Hastings Corporation is interested in acquiring Vandell Corporation. Vandell currently has 1 million shares outstanding and a target capital structure consisting of 30% debt; its current beta is 1.10 (i.e., based on its target capital structure). Vandell's debt interest rate is 7.9%. Assume that the risk-free rate of interest is 7% and the market risk premium is 8%. Both Vandell and Hastings face a 30% tax rate.
Hastings Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandell’s free cash flows to be $2.4 million, $3.0 million, $3.4 million, and $3.79 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 4% rate. Hastings plans to assume Vandell’s $11.48 million in debt (which has a 7.9% interest rate) and raise additional debt financing at the time of the acquisition. Hastings estimates that interest payments will be $1.5 million each year for Years 1, 2, and 3. After Year 3, a target capital structure of 30% debt will be maintained. Interest at Year 4 will be $1.436 million, after which the interest and the tax shield will grow at 4%.
A) What is Vandell's pre-acquisiton levered cost of equity? What is its unlevered cost of equity?