Merger, Acquisition & Restructuring

Transcription

1 13 Merger, Acquisition & Restructuring Question 1 Explain synergy in the context of Mergers and Acquisitions. (4 Marks) (November 2012) Synergy May be defined as follows: V (AB) > V(A) + V (B). In other words the combined value of two firms or companies shall be more than their individual value. This may be result of complimentary services economics of scale or both. A good example of complimentary activities can a company may have a good networking of branches and other company may have efficient production system. Thus the merged companies will be more efficient than individual companies. On Similar lines, economics of large scale is also one of the reason for synergy benefits. The main reason is that, the large scale production results in lower average cost of production e.g. reduction in overhead costs on account of sharing of central services such as accounting and finances, Office executives, top level management, legal, sales promotion and advertisement etc. These economics can be real arising out of reduction in factor input per unit of output, whereas pecuniary economics are realized from paying lower prices for factor inputs to bulk transactions. Question 2 Explain the term 'Buy-Outs'. (8 Marks) (November 2003) Write brief notes on Leveraged Buy-Outs (LBO). (4 Marks) (May 2007) A very important phenomenon witnessed in the Mergers and Acquisitions scene, in recent times is one of buy - outs. A buy-out happens when a person or group of persons gain control of a company by buying all or a majority of its shares. A buyout involves two entities, the acquirer and the target company. The acquirer seeks to gain controlling interest in the company being acquired normally through purchase of shares. There are two common types of buy-outs: Leveraged Buyouts (LBO) and Management Buy-outs (MBO). LBO is the purchase of assets or the equity of a company where the buyer uses a significant amount of debt and very

2 Merger, Acquisition & Restructuring 13.2 little equity capital of his own for payment of the consideration for acquisition. MBO is the purchase of a business by its management, who when threatened with the sale of its business to third parties or frustrated by the slow growth of the company, step-in and acquire the business from the owners, and run the business for themselves. The majority of buy-outs is management buy-outs and involves the acquisition by incumbent management of the business where they are employed. Typically, the purchase price is met by a small amount of their own funds and the rest from a mix of venture capital and bank debt. Internationally, the two most common sources of buy-out operations are divestment of parts of larger groups and family companies facing succession problems. Corporate groups may seek to sell subsidiaries as part of a planned strategic disposal programme or more forced reorganisation in the face of parental financing problems. Public companies have, however, increasingly sought to dispose of subsidiaries through an auction process partly to satisfy shareholder pressure for value maximisation. In recessionary periods, buy-outs play a big part in the restructuring of a failed or failing businesses and in an environment of generally weakened corporate performance often represent the only viable purchasers when parents wish to dispose of subsidiaries. Buy-outs are one of the most common forms of privatisation, offering opportunities for enhancing the performances of parts of the public sector, widening employee ownership and giving managers and employees incentives to make best use of their expertise in particular sectors. Question 3 What is take over by reverse bid? (3 Marks) (May 2006), (4 Marks) (November 2011) (4 Marks) (November 2014) Generally, a big company takes over a small company. When the smaller company gains control of a larger one then it is called Take-over by reverse bid. In case of reverse takeover, a small company takes over a big company. This concept has been successfully followed for revival of sick industries. The acquired company is said to be big if any one of the following conditions is satisfied: (i) The assets of the transferor company are greater than the transferee company; (ii) Equity capital to be issued by the transferee company pursuant to the acquisition exceeds its original issued capital, and (iii) The change of control in the transferee company will be through the introduction of minority holder or group of holders. Reverse takeover takes place in the following cases: (1) When the acquired company (big company) is a financially weak company (2) When the acquirer (the small company) already holds a significant proportion of shares of the acquired company (small company)

