Question

Problem 13-20 Firm Valuation 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 costs of capital for Schultz and Arras are 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 answer to 2 decimal places, e.g., 32.16.)

Price per share?

Answer 1

Answer:-

The current cash flow for Arras = $ 8.3 million
The cash flows are growing at 7% for next 5 years and will grow at 4% at perpetuity.
The last cash flow will have (0.09 - 0.04) in denominator. The discount rate of 9% ( cost of capital of Arras) and the long term growth rate of 4% in perpetuity

The PV of cash flows of Arras

NPV = $ 8.3 m + $ 8.3 m x (1.07) /1.09 + $ 8.3 m x (1.07)²  / 1.09² + $ 8.3 m x (1.07)³ / 1.09³ + $ 8.3 m x (1.07)⁴ / 1.09⁴ + $ 8.3 m x (1.07)⁵ / 1.09⁵ + $ 8.3 m x (1.07)⁵ x 1.04/ 1.09⁵ x (0.09 - 0.04)

NPV = $ 8.3 m + $ 8.15 m + $ 7.99 m + $ 7.85 m + $ 7.71 m + $ 7.56 m + $ 157.23 m

NPV = $ 204.79 million

The total value of Arras = $ 204.79 million
The value of Equity = Total value - Value of debt
The value of Equity = $ 204.79 m - $ 25 m
The value of Equity = $ 179.79 million
Total number of shares outstanding  of Arras = 3 million

The Price per share = Value of Equity / Number of shares outstanding
= $ 179.79 m / 3 m = $ 59.93

Therefore the maximum price per share Schultz should pay for Arras = $ 59.93