Schultz Industries is considering the purchase of Arras Manufacturing. Arras is
ID: 2643643 • 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 $7.5 million. The cash flows are expected to grow at 8 percent for the next five years before leveling off to 4 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))
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 $7.5 million. The cash flows are expected to grow at 8 percent for the next five years before leveling off to 4 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))
Explanation / Answer
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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 $8.3 million. The cash flows are expected to grow at 7 percent for the next five years before leveling off to 4 percent for the indefinite future. The cost of capital for Schultz and Arras is 11 percent and 9 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?
Answer
Current Cash Inflows of Arras Manufacturing = $ 8,300,000
Growth Rate for the next 5 years = 7% (given)
Growth Rate for beyond 5 years = 4%
Cost of Capital for Arras Manufacturing = 9%
We need to find the present value of expected cash inflows for the next 5 years and then, beyond 5 years.
For the first 5 years:
Beyond 5 years:
Cash Inflow for the 6th year = Cash flow of the 5th year + Growth = $ 11,641,179 x 1.07 = $ 12,456,062
Therefore, cash inflow beyond 5 years = Cash Flow for the 6th year/ (Cost of capital - Growth rate)
= 12456062/(0.09-0.04) = $ 249, 121, 238
Discount factor the 6th year = 1/(1.09)6 = 0.596
Present value for the cash inflow of the 6th year = $ 249, 121, 238 x 0.596 = $ 148, 542, 855
Therefore, total present value of Expected cash Inflows for the First 5 years and beyond 5 years = $ 39, 270, 720 + $ 148, 542, 855 = $ 187, 813, 575
Cost of capital for Schultz Industries = 11% (given)
As per the IRR approach,
Present value of Outflow = Present value of Inflow
Present value of Outflow for Schultz Industries = Expected Cash Inflows from Arras Manufacturing discounted at the cost of capital rate of Schultz Industries
Present value of Outflow = Expected Cash Inflows Arras Manufacturing/ Cost of capital rate of Schultz Industries
Present value of Outflow = 187, 813, 575 / 1.11 = $ 169, 201, 419
This means this is the amount that will be required to buy Arras Manufacturing.
No. of shares in Arras Manufacturing = 3,000,000
Therefore, maximum price per share Schultz Industries should pay for Arras Manufacturing = $169,201,419/3,000,000 = $ 56.40 (Answer)
Workings of Expected Cash Flows Expected Cash Flows ($) Discounting Factor Present Value of Expected Cash Flows ($) 8,300,000 x 1.07 8,881,000 1/1.09 8147706 8,881,000 x 1.07 9,502,670 1/(1.09)2 7998207 9,502,670 x 1.07 10,167,857 1/(1.09)3 7,851,451 10,167,857 x 1.07 10, 879, 607 1/(1.09)4 7,707,388 10, 879, 607 x 1.07 11,641, 179 1/(1.09)5 7,565,968 Total 39,270,720Related Questions
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