3 13.3 Strategic Financial Management (3) When the people holding top management positions in the acquirer company want to be relived off of their responsibilities. The concept of take-over by reverse bid, or of reverse merger, is thus not the usual case of amalgamation of a sick unit which is non-viable with a healthy or prosperous unit but is a case whereby the entire undertaking of the healthy and prosperous company is to be merged and vested in the sick company which is non-viable. Question 4 Write a short note on Financial restructuring. (5 Marks) (November 2008) (S), (4 Marks) (May 2013) Financial restructuring, is carried out internally in the firm with the consent of its various stakeholders. Financial restructuring is a suitable mode of restructuring of corporate firms that have incurred accumulated sizable losses for / over a number of years. As a sequel, the share capital of such firms, in many cases, gets substantially eroded / lost; in fact, in some cases, accumulated losses over the years may be more than share capital, causing negative net worth. Given such a dismal state of financial affairs, a vast majority of such firms are likely to have a dubious potential for liquidation. Can some of these Firms be revived? Financial restructuring is one such a measure for the revival of only those firms that hold promise/prospects for better financial performance in the years to come. To achieve the desired objective, 'such firms warrant / merit a restart with a fresh balance sheet, which does not contain past accumulated losses and fictitious assets and shows share capital at its real/true worth. Question 5 What is reverse merger? (4 Marks) (November 2010) (M) A merger is considered to be the fusion of two Companies. The two Companies which have merged into another Company in the same industry, normally the market share of the company would increase. In addition to normal merger (where smaller companies merge into larger Company), vertical merger (where to companies of different industry merge together), there is one more hand of merger, known as Reverse Merger. In this, two Companies are normally of the same industry but here bigger company merges into smaller company that s why it is called reverse merger. In order to avail benefit of carry forward of losses which are available as per tax laws, the profit making Company is merged with companies having accumulates losses. Following three things are very important for reverse merger. 1. The assets of transfer company are greater than the transferee company. 2. Equity Capital to be issued by the transferee company pursuant to the merger exceeds to original capital.

4 Merger, Acquisition & Restructuring There is a change in control in the transferee company through the introduction of a minority group or new group of shareholders. Question 6 What is an equity curve out? How does it differ from a spin off? (4 Marks) (November 2013) Equity Curve out can be defined as partial spin off in which a company creates its own new subsidiary and subsequently bring out its IPO. It should be however noted that parent company retains its control and only a part of new shares are issued to public. On the other hand in Spin off parent company does not receive any cash as shares of subsidiary company are issued to existing shareholder in the form of dividend. Thus, shareholders in new company remain the same but not in case of Equity curve out. Question 7 B Ltd. is a highly successful company and wishes to expand by acquiring other firms. Its expected high growth in earnings and dividends is reflected in its PE ratio of 17. The Board of Directors of B Ltd. has been advised that if it were to take over firms with a lower PE ratio than it own, using a share-for-share exchange, then it could increase its reported earnings per share. C Ltd. has been suggested as a possible target for a takeover, which has a PE ratio of 10 and 1,00,000 shares in issue with a share price of ` 15. B Ltd. has 5,00,000 shares in issue with a share price of ` 12. Calculate the change in earnings per share of B Ltd. if it acquires the whole of C Ltd. by issuing shares at its market price of `12. Assume the price of B Ltd. shares remains constant. (8 Marks) (November 2009) (M) Total market value of C Ltd is = 1,00,000 x ` 15 = ` 15,00,000 PE ratio (given) = 10 Therefore, earnings = ` 15,00,000 /10 = ` 1,50,000 Total market value of B Ltd. is = 5,00,000 x ` 12 = ` 60,00,000 PE ratio ( given) = 17 Therefore, earnings = ` 60,00,000/17 = ` 3,52,941 The number of shares to be issued by B Ltd. ` 15,00, = 1,25,000 Total number of shares of B Ltd = 5,00, ,25,000 = 6,25,000

5 13.5 Strategic Financial Management The EPS of the new firm is = (` 3,52,941+`1,50,000)/6,25,000 = ` 0.80 The present EPS of B Ltd is = ` 3,52,941 /5,00,000 = ` 0.71 So the EPS affirm B will increase from Re to ` 0.80 as a result of merger. Question 8 ABC Company is considering acquisition of XYZ Ltd. which has 1.5 crores shares outstanding and issued. The market price per share is ` 400 at present. ABC's average cost of capital is 12%.Available information from XYZ indicates its expected cash accruals for the next 3 years as follows: Year ` Cr Calculate the range of valuation that ABC has to consider. (PV factors at 12% for years 1 to 3 respectively: 0.893, and 0.712). (4 Marks) (November 2009) (M) VALUATION BASED ON MARKET PRICE Market Price per share ` 400 Thus value of total business is (` 400 x 1.5 Cr.) ` 600 Cr. VALUATION BASED ON DISCOUNTED CASH FLOW Present Value of cash flows (` 250 cr x 0.893) + (` 300 cr. X 0.797) + ( ` 400 cr. X ) = ` Cr. Value of per share (` Cr. / 1.5 Cr) ` per share RANGE OF VALUATION Per Share ` Total ` Cr. Minimum Maximum Question 9 ABC Limited is considering acquisition of DEF Ltd., which has 3.10 crore shares issued and outstanding. The market price per share is ` at present. ABC Ltd.'s average

