of equity and cost of

capital for the post-horizon period? b. Uiing the adjusted present value approach, what is Flagg's value of operations to Red Valley?

Easy Problem 1

,,R Intermediate

' Problems 2-3

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The fotlowing infonnation is required to work Problems 22-1 through 22-4'

Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capitai structure consisting csf 30o/o debt. Yandell's

debt interest rate is 8%. Assume that the risk-free rate of interest is 5% and the market risk

premium is 6%. Both Vandell and Hastings face a 40oio tax rate.

Vandell's free cash flotv (FCFo) is $2 million per year and is expected to grow at a constant

rate of 5o/o afear; its beta is 1.4. What is the value of Vandell's operations? If Vandell has

$10.82 million in debt, what is the current vaiue of vandell's stock? (Hint: Use the corporate vaiuation model from Chapter 7')

Hastings estimates that if it acquires Vandell, interest pa)'rnents will be $1.5 million per year for 3 ,vears, after which the current target capital structure of 30% debt will be

maintained. Interest in the fourth year will be $i.472 milIion, after which interest and the

tax shield will grow at 5%o. Synergies wili cause the free cash flows to be $2.5 million' $2.9 million, $3.4 million, and $3.57 million in Years I through 4, respectively, after which the free cash flows will grow at a 5% rate. What is the unlevered value of Vandeli, and what is

the value of its tax shields? what is the per share vaiue of vandell to Hastings that Vandell now has $10.82 lulli

On the basis of your answers to Probierns 2TL and22-2, indicate the range of possible prices that could bid for each share of Vandell

Assuming the same 22-2, suppose Hastings will increase Vandell's level of debt at

'ear 3 to $30.6 million so that the target capital

structure is now 45o/,, debt. that with this higher level of debt the interest rate at payments in Year 4 are based on the new debt

(22-3)

Merger Bid

tll:eil.e:rpi"rrg Fr,r,i:ic*:r ,l^.li

(22-41

Merger Valuation with Change in

Capital Stmcture would be 8.5%, and level from the end of 3anda interest rate. Again, free cash flows and tax shields

Solutlon Appears ln APPenclix A