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 $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? (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 $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? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Firm value = Present value of first five year cash flows and present valeu of terminal value

8.3*1.07/1.11 + 8.3*1.07^2/1.11^2 + 8.3*1.07^3/1.11^3 + 8.3*1.07^4/1.11^4 + 8.3*1.07^5/1.11^5 + 8.3*1.07^5*1.04/(.11-.04) / 1.11^5

= 139.8635 million

Value of equity = 139.8635 - 25

= 114.8635 million

Maximum price per share Schultz should pay for Arras = 114.8635 / 3

= $ 38.29

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