6 Merger, Acquisition & Restructuring 13.6 cost of capital is 12%. The cash inflows of DEF Ltd. for the next three years are as under: Year ` in crores You are required to calculate the range of valuation that ABC Ltd. has to consider. Take P.V.F. (12%, 3) =0.893, 0.797, (5 Marks) (May 2013) Valuation based on Market Price Market Price per share ` Thus value of total business is (3.10 crore x ` 440) ` 1, Crore Valuation based on Discounted Cash Flow Present Value of cash flows (` 460 Crore x 0.893) + (` 600 Crore X 0.797) + (` 740 Crore X ) = ` 1, Crore Value of per share (` Crore / 3.10 Crore) ` per share Range of valuation Per Share (`) Total (` Crore) Minimum Maximum Question 10 Elrond Limited plans to acquire Doom Limited. The relevant financial details of the two firms prior to the merger announcement are: Elrond Limited Doom Limited Market price per share ` 50 ` 25 Number of outstanding shares 20 lakhs 10 Lakhs The merger is expected to generate gains, which have a present value of ` 200 lakhs. The exchange ratio agreed to is 0.5. What is the true cost of the merger from the point of view of Elrond Limited? (5 Marks) (November 2014) Shareholders of Doom Ltd. will get 5 lakh share of Elrond Limited, so they will get:

7 13.7 Strategic Financial Management 5 lakh = = 20% of shares Elrond Limited 20 lakh+ 5 lakh The value of Elrond Ltd. after merger will be: = `50 x 20 lakh + `25 x 10 lakh + `200 lakh = `1000 lakh + `250 lakh + `200 lakh = `1450 lakh True Cost of Merger will be: (`1450 x 20%) `290 lakhs `250 lakhs = `40 lakhs Question 11 X Ltd. reported a profit of `65 lakhs after 35% tax for the financial year An analysis of the accounts revealed that the income included extraordinary items `10 lakhs and an extraordinary loss `3 lakhs. The existing operations, except for the extraordinary items, are expected to continue in the future; in addition, the results of the launch of a new product are expected to be as follows: ` lakhs Sales 60 Material costs 15 Labour Costs 10 Fixed costs 8 You are required to : (a) Compute the value of the business, given that the capitalization rate is 15%. (b) Determine the market price per equity share, with X Ltd. s share capital being comprised of 1,00,000 11% preference shares of ` 100 each and 40,00,000 equity shares of ` 10 each and the P/E ratio being 8 times.. (10 Marks) (June 2009) (M) 65 (a) Profit before tax Less: Extraordinary income (10) Add: Extraordinary losses 3 93 Profit from new product Sales 60 Less: Material costs 15

8 Merger, Acquisition & Restructuring 13.8 Labour costs 10 Fixed costs 8 (33) 27 Expected profits before taxes % (42) Profit after taxes 78 Capitalization rate 15% 78 Value of business = (b) Future maintainable profits (After Tax) 78 Less: Preference share dividends 100,000 shares of 11% (11) 67 Earning per share = ` 67,00,000 `40,00,000 = ` PE ratio 8 Market price per share `13.40 Question 12 Eagle Ltd. reported a profit of ` 77 lakhs after 30% tax for the financial year An analysis of the accounts revealed that the income included extraordinary items of ` 8 lakhs and an extraordinary loss of `10 lakhs. The existing operations, except for the extraordinary items, are expected to continue in the future. In addition, the results of the launch of a new product are expected to be as follows: ` In lakhs Sales 70 Material costs 20 Labour costs 12 Fixed costs 10 You are required to: (i) Calculate the value of the business, given that the capitalization rate is 14%. (ii) Determine the market price per equity share, with Eagle Ltd. s share capital being comprised of 1,00,000 13% preference shares of `100 each and 50,00,000 equity shares of `10 each and the P/E ratio being 10 times. (8 Marks) (November 2012)

