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 $6.9 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

TOTAL VALUE OF ARRAS BUSINESS

PERPETUITY VALUE AT YEAR 5

= CASH FLOW OF YEAR 6 / (COST OF CAPITAL - GROWTH)

= $11.254 / (11% - 6%)

= $11.254 / 5%

= $225.08

TOTAL PRESENT VALUE OF STOCK

= $166.32 - $25

= $141.32

PRICE PER SHARE= $141.32 / 3

= $47.11

THE MAXIMUM PRICE IS $47.11

YEAR CASH FLOW DISCOUNTING FACTOR DISCOUNTED CASH FLOW 1 $7.521 0.9091 $6.84 2 $8.198 0.8116 $6.65 3 $8.936 0.7312 $6.53 4 $9.740 0.6587 $6.42 5 $10.617 0.5935 $6.30 5 $225.08 0.5935 $133.58 PRESENT VALUE $166.32

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