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## Problem 12-20: 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 $6.6 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 cost of capital for Schultz and Arras is 11 percent and 9 percent, respectively. Arras currently has 3 million shares of stock outstanding and $25 million in debt outstanding. **Question:** 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.)*

## Problem 12-20: 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 $6.6 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 cost of capital for Schultz and Arras is 11 percent and 9 percent, respectively. Arras currently has 3 million shares of stock outstanding and $25 million in debt outstanding. **Question:** 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.)*

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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## Problem 12-20: 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 $6.6 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 cost of capital for Schultz and Arras is 11 percent and 9 percent, respectively. Arras currently has 3 million shares of stock outstanding and $25 million in debt outstanding. **Question:** 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.)*
Transcribed Image Text:## Problem 12-20: 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 $6.6 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 cost of capital for Schultz and Arras is 11 percent and 9 percent, respectively. Arras currently has 3 million shares of stock outstanding and $25 million in debt outstanding. **Question:** 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.)*
Expert Solution
Step 1

Schultz is purchasing Arras therefore, we need to evalute value of Arras and need to calculate share price of Arras , therefore need to use cost of capital of Arras.

given,

cost of capital of Arras = 9%

cashflow of Arras :

cashflow at year 0 = $6.6 million

cash flow grows at rate rate 7% for 5 years

cashflow at year 1 (CF1)= 6.6 x (1+7%) = $7.062

cashflow at year 2 (CF2)= 7.062 x (1+7%) = $7.55634

cashflow at year 3 (CF3)= $7.55634 x (1+7%) = $8.085

cashflow at year 4 (CF4)=$8.085 x (1+7%) = $8.65

cashflow at year 5 (CF5)= $8.65 x (1+7%) = $9.257

after 5th year  growth rate is 4% for perpetuity

therefore cashflow at year 6

cashflow at year 6 (CF6) = $9.257 x (1+4%) = $9.625

 

Step 2

given 

r = 9%

applying terminal value formula:

terminal value = CF6r-g=9.6259%-4%=$192.54

market value of firm=CF11+R1+CF21+R2+CF31+R3+CF41+R4+CF51+R5+TERMINAL VALUE1+R5=7.0621+9%1+7.551+9%2+8.0851+9%3+8.651+9%4+9.2571+9%5+193.541+9%5=$146.03 million

given, debt of $25 million

market value of equity= market value of firm - market value of debt=146.03-$25=$121.03 million

 

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