9 13.9 Strategic Financial Management (i) Computation of Business Value (` Lakhs) Profit before tax Less: Extraordinary income (8) Add: Extraordinary losses Profit from new product (` Lakhs) Sales 70 Less: Material costs 20 Labour costs 12 Fixed costs 10 (42) Less: Future Maintainable Profit after taxes Relevant Capitalisation Factor 0.14 Value of Business (`98/0.14) 700 (ii) Determination of Market Price of Equity Share Future maintainable profits (After Tax) ` 98,00,000 Less: Preference share dividends 1,00,000 shares of ` 13% ` 13,00,000 Earnings available for Equity Shareholders ` 85,00,000 No. of Equity Shares 50,00,000 Earning per share = ` 85,00,000 50,00,000 = ` 1.70 PE ratio 10 Market price per share ` 17 Question 13 The equity shares of XYZ Ltd. are currently being traded at ` 24 per share in the market. XYZ Ltd. has total 10,00,000 equity shares outstanding in number; and promoters' equity holding in the company is 40%. PQR Ltd. wishes to acquire XYZ Ltd. because of likely synergies. The estimated present value of these synergies is ` 80,00,000.

10 Merger, Acquisition & Restructuring Further PQR feels that management of XYZ Ltd. has been over paid. With better motivation, lower salaries and fewer perks for the top management, will lead to savings of ` 4,00,000 p.a. Top management with their families are promoters of XYZ Ltd. Present value of these savings would add ` 30,00,000 in value to the acquisition. Following additional information is available regarding PQR Ltd.: Earnings per share : ` 4 Total number of equity shares outstanding : 15,00,000 Market price of equity share : ` 40 Required: (i) What is the maximum price per equity share which PQR Ltd. can offer to pay for XYZ Ltd.? (ii) What is the minimum price per equity share at which the management of XYZ Ltd. will be willing to offer their controlling interest? (4 + 2 = 6 Marks) (May 2014) (a) Calculation of maximum price per share at which PQR Ltd. can offer to pay for XYZ Ltd. s share Market Value (10,00,000 x ` 24) ` 2,40,00,000 Synergy Gain ` 80,00,000 Saving of Overpayment ` 30,00,000 ` 3,50,00,000 Maximum Price (` 3,50,00,000/10,00,000) ` 35 (b) Calculation of minimum price per share at which the management of XYZ Ltd. s will be willing to offer their controlling interest Value of XYZ Ltd. s Management Holding ` 96,00,000 (40% of 10,00,000 x ` 24) Add: PV of loss of remuneration to top management ` 30,00,000 ` 1,26,00,000 No. of Shares 4,00,000 Minimum Price (` 1,26,00,000/4,00,000) ` Question 14 Following information is given in respect of WXY Ltd., which is expected to grow at a rate of 20% p.a. for the next three years, after which the growth rate will stabilize at 8% p.a. normal level, in perpetuity.

11 13.11 Strategic Financial Management Revenues Cost of Goods Sold (COGS) Operating Expenses Capital Expenditure Depreciation (included in COGS & Operating Expenses) For the year ended March 31, 2014 ` 7,500 Crores ` 3,000 Crores ` 2,250 Crores ` 750 Crores ` 600 Crores During high growth period, revenues & Earnings before Interest & Tax (EBIT) will grow at 20% p.a. and capital expenditure net of depreciation will grow at 15% p.a. From year 4 onwards, i.e. normal growth period revenues and EBIT will grow at 8% p.a. and incremental capital expenditure will be offset by the depreciation. During both high growth & normal growth period, net working capital requirement will be 25% of revenues. The Weighted Average Cost of Capital (WACC) of WXY Ltd. is 15%. Corporate Income Tax rate will be 30%. Required: Estimate the value of WXY Ltd. using Free Cash Flows to Firm (FCFF) & WACC methodology. The 15 % for the three years are as below: Year t 1 t 2 t 3 PVIF (8 Marks) (May 2014) Determination of forecasted Free Cash Flow of the Firm (FCFF) (` in crores) Yr. 1 Yr. 2 Yr 3 Terminal Year Revenue COGS Operating Expenses Depreciation EBIT EAT Capital Exp. Dep Working Capital Free Cash Flow (FCF)

