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 $6.4 million. The cash flows are expected to grow at 9 percent for the next five years before leveling off to 6 percent for the indefinite future. The cost of capital for Schultz and Arras is 13 percent and 11 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.)

Question

Business

Merlin

11 April, 12:27

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 $6.4 million. The cash flows are expected to grow at 9 percent for the next five years before leveling off to 6 percent for the indefinite future. The cost of capital for Schultz and Arras is 13 percent and 11 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.)

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Answers (1)

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Mohammed Quinn · Answer 1

Share price = $20.54

Explanation:

current cash flow from assets for Arras is $6,400,000 million

Seance the cash flows are expected to grow at 9 percent for the next five years, therefore, the next five years cash flow will be:

Year 1: $6,400,000*1.09 = $6,976,000

Year 2: $6,976,000*1.09 = $7,603,840

Year 3: $7,931,520*1.09 = $8,288,185.6

Year 4: $8,566,042*1.09 = $9,034,122.304

Year 5: $9,251,325 (1 +.08) = $9,847,193.311

According to the question after five years the cash flows are expected to grow at 6 percent for the indefinite future.

Therefore, the cash flow of 6th year = $9,847,193.311*1.06 = $10,438,024.91

We know that terminal value of current year = Cash flow of next year / (WACC-g)

As after year 5 the cash flow will be grown at a specific rate for indefinite future, the terminal value 5th year = $10,438,024.91 / (.11-.06) = 94,891,135.49.

Present value of the cash flow = $ (6,976,000/1.11) + $ (7,603,840/1.11^2) + $ (8,288,185.6/1.11^3) + $ (9,034,122.304/1.11^4) + $[ (9,847,193.311+94,891,135.49) / 1.11^5] = $86,624,537.47

The market value of the equity = Market value of the company's present cash flow - Market value of the debt

The market value of the equity = $86,624,537.47 - $25,000,000

The market value of the equity = $61,624,537.47

Therefore, the maximum price per share Schultz should pay for Arras,

Share price = $61,624,537.47/3,000,000

Share price = $20.54