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 $7. 7 million. The cash flows are expected to grow at 6 percent for the next five years before leveling off to 3 percent for the indefinite future. The cost of capital for Schultz and Arras is 10 percent and 8 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?

Answer 1

The maximum price per share Schultz should pay for Arras is  $147,001,195.75.

How to find the market value of the equity ?

Given

Current cash flow = $7.7million.

Growth rate = 6% for 5 years before leveling off to 3% for the indefinite future.

Costs of capital

For Schultz = 10%

For Arras = 8%

Arras shares = 3 million in stock outstanding

Arras Shares $25 million in debt outstanding.

Price per share in year 1 is calculated as follows;

$7.7 million (1 + 6%)

= $7700000 * 106%

= $7,700,000 * 1.06

= $8,162,000

In year 2;

= $8,162,000 * (1 + 6%)

= $8,162,000 * 106%

= $8,162,000 * 1.06

= $8,651,720

In year 3;

= $8,651,720 * (1 + 6%)

= $8,651,720 * 106%

= $8,651,720* 1.06

= $9,170,823.2

In year 4:

= $9,170,823.2 * (1 + 6%)

= $9,170,823.2 * 106%

= $9,170,823.2* 1.06

= $9,306,651.671

In year 5;

= $9,306,651.671 * (1 + 7%)

= $9,306,651.671 * 107%

= $9,306,651.671 * 1.07

= $9,721,072.592

In year 6;

= $9,721,072.592 * (1 + 3%)

= $9,721,072.592 * 103%

= $9,721,072.592* 1.03

= $10,012,704.77

Next, we'll calculate the terminal value in Year 5 since the cash flows begin a perpetual growth rate. Since we are valuing Arras, The cost of capital for Schultz is irrelevant in this case.

So, the terminal value is:

TV5= CF6/ (RWACC– g)

TV5= $10,012,704.77 / (.08 – .03)

TV5 = $10,012,704.77 / (.05

TV5= $200,254,095.4

Next, we calculate the discount for each flows, using the cost of capital for Arras, we find the value of the company today is:

V0= $8,162,000 / (1+.08) + $8,651,720 / (1+.08)² + $9,170,823.2 / (1+.08)³+ $9,306,651.671 /(1+.08)⁴+ ($9,721,072.592+ $200,254,095.4) /(1+.08)^5

V0= $172001195.9

V0 = $172001195.9

The market value of the equity is the market value of the company minus the market value of the debt, or:

S= $172001195.9– $25,000,000 S=$147,001,195.75

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Answer 2

The maximum price per share Schultz should pay for Arras is  $147,001,195.75.

How to find the market value of the equity ?

Given

Current cash flow = $7.7million.

Growth rate = 6% for 5 years before leveling off to 3% for the indefinite future.

Costs of capital

For Schultz = 10%

For Arras = 8%

Arras shares = 3 million in stock outstanding

Arras Shares $25 million in debt outstanding.

Price per share in year 1 is calculated as follows;

$7.7 million (1 + 6%)

= $7700000 * 106%

= $7,700,000 * 1.06

= $8,162,000

In year 2;

= $8,162,000 * (1 + 6%)

= $8,162,000 * 106%

= $8,162,000 * 1.06

= $8,651,720

In year 3;

= $8,651,720 * (1 + 6%)

= $8,651,720 * 106%

= $8,651,720* 1.06

= $9,170,823.2

In year 4:

= $9,170,823.2 * (1 + 6%)

= $9,170,823.2 * 106%

= $9,170,823.2* 1.06

= $9,306,651.671

In year 5;

= $9,306,651.671 * (1 + 7%)

= $9,306,651.671 * 107%

= $9,306,651.671 * 1.07

= $9,721,072.592

In year 6;

= $9,721,072.592 * (1 + 3%)

= $9,721,072.592 * 103%

= $9,721,072.592* 1.03

= $10,012,704.77

Next, we'll calculate the terminal value in Year 5 since the cash flows begin a perpetual growth rate. Since we are valuing Arras, The cost of capital for Schultz is irrelevant in this case.

So, the terminal value is:

TV5= CF6/ (RWACC– g)

TV5= $10,012,704.77 / (.08 – .03)

TV5 = $10,012,704.77 / (.05

TV5= $200,254,095.4

Next, we calculate the discount for each flows, using the cost of capital for Arras, we find the value of the company today is:

V0= $8,162,000 / (1+.08) + $8,651,720 / (1+.08)² + $9,170,823.2 / (1+.08)³+ $9,306,651.671 /(1+.08)⁴+ ($9,721,072.592+ $200,254,095.4) /(1+.08)^5

V0= $172001195.9

V0 = $172001195.9

The market value of the equity is the market value of the company minus the market value of the debt, or:

S= $172001195.9– $25,000,000 S=$147,001,195.75

To learn more about Terminal value refer,

brainly.com/question/15404593

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