12 Merger, Acquisition & Restructuring Present Value (PV) of FCFF during the explicit forecast period is: FCFF (` in crores) 15% PV (` in crores) PV of the terminal, value is: x (1.15) 3 = ` Crore x = ` Crore The value of the firm is : ` Crores + ` Crores = ` 28, Crores Question 15 ABC Co. is considering a new sales strategy that will be valid for the next 4 years. They want to know the value of the new strategy. Following information relating to the year which has just ended, is available: Income Statement ` Sales 20,000 Gross margin (20%) 4,000 Administration, Selling & distribution expense (10%) 2,000 PBT 2,000 Tax (30%) 600 PAT 1,400 Balance Sheet Information Fixed Assets 8,000 Current Assets 4,000 Equity 12,000 If it adopts the new strategy, sales will grow at the rate of 20% per year for three years. The gross margin ratio, Assets turnover ratio, the Capital structure and the income tax rate will remain unchanged. Depreciation would be at 10% of net fixed assets at the beginning of the year. The Company s target rate of return is 15%. Determine the incremental value due to adoption of the strategy. (8 Marks) (May 2007)

13 13.13 Strategic Financial Management Projected Balance Sheet Year 1 Year 2 Year 3 Year 4 Fixed Assets (40%) of Sales 9,600 11,520 13,824 13,824 Current Assets (20%) of Sales 4,800 5,760 6,912 6,912 Total Assets 14,400 17,280 20,736 20,736 Equity 14,400 17,280 20,736 20,736 Projected Cash Flows:- Year 1 Year 2 Year 3 Year 4 Sales 24,000 28,800 34,560 34,560 PBT (10%) of sale 2,400 2,880 3,456 3,456 PAT (70%) 1,680 2,016 2, , Depreciation ,152 1,382 Addition to Fixed Assets 2,400 2,880 3,456 1,382 Increase in Current Assets ,152 - Operating cash flow (720) (864) (1,036.80) 2, Projected Cash Flows:- Present value of Projected Cash Flows:- Cash Flows PV at 15% PV , , Residual Value /0.15 = 16,128 Present value of Residual value = 16128/(1.15) 3 = 16128/1.521 = Total shareholders value = 10, , = 8, Pre strategy value = 1,400 / 0.15 = 9, Value of strategy = 8, , = Conclusion: The strategy is not financially viable

14 Merger, Acquisition & Restructuring Question 16 Helium Ltd has evolved a new sales strategy for the next 4 years. The following information is given: Income Statement ` in thousands Sales 40,000 Gross Margin at 30% 12,000 Accounting, administration and distribution expense at 15% 6,000 Profit before tax 6,000 Tax at 30% 1,800 Profit after tax 4,200 Balance sheet information Fixed Assets 10,000 Current Assets 6,000 Equity 15,000 As per the new strategy, sales will grow at 30 percent per year for the next four years. The gross margin ratio will increase to 35 percent. The Assets turnover ratio and income tax rate will remain unchanged. Depreciation is to be at 15 percent on the value of the net fixed assets at the beginning of the year. Company's target rate of return is 14%. Determine if the strategy is financially viable giving detailed workings. (10 Marks) (November 2011) s (a) Solution if candidates have assumed that if the Equity amount is instead of

15 13.15 Strategic Financial Management Projected Balance Sheet (In ` Thousands) Year Fixed Assets (25% of sales) Current Assets (12.5% of sales) Total Assets Equity and Reserves Projected Cash Flows (In ` Thousands) Sales (30% yoy) PBT 15% PAT 70% Depreciation 15% Addition to Fixed Assets Increase in Current Assets Operating Cash Flow Present value 14% Present value of cash 14% (In ` Thousands) Total for first 4 years (A) Residual value ( /0.14) Present value of Residual value [85683/(1.14) 4 ] (B) Total Shareholders value (C) = (A) +(B) Pre strategy value (4200/0.14) (D) Value of strategy (C) (D) Conclusion: The strategy is financially viable.

16 Merger, Acquisition & Restructuring Alternative Solution If candidates have assumed that if the Equity amount is instead of Projected Balance Sheet (In ` Thousands) Year Fixed Assets (25% of sales) Current Assets (15% of sales) Total Assets Current Liability Equity and Reserves (In ` Thousands) Sales (30% yoy) PBT 15% PAT 70% Depreciation 15% Addition to Fixed Assets Increase in Current Assets Operating Cash Flow Present value 14% Present value of cash (In ` Thousands) Total for first 4 years (A) Residual value ( /0.14) Present value of Residual value [ /(1.14) 4 ] (B) Total Shareholders value (C) = (A) +(B) Pre strategy value (4200/0.14) (D) Value of strategy (C) (D) Conclusion: The strategy is financially not viable.

