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 $6.8 million. The cash flows are expected to grow at 8% for the next 5 years before leveling off to 4% for the indefinite future. The cost of capital for Shultz and Arras is 12% and 10%, respectively. Arras currently has 2.4 million shares of stock outstanding and $25 million in debt outstanding. What is the maximum price per share Schultz should pay for Arras? Required: 1. First calculate the annual cash flows for years 1 through 6: Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 2. Calculate the terminal value in year 6, since that is when cash flows become perpetual. TV5 = CF6/(RWACC – g) Terminal Value = 3. Discount the cash flows for the 5 years plus the terminal value back to today. The total is equal to the market value of the company. Year 1 Year 2 Year 3 Year 4 Year 5 MV of Company = 4. Calculate the market value of equity and price per share. MV of equity = Price per share = 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 $6.8 million. The cash flows are expected to grow at 8% for the next 5 years before leveling off to 4% for the indefinite future. The cost of capital for Shultz and Arras is 12% and 10%, respectively. Arras currently has 2.4 million shares of stock outstanding and $25 million in debt outstanding. What is the maximum price per share Schultz should pay for Arras? Required: 1. First calculate the annual cash flows for years 1 through 6: Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 2. Calculate the terminal value in year 6, since that is when cash flows become perpetual. TV5 = CF6/(RWACC – g) Terminal Value = 3. Discount the cash flows for the 5 years plus the terminal value back to today. The total is equal to the market value of the company. Year 1 Year 2 Year 3 Year 4 Year 5 MV of Company = 4. Calculate the market value of equity and price per share. MV of equity = Price per share =

Explanation / Answer

1. First calculate the annual cash flows for years 1 through 6: Year 1 6800000 Year 2 7344000 Year 3 7931520 Year 4 8566041.6 Year 5 9251324.93 Year 6 9621377.93 2. Calculate the terminal value in year 6, since that is when cash flows become perpetual. TV5 = 9621377.93/(0.1-0.04) = Terminal Value = 160356299 3. Discount the cash flows for the 5 years plus the terminal value back to today. The total is equal to the market value of the company. Year Cash flows PV factors @ 10% PC of cash flows 1 6800000 0.90909091 6181818.18 2 7344000 0.82644628 6069421.49 3 7931520 0.7513148 5959068.37 4 8566041.6 0.68301346 5850721.67 5 9251324.93 0.62092132 5744344.91 Horizon 160356299 0.62092132 99568645.2 MV of Company = 129374020 4. Calculate the market value of equity and price per share. MV of equity = Value of firm - value of debt = =129374020 -25000000 = 104374020 Price per share = MV of equity/ No. of shares = =104374020/2400000 43.489175 This is the maximum offer price. Please provide feedback……... thanks in advance……… :-)

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