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 maximum price per share Schultz should pay for Arras?

Explanation / Answer

Let's first calculate the cashflows for Arras for the next 6 years @6% for first 5 and Terminal value @3% for beyond

Cashflow for year 1 = $6.7 Mn * (1+6%) = $6.7 * 1.06 = $7102000

Cashflow for year 2 = $7.102 Mn * (1+6%) = $7.102 * 1.06 = $7528120

Cashflow for year 3 = $7.52812 Mn * (1+6%) = $7.52812 Mn * 1.06 = $7979807

Cashflow for year 4 = $7.979807 Mn * (1+6%) = $7.979807 * 1.06 = $8458595

Cashflow for year 5 = $8.458595 * (1+6%) = $8.458595 * 1.06 = $8458595

After 5 years growth rate becomes constant for indefinite future, so terminal value of cashflows can be calculated as

Terminal Cashflow = $8966111 * (1+ growth rate) / ( rate of return - growth rate) = $8966111 * ( 1+3%)/(8%-3%)

= $184701886.6

Now by discounting all these cashflows to present value @8% will give us the value of Arras

Present Value of Arras = $7102000/ 1.08 + $7528120 /1.082 + $7979807/1.083 + $8458595/1.084 + ($8458595 + $184701886.6)/ 1.085

= $157043801.5

Total Market Value = Market Value of Debt + Market value of Equity

$157043801.5 = $25000000 + Market Value of Equity

Market Value of Equity = $132043801.5

Number of shares outstanding = 3000000

Market Value per share = $132043801.5 / 3000000 = $44.015

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