Schultz Industries is considering the purchase of Arras Manufacturing. Arras is
ID: 2382554 • Letter: S
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 $8.0 million. The cash flows are expected to grow at 9 percent for the next five years before leveling off to 6 percent for the indefinite future. The cost of capital for Schultz and Arras is 13 percent and 11 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?
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 $8.0 million. The cash flows are expected to grow at 9 percent for the next five years before leveling off to 6 percent for the indefinite future. The cost of capital for Schultz and Arras is 13 percent and 11 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
The cost of capital for Shultz will be considered as it is the acquiring company.
Present value of future cash flows = 8 *(1.09) / 1.13 + 8(1.09)2/1.132 + 8(1.09)3/1.133 + 8(1.09)4/1.134 + 8(1.09)5/1.135 + 8(1.09)5(1.06)/1.136 + -----------------------------------
= 8 *(1.09) / 1.13 + 8(1.09)2/1.132 + 8(1.09)3/1.133 + 8(1.09)4/1.134 + 8(1.09)5/1.135 + 8(1.09)5(1.06)/1.136
1-[(1.06)/(1.13)]
= 35.9475 + [6.2670/0.06195]
= $137.11 million
Maximum Price per share = 137.11/3 = $45.70
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