Question

Problem 13-20 Firm Valuation 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 $8.3 million. The cash flows are expected to grow at 7 percent for the next five years before leveling off to 4 percent for the indefinite future. The costs of capital for Schultz and Arras are 11 percent and 9 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 answer to 2 decimal places, e.g., 32.16.)

The answer is not $59.93

Answer 1

current cash flow from assets for Arras is CF0 = 8.3 Million
cash flows are expected to grow at 5% for Next 5 Years (G1) =  7.00%  
First Stage Growth Years n = 5 Years
Terminal Growth for indefinite period Gn =  4.00%
Cost of Capital for Arras r =  9.00%
No of Shares O/S of Arras   = 3 Million
O/S Debt of Arras   =25 Million

Step 1 : Cash Flow at nth Year During the First Stage of Growth Model CFn = CF0 * ( 1 + G1)^n

Step 2 : Present Value of Future Cash Flow During Nth Year = CF0 * ( ( 1 + G1)^n ) / ( ( 1 + r) ^n )

Step 3 : Next, we'll calculate the terminal value in Year 5

Here the cash flows begin a perpetual growth rate.

the terminal value at Year 5 is

TV5= CF6/ (r – Gn)

CF6 = CF5 * ( 1+G1)

Now we will calculate PV of Future Terminal Cash Flows =  TV5 / (1+r)^5 (Because it is in Year 5)

Step 4 : We will Sum All present value of Future Cash Flows = Sum of Present Value of Future Cash Flow During Nth Year + PV of Terminal Cash Flows at Year 5

Step 5 : Value of Equity = Total PV Cash Flow (Firn Value) - Value of Debt

Step 6 : Value of Shares =  Value of Equity / No of Shares Outstanding

the maximum price per share Schultz should pay for Arras = $ 57.21