Schultz Industries is considering the purchase of Arras Manufacturing. Arras is

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 $8.3 million. The cash flows are expected to grow at 7 percent for the next five years before leveling off to 4 percent for the indefinite future. The cost of capital for Schultz and Arras is 11 percent and 9 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 final answer to 2 decimal places. (e.g., 32.16))

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 $8.3 million. The cash flows are expected to grow at 7 percent for the next five years before leveling off to 4 percent for the indefinite future. The cost of capital for Schultz and Arras is 11 percent and 9 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 final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Step1: Computaion of Present value of future cash flows of Arras Manufacturing.We have,

Current Cash flow = $ 8.3 million

Growth rate (g1 ) = 7%

Growth rate (g2)      = 4%

Cost of Capital     = 9%

Number of years = 5 years

Present value of Future Cash inflow = CF1 (1 + g1 )/ (1 + Ke ) + CF2 (1+g1 )2 / (1 + Ke )2 +                                     CF3 / (1 + g1 )3 / (1+ Ke )3 + CF4 (1 + g1 )4 / (1 + Ke )4 + CF5 (1+g1 )5 /( Ke - g2 ) / (1 + Ke )5

Present value of future cash inflow = 8.3(1.07)/ (1.09) + 8.3(1.07)2/ (1.09)2 + 8.3(1.07)3/ (1.09)3 + 8.3(1.07)4/ (1.09)4      + 8.3(1.07)5/ (0.09 - 0.04)/(1.09)5

Present value of future cash inflow = 8.15 + 8.00 + 7.85 + 7.71 + 151.32

Present value of future cash inflow = $ 183.03 million

Total debt outstanding of Arras Manufacturing = $ 25 million

Step2: Computation of Maximum market value of Arras Manufacturing.We have,

Maximum Market value = Present value of future cash inflow + Total outstanding Debt

Maximum market value = 183.03 + 25.00 = $ 208.03 million

Step3: Computation of Maximum price per share of Arras Manufacturing.We have,

Number of share outstanding = 3 million

Maximum market value        = $ 208.03 Million

Maximum price per share = Maximum market value/ Total number of share outstanding

Maximum price per share = 208.03 / 3.00 = $ 69.34

Hence, Maximum price per share schultz should pay for Arras is $ 69.34.

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