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 control its material supply. The current cash flow from assets for Arras is $7. 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 And 11 percent and 9 percent, respectively. Arras currently has 2.5 million shares 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.)

Answer 1

The cost of capital of Arras which is 9% has been used for the purpose of calculations

The current cash flow $7 is assumed to be in millions only.

The present value of the infinite series of inflows is calculated at the end of 5th year and again discounted @9% to derive its present value at year 0.

The maximum price to be paid for a share should be the net of inflows and outflows. Debt is an outflow so it has been deducted from the present value fo inflows to find the net price that should be paid.