Question

Schultz Industries is considering the purchase of Arras Manufacturing. Arras is currently a supplier for Schultz and the acquisition would allow Schultz control its material supply. The current cash flow from assets for Arras is $7.1 million. The cash flows are expected to grow at 10 percent for the next five years before 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 2.5 million shares of stock outstanding and $22 million in debt outstanding. What is the maximum price per share Schultz should pay for Arras?

Do not round your intermediate calculations. Show all formulas and steps.

Answer 1

The share price can be calculated using Discounted Cash Flow method.

Future 5 years cashflows can be calculated as 7,100,000 * (1+ 10%) as they are expected to grow at 10% for 5 years

Year 1 = 7,100,000 * (1+ 10%)

Year 2 = 7,100,000 * (1+ 10%)^2

Year 3 = 7,100,000 * (1+ 10%)^3

Year 4 = 7,100,000 * (1+ 10%)^4

Year 5 = 7,100,000 * (1+ 10%)^5

Terminal Value calculated using Year 5 cashflow growing in perpetuity at 4% and WACC 9% [$11,434,621 * (1 + 4%)]/(9% - 4%)

Discounting these future values at WACC 9%

Discount Factor Year 1 = 1/(1+9%)

Discount Factor Year 2 = 1/(1+9%)^2

Discount Factor Year 3 = 1/(1+9%)^3

Discount Factor Year 4 = 1/(1+9%)^4

Discount Factor Year 5 = 1/(1+9%)^5

Terminal Value will also be discounted by 5 years

Adding all these gives us Enterprise value = 191,068,855.45

Removing Debt portion gives the Equity value = 169,068,855.45

Dividing with total no, of shares outstanding of 2,500,000

Price per Share = $67.63

Schultz should pay no more than $67.63