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 $6.7 million. The cash flows are expected to grow at 6 percent for the next five years before leveling off to 3 percent for the indefinite future. The cost of capital for Schultz and Arras is 10 percent and 8 percent, respectively. Arras currently has 3 million shares of stock outstanding and $25 million in debt outstanding.

What is the Max Price/Share Schultz should pay for Arras?

Price Per Shre=?

Explanation / Answer

Find the present vaue of Arras

D0 = 6.7

D1 = 6.7*(1+0.06)

D2 = 6.7*(1+0.06)^2

D3 = 6.7*(1+0.06)^3

D4 = 6.7*(1+0.06)^4

D5 = 6.7*(1+0.06)^5

D6 = 6.7*(1+0.06)^5*1.03

According to dividend-discount model,

P0 = D1/(R-G)

P0 = Current stock price

D1 - Dividend at t =1

R - Required rate

G - Growth rate

P5 = D6/(R-g) = 6.7*(1+0.06)^5*1.03/(0.08-0.03) = 184.70

PV is calculated by discounting the future cashflows

P0 = 6.7*1.06/(1+0.08)^1 + 6.7*1.06^2/(1+0.08)^2 + 6.7*1.06^3/(1+0.08)^3 + 6.7*1.06^4/(1+0.08)^4 + 6.7*1.06^5/(1+0.08)^5 + 184.70/(1+0.08)^5 = 157.39

Current enterprise value = 157.39 million

Equity value = 157.39 - 25 = 132.39 million

Price per share = 132.39/3 = $44.13 per share

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