17 13.17 Strategic Financial Management Question 17 Cauliflower Limited is contemplating acquisition of Cabbage Limited. Cauliflower Limited has 5 lakh shares having market value of ` 40 per share while Cabbage Limited has 3 lakh shares having market value of ` 25 per share. The EPS for Cabbage Limited and Cauliflower Limited are ` 3 per share and ` 5 per share respectively. The managements of both the companies are discussing two alternatives for exchange of shares as follows: (i) In proportion to relative earnings per share of the two companies. (ii) 1 share of Cauliflower Limited for two shares of Cabbage Limited. Required: (i) Calculate the EPS after merger under both the alternatives. (ii) Show the impact on EPS for the shareholders of the two companies under both the alternatives. (10 Marks)(November 2014) (i) Exchange ratio in proportion to relative EPS (in `) Company Existing No. of shares EPS Total earnings Cauliflower Ltd. 5,00, ,00,000 Cabbage Ltd. 3,00, ,00,000 Total earnings 34,00,000 No. of shares after merger 5,00, ,80,000 = 6,80, Note: 1,80,000 may be calculated as = 3,00, ,00,000 EPS for Cauliflower Ltd. after merger = = ` ,80,000 Impact on EPS Cauliflower Ltd. shareholders ` EPS before merger 5.00 EPS after merger 5.00 Increase/ Decrease in EPS 0.00 Cabbage Ltd.' Shareholders EPS before merger 3.00

18 Merger, Acquisition & Restructuring EPS after the merger 5.00 x 3/ Increase/ Decrease in EPS 0.00 (ii) Merger effect on EPS with share exchange ratio of 1 : 2 Total earnings after merger ` 34,00,000 No. of shares post merger 5,00, ,50,000 (0.5 3,00,000) 6,50,000 EPS 34,00,000 6,50, Impact on EPS Cauliflower Ltd. shareholders ` EPS before merger 5.00 EPS after merger 5.23 Increase in EPS 0.23 Cabbage Ltd. shareholders ` EPS before merger EPS after the merger 5.23 x Decrease in EPS Question 18 MK Ltd. is considering acquiring NN Ltd. The following information is available: Company Earning after tax(`) No. of Equity Shares Market Value Per Share(`) MK Ltd. 60,00,000 12,00, NN Ltd. 18,00,000 3,00, Exchange of equity shares for acquisition is based on current market value as above. There is no synergy advantage available. (i) Find the earning per share for company MK Ltd. after merger, and (ii) Find the exchange ratio so that shareholders of NN Ltd. would not be at a loss. (8 Marks) (November 2010) (S) (i) Earning per share of company MK Ltd after merger:- Exchange ratio 160 : 200 = 4 : 5. that is 4 shares of MK Ltd. for every 5 shares of NN Ltd.

19 13.19 Strategic Financial Management Total number of shares to be issued = 4/5 3,00,000 = 2,40,000 Shares. Total number of shares of MK Ltd. and NN Ltd.=12,00,000 (MK Ltd.)+2,40,000 (NN Ltd.) = 14,40,000 Shares Total profit after tax = ` 60,00,000 MK Ltd. = ` 18,00,000 NN Ltd. = ` 78,00,000 EPS. (Earning Per Share) of MK Ltd. after merger ` 78,00,000/14,40,000 = ` 5.42 per share (ii) To find the exchange ratio so that shareholders of NN Ltd. would not be at a Loss: Present earning per share for company MK Ltd. = ` 60,00,000/12,00,000 = ` 5.00 Present earning per share for company NN Ltd. = ` 18,00,000/3,00,000 = ` 6.00 Exchange ratio should be 6 shares of MK Ltd. for every 5 shares of NN Ltd. Shares to be issued to NN Ltd. = 3,00,000 6/5 = 3,60,000 shares Now, total No. of shares of MK Ltd. and NN Ltd. =12,00,000 (MK Ltd.)+3,60,000 (NN Ltd.) = 15,60,000 shares EPS after merger = ` 78,00,000/15,60,000 = ` 5.00 per share Total earnings available to shareholders of NN Ltd. after merger = 3,60,000 shares ` 5.00 = ` 18,00,000. This is equal to earnings prior merger for NN Ltd. Exchange ratio on the basis of earnings per share is recommended. Question 19 A Ltd. wants to acquire T Ltd. and has offered a swap ratio of 1:2 (0.5 shares for every one share of T Ltd.). Following information is provided: A Ltd. T. Ltd. Profit after tax `18,00,000 `3,60,000 Equity shares outstanding (Nos.) 6,00,000 1,80,000 EPS `3 `2 PE Ratio 10 times 7 times Market price per share `30 `14

