PLEASE SHOW STEP BY STEP SOLUTION USING EXCEL.
Hastings Corporation estimates that if it acquires Vandell Corporation, synergies willcause Vandell ’ s free cash flows to be $2.5 million, $2.9 million, $3.4 million, and $3.57million at Years 1 through 4, respectively, after which the free cash flows will grow at aconstant 5% rate. Hastings plans to assume Vandell ’ s $10.82 million in debt and raiseadditional debt financing at the time of the acquisition. Hastings estimates that interestpayments will be $1.5 million each year for Years 1, 2, and 3. Unlike Problem 22-3,suppose Hastings will increase Vandell ’ s level of debt at Year 3 to $30.6 million so that thetarget capital structure becomes 45% debt. Assume that with this higher level of debt, theinterest rate would be 8.5%, and assume that interest payments in Year 4 are based onthe new debt level at Year 3 and the 8.5% interest rate. The Year-4 interest expense isexpected to grow at 5% after Year 4. As described in Problem 22-1, Vandell currently has1 million shares outstanding and a target capital structure consisting of 30% debt; itscurrent beta is 1.4 (i.e., based on its target capital structure).
a. What is the Year-4 interest expense? What is the Year-4 tax shield?
b. What is the unlevered value of operations? What is the value of the tax shield?
The risk-free rate of interest is 5% and the market risk premium is 6%