Question

S Ltd is considering purchase of A Ltd. A Ltd is a supplier for S Ltd ans the aquisition will allow S Ltd to better control its material supply. Free cash flow to the firm for A Ltd is $8 million today. The CFs are expected to grow at 10% for the next 6 years before levelling off to 4% for the indefinite future considering the synergy is realised. The cost of capital for A Letd is 15%. A Ltd has 3 million shares outstanding and $20 million in debt outstanding.

What is the maximum price per share S Ltd should pay for A Ltd

Answer 1

Today's Free cashflow CF0=$8,000,000. Then it grows at 10% for the next 6 years

CF1=CF0*(1+g)=$8,000,000*(1+10%)=$8,800,000

CF2=CF1*(1+10%)=$8,800,000*(1.1)=$9,680,000

CF3=CF2*(1+10%)=$9,680,000*1.1=$10,648,000

CF4=CF3*(1+10%)=$10,648,000*1.1=$11,712,800

CF5=CF4*(1+10%)=$11,712,800*1.1=$12,884,080

CF6=CF5*(1+10%)=$12,884,080*1.1=$14,172,488

Fom tthere it grows at 4% indefinitely

CF7=CF6*(1+g)=$14,172,488*(1+4%)=$14,739,388

Terminal value at Year6=CF7/(cost of capital - growth rate)=$14,739,388/(15%-4%)=$133,994,432

Value of the firm=(CF1/(1+15%))+(CF2/(1+15%)^2)+(CF3/(1+15%)^3)+(CF4/(1+15%)^4)+(CF5/(1+15%)^5)+((CF6+Terminal value at year6)/(1+15%)^6)

=(8800000/1.15)+(9680000/1.15^2)+(10648000/1.15^3)+(11712800/1.15^4)+(12884080/1.15^5)+(148166920/1.15^6)

=7652174+7319471+7001233+6696831+6405665+64056648

=$99132022

Value of the equity=Value of the firm-Value of the debt

=$99132022-$20,000,000

=$79132022

Value of the share=Value of the equity/Shares Outstanding=$79,132,022/3,000,000=$26.38