Question

Schultz Industries is considering the purchase of Arras Manufacturing. Arras is currently a supplier for Schultz, and the acquisition would allow Schultz to better control its material supply. The current cash flow from assets for Arras is $6.8 million. The cash flows are expected to grow at 5 percent for the next five years before leveling off to 2 percent for the indefinite future. The cost of capital for Schultz and Arras is 9 percent and 7 percent, respectively. Arras currently has 3 million shares of stock outstanding and $25 million in debt outstanding.

What is the maximum price per share Schultz should pay for Arras? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

  

Price per share

$

Answer 1

HI

Current Cash Flow, CF0 = $6,800,000

Growth rate for next five years is 5%, followed by a constant growth rate (g) of 2%

CF1 = $6,800,000 * 1.05 = $7,140,000
CF2 = $7,140,000 * 1.05 = $7,497,000
CF3 = $7,497,000 * 1.05 = $7,871,850
CF4 = $7,871,850 * 1.05 = $8,265,442.50
CF5 = $8,265,442.50 * 1.05 = $8,678,714.63
CF6 = $8,678,714.63 * 1.02 = $8,852,288.92

Terminal value of the end of year 5 = 8.852,288.92/(WACC-g)

WACC for Arras= 7%

Terminal value of the end of year 5 = 8.852,288.92/(7%-2%)

=$177,045,778.35

Value of company today V0=7,140,000/ (1.07)¹ + 7497000/ (1.07)² + 7871850/ (1.07)³ + 8265442.50/ (1.07)⁴ + 8678714.63/ (1.07)⁵ + 177045778.35/ (1.07)⁵

V0 = Value of Arras = $158,371,504.98
Value of Debt = $25,000,000

Value of Equity = Value of Arras - Value of Debt
Value of Equity = $158,371,504.98 - $25,000,000
Value of Equity = $133,371,504.98

Price per share = Value of Equity / Number of shares outstanding
Price per share = $133,371,504.98 / 3,000,000
Price per share = $44.46

Thanks