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# Valuation in Mergers

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Problem 25-1 Valuation:

Vandell's free cash flow (FCF) is million per year and is expected to grow at a constant rate of 5% a year, its beta is 1.4. What is the value of Vandell's operations? If Vandell has \$10.82 millions in debt, What is the current value of Vandell's stock? (Hi nt Use the corporate valuation model of ch-15) Use the corporate tax rate of 40%.

Problem 25-2 Merger Valuation:

Hastings estimates that if it acquires Vandells, interest payments will be \$1,500,000 per year for 3 years, after which the current target capital structure of 30%debt will be maintained. Interest in thee fourth year will be \$1.472 million , after which interest and the tax shield will grow at 5%. Synergies will cause the free cash flows to be \$2.5 million, \$2.9 million, \$3.4 million, and then \$3.57, in years 1 unlevered value of Vandell to Hastings Corporation? Assume Vandell now has \$10.82 million in debt.

Problem 25-5 Merger Analysis:

Maraston Marble Corporation is considering a merger with the Conroy Concrete Company. Conroy is publicly traded company, and its beta is 1.30. Conroy has been barely profitable, so it has paid an average of only 20% in taxes during the last several years. In addition, it uses little debt, having a target ratio of just 25% , with the cost of debt 9%.
If the acquisition were made, Marston would operate Conroy as a separate, wholly owned subsidiary. Marston would pay taxes on a consolidate basis, and the tax rate would therefore increase to 35%. Marston also would increase the debt capitalization in the Conroy subsidiary to wD = 40% for a total of \$22.27 million in debt by the end of year 4 and pay 9.5% on the debt. Marston's acquisition department estimates that Conroy, if acquired, would generate the following free cash flows and interest expenses (in millions of dollars) in Year 1-5:

YEAR Free Cash Flows Interest Expense
1 \$1.2 \$1.30
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 its beginning of year (that is, the end of Year 4) debt, and in subsequent years both interest expense and free cash flows are projected to grow at a rate of 6%.
These cash flows include all acquisition effects. Marston's cost of equity is 10.5%, its beta is 1.0, and its cost of debt is 9.5%. The risk free rate is 6%, and the market risk premium is 4.5%.
A- What is the value of Conroy's unlevered operation, and what is the value of Conroy's tax shield under the proposed merger and financing arrangements?
B- What is the dollar value of Conroy's operations? If Conroy has \$10 million in debt outstanding, how much would Marston be willing to pay for Conroy?