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 $7.3 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 costs of capital for Schultz and Arras are 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 answer to 2 decimal places, e.g., 32.16.)

Answer 1

Maximum Price per share to be paid by Schultz for Arras

Maximum Price per share Schultz should pay for Arras = [Value of the firm – Value of Debt] / Number of common shares outstanding

Value of the firm = Present Value of Annual Cash flows + Present Value of Terminal Flow

Present Value of Annual Cash flows

Year	Cash flow ($)	Present Value factor at 7%	Present Value of cash flows ($)
1	76,65,000 [$73,00,000 x 105%]	0.9345794	71,63,551
2	80,48,250 [$76,65,000 x 105%]	0.8734387	70,29,653
3	84,50,663 [$80,48,250 x 105%]	0.8162979	68,98,258
4	88,73,196 [$84,50,663 x 105%]	0.7628952	67,69,318
5	93,16,855 [$88,73,196 x 105%]	0.7129862	66,42,789
TOTAL			3,45,03,570

Present Value of Terminal Flow

Terminal Flow = CF5(1 + g) / (Ke – g)

= $93,16,855(1 + 0.02) / (0.07 – 0.02)

= $95,03,193 / 0.05

= $19,00,63,850

Present Value of Terminal Flow

= Terminal Flow x [PVIF 7%, 5 Year]

= $19,00,63,850 x 0.7129862

= $13,55,12,898

Total Value of the Firm

= $3,45,03,570 + $13,55,12,898

= $17,00,16,469

Maximum Price per share Schultz should pay for Arras = [Value of the firm – Value of Debt] / Number of common shares outstanding

= [$17,00,16,469 - 250,00,000] / 30,00,000 common shares outstanding

= $14,50,16,469 / 30,00,000 common shares outstanding

= $48.34 per share

“Maximum Price per share Schultz should pay for Arras would be $48.34 per share”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.