Schultz Industries is considering the purchase of Arras Manu

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 $7.4 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, restvely 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

Solution

Current Cash Flow, CF0 = $7,400,000

Growth rate for next five years is 9%, followed by a constant growth rate (g) of 6%

CF1 = $7,400,000 * 1.09 = $8,066,000
CF2 = $8,066,000 * 1.09 = $8,791,940
CF3 = $8,791,940 * 1.09 = $9,583,215
CF4 = $9,583,215 * 1.09 = $10,445,704
CF5 = $10,445,704 * 1.09 = $11,385,817
CF6 = $11,385,817 * 1.06 = $12,068,966

WACC = 11%

V5 = CF6 / (WACC - g)
V5 = $12,068,966 / (0.11 - 0.06)
V5 = $241,379,320

V0 = $8,066,000/1.11 + $8,791,940/1.11^2 + $9,583,215/1.11^3 + $10,445,704/1.11^4 + $11,385,817/1.11^5 + $241,379,320/1.11^5
V0 = $178,294,281.63

Value of Arras = $178,294,281.63
Value of Debt = $25,000,000

Value of Equity = Value of Arras - Value of Debt
Value of Equity = $178,294,281.63 - $25,000,000
Value of Equity = $153,294,281.63

Price per share = Value of Equity / Number of shares outstanding
Price per share = $153,294,281.63 / 3,000,000
Price per share = $51.10