Question

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 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? (do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) price per share $

Answer 1

Based on the calculations, the maximum price per share that Schultz should pay for Arras is approximately equal to $53.00.

How to calculate the maximum price per share?

First of all, we would determine the cash flows for the company until the growth rate changes at a constant perpetual rate:

Year 1: $8,000,000(1 + 0.09) = $8,720,000.

Year 2: $8,720,000(1 + 0.09) = $9,504,800.

Year 3: $9,504,800(1 + 0.09) = $10,360,232.

Year 4: $10,360,232(1 + 0.09) = $11,292,652.88.

Year 5: $11,292,652.88(1 + 0.09) = $12,308,991.6392.

Year 6: $12,308,991.6392(1 + 0.06) = $13,047,5311.137552.

Next, we would calculate the terminal value in Year 5:

TV₅ = CF₆/(RWACC - g)

TV₅ = CF₆/(0.11 - 0.06)

TV₅ = $12,308,991.6392/0.05

TV₅ = $246,179,832.784.

By using Arras' cost of capital, we would determine its present value:

V₀ = $8,720,000/(1 + 0.11) + $9,504,800/(1 + 0.11)² + $10,360,232/(1 + 0.11)³+ $11,292,652.88/(1 + 0.11)⁴+ ($12,308,991.6392 + $246,179,832.784)/(1 + 0.11)⁵.

V₀ = $8,720,000/(1.11) + $9,504,800/(1.11)² + $10,360,232/(1.11)³+ $11,292,652.88/(1.11)⁴+ ($12,308,991.6392 + $246,179,832.784)/(1.11)⁵.

V₀ = 7,855,855.8559 + 7,714,308.9035 + 7,575,312.3467 + 7,438,820.2323 + 153,400,536.1422.

V₀ = $183,984,855.4806.

For the market value of the equity, we have:

S = 183,984,855.4806 - 25,000,000

S = $158,984,855.4806.

Now, we can find the maximum price per share:

Maximum price per share = 158,984,855.4806/3,000,000

Maximum price per share = $52.9949 ≈ $53.00.

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