Tundra Corporation is interested in acquiring Tantrell Corporation. Tantrell has 2 million shares outstanding and a target capital structure consisting of 40 percent debt. The debt interest rate is 8 percent. Assume that the risk-free rate of interest is 3 percent and the market risk premium is 7 percent.
Tantrell's free cash flow (FCF0) is $3 million per year and is expected to grow at a constant rate of 6 percent a year; its beta is 1.2. Tantrell has $5 million in debt. The tax rate for both companies is 30 percent.
a. Calculate the required rate of return on equity using equation: r s= KRF + RPM(b)
b. Calculate weighted average cost of capital, using equation: WACC = W drd(1-%) + w sr
c. Calculate the value of operations, using equation: V ops = FCF0(1+g)/WACC - g)
d. Calculate the value of the company's equity, using equation: Vs = Vops - debt
e. Calculate the current value of the company's stock, using equation:
Price per share = Vs/shares outstanding
The solution looks at acquiring Tantrell Corporation.The solution calculates the required rate of return on equity and the weighted average cost of capital.