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 $6.5 million. The cash flows are expected to grow at 8 percent for the next five years before leveling off to 5 percent for the indefinite future. The cost of capital for Schultz and Arras is 12 percent and 10 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)) Price per share $

Explanation / Answer

We can calculate the terminal value in Year 5 since the cash flows begin a perpetual growth rate.Since we are valuing Arras, we need to use the cost of capital for that company since this rate isbased on the risk of Arras. The cost of capital for Schultz is irrelevant in this case. So, the terminalvalue is

TV5= CF6/ (RWACC–g)

TV5= $10,028,164 / (.10 – .05)

TV5= $200,563,282

Now we can discount the cash flows for the first 5 years as well as the terminal value back to today.Again, using the cost of capital for Arras, we find the value of the company today is

V0= $7,020,000 / 1.10 + $7581,600 / (1.10)2+ $8188,128 / (1.10)3+ $8,843,178 / (1.10)4+ ($9550,632 + 200,563,282) / (1.10)5

V0=$155,303,685

The market value of the equity is the market value of the company minus the market value of thedebt, or

S0 =$155,303,685-$25,000,000 =$130,303,685

To find the maximum offer price, we divide the market value of equity by the shares outstanding,

=$130,303,685/3000,000 shares

=$43.43 per share

year Cashflows $        1 6500,000*1.08         7,020,000        2 7020,000*1.08         7,581,600        3 7581,600*1.08         8,188,128        4 8188,128*1.08         8,843,178        5 8843,178*1.08         9,550,632        6 9550,632*1.05       10,028,164

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