Question

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 $7.1 million. The cash flows are expected to grow at 10 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 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?

Answer 1

Solution:
	maximum price per share    $67.63
Working Notes:
	Each year future cash flows
	Year 1=Year 0 (1+growth rate)
	Year 1 = $7,100,000 × (1 + 0.10) = $7,810,000
	Year 2 = $7,810,000 × (1 + 0.10) = 8591,000
	Year 3 = $8591,000 × (1 + 0.10) = $9,450,100
	Year 4 =$9,450,100 × (1 + 0.10) = $10,395,110
	Year 5= $10,395,110 × (1 + 0.10) = $11,434,621
	Year 6=$11,434,621 × (1 + 0.04) = 11,892,005.84
	present value of all the future cash flow at the end of 5th year
	As per constant growth model
	Year 5 = Year 6 cash flow/(WACC -g)
	WACC=9% required rate of return
	g= growth rate = 4%
	= 11,892,005.84/( 0.09 -0.04)
	=$237,840,116.80
	Now
	Current price of the stock
		I	II	III=I x II
	Year	Cash Flow	PVF @ 9%	Present value
	1	7,810,000.00	0.917431193	7,165,137.61468
	2	8,591,000.00	0.841679993	7,230,872.82215
	3	9,450,100.00	0.772183480	7,297,211.10493
	4	10,395,110.00	0.708425211	7,364,157.99580
	5	11,434,621.00	0.649931386	7,431,719.07833
	5	237,840,116.80	0.649931386	154,579,756.82918
		Value of Arras		191,068,855.445063
	Notes: PVF is calculated @ r% = 1/(1+r%)^n     where n is the period for which PVF is calculated.
	Market value of equity of Arras = Value of Arras - Market value of debt
		=191,068,855.445063 - 22,000,000
		=169,068,855.44506
	Maximum price the Schultz should pay for offer = Market value of equity of Arras / No of share outstanding
		=169,068,855.44506 /2,500,000
		=67.62754218
		=$67.63 per share
Please feel free to ask if anything about above solution in comment section of the question.