1) Vandells free cash flow (FCF0) is $2 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 Vandells operations?
If Vandell has $10.82 million in debt, what is the current value of Vandells stock?
(Hint:Use the corporate valuation model)
2) estimates that if it acquires Vandell, 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 the 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 $3.57 million in Years 1 through 4,
respectively, after which the free cash flows will grow at a 5% rate. What is the
unlevered value of Vandell, and what is the value of its tax shields? What is the per
share value of Vandell to Hastings Corporation? Assume that Vandell now has
$10.82 million in debt.
3) Marston Marble Corporation is considering a merger with the Conroy Concrete
Company. Conroy is a 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; its target ratio is 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 consolidated 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. Marstons acquisition department estimates
that Conroy, if acquired, would generate the following free cash flows and interest
expenses (in millions of dollars) in Years 15:
Year Free Cash Flows Interest Expense
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, Conroys 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. Marstons 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 Conroys unlevered operations, and what is the value of
Conroys tax shields under the proposed merger and financing arrangements?
b. What is the dollar value of Conroys operations? If Conroy has $10 million in
debt outstanding, how much would Marston be willing to pay for Conroy?
4) Spreadsheet Problem( Use Attached spreadsheet to answer)
Start with the partial model in the fileCh22 P05 Build a Model.xlson the textbooks
Web site. Duchon Industries had the following balance sheet at the time it defaulted
on its interest payments and filed for liquidation under Chapter 7. Sale of the fixed
assets, which were pledged as collateral to the mortgage bondholders, brought in
$900 million, while the current assets were sold for another $401 million. Thus, the
total proceeds from the liquidation sales were $1,300 million. The trustees costs
amounted to $1 million; no single worker was due more than $2,000 in wages; and
there were no unfunded pension plan liabilities. Determine the amount available for
distribution to shareholders and all claimants.
Duchon Industriess Balance Sheets (Millions of Dollars)
Current assets $ 400 Accounts payable $ 50
Net fixed assets 600 Accrued taxes 40
Accrued wages 30
Notes payable 180
Total current liabilities $ 300
First-mortgage bondsa 300
Second-mortgage bondsa 200
Debentures 200
Subordinated debenturesb 100
Common stock 50
Retained earnings (150)
Total assets $1,000 Total claims $1000