20 Merger, Acquisition & Restructuring Required: (i) The number of equity shares to be issued by A Ltd. for acquisition of T Ltd. (ii) What is the EPS of A Ltd. after the acquisition? (iii) Determine the equivalent earnings per share of T Ltd. (iv) What is the expected market price per share of A Ltd. after the acquisition, assuming its PE multiple remains unchanged? (v) Determine the market value of the merged firm. (10 Marks) (November 2007) (i) (ii) (iii) (iv) (v) The number of shares to be issued by A Ltd.: The Exchange ratio is 0.5 So, new Shares = 1,80,000 x 0.5 = 90,000 shares. EPS of A Ltd. After a acquisition: Total Earnings (` 18,00,000 + ` 3,60,000) `21,60,000 No. of Shares (6,00, ,000) 6,90,000 EPS (` 21,60,000)/6,90,000) `3.13 Equivalent EPS of T Ltd.: No. of new Shares 0.5 EPS `3.13 Equivalent EPS (` 3.13 x 0.5) `1.57 New Market Price of A Ltd. (P/E remaining unchanged): Present P/E Ratio of A Ltd. 10 times Expected EPS after merger `3.13 Expected Market Price (`3.13 x 10) `31.30 Market Value of merged firm: Total number of Shares 6,90,000 Expected Market Price `31.30 Total value (6,90,000 x 31.30) `2,15,97,000 Question 20 ABC Ltd. is intending to acquire XYZ Ltd. by merger and the following information is available in respect of the companies: ABC Ltd. XYZ Ltd. Number of equity shares 10,00,000 6,00,000

21 13.21 Strategic Financial Management Earnings after tax (`) 50,00,000 18,00,000 Market value per share (`) Required: (i) What is the present EPS of both the companies? (ii) If the proposed merger takes place, what would be the new earning per share for ABC Ltd.? Assume that the merger takes place by exchange of equity shares and the exchange ratio is based on the current market price. (iii) What should be exchange ratio, if XYZ Ltd. wants to ensure the earnings to members are as before the merger takes place? (8 Marks) (May 2004) (i) (ii) Earnings per share = Earnings after tax /No. of equity shares ABC Ltd. = ` 50,00,000/10,00,000 = ` 5 XYZ Ltd. = ` 18,00,000 / 6,00,000 = ` 3 Number of Shares XYZ limited s shareholders will get in ABC Ltd. based on market value per share = ` 28/ 42 6,00,000 = 4,00,000 shares Total number of equity shares of ABC Ltd. after merger = 10,00, ,00,000 = 14,00,000 shares Earnings per share after merger = ` 50,00, ,00,000/14,00,000 = ` 4.86 (iii) Calculation of exchange ratio to ensure shareholders of XYZ Ltd. to earn the same as was before merger: Shares to be exchanged based on EPS = (` 3/` 5) 6,00,000 = 3,60,000 shares EPS after merger = (` 50,00, ,00,000)/13,60,000 = ` 5 Total earnings in ABC Ltd. available to shareholders of XYZ Ltd. = 3,60,000 ` 5 = ` 18,00,000. Thus, to ensure that Earning to members are same as before, the ratio of exchange should be 0.6 share for 1 share. Question 21 XYZ Ltd. is considering merger with ABC Ltd. XYZ Ltd. s shares are currently traded at ` 25. it has 2,00,000 shares outstanding and its earning after taxes (EAT) amount to ` 4,00,000. ABC Ltd. has 1,00,000 shares outstanding; its current market price is ` and its EAT is ` 1,00,000. The merger will be effected by means of a stock swap (exchange). ABC Ltd. has agreed to a plan under which XYZ Ltd. will offer the current market value of ABC Ltd. s shares.

22 Merger, Acquisition & Restructuring (i) (ii) What is the pre-merger earnings per share (EPS) and P/E ratios of both the companies? If ABC Ltd. s P/E ratio is 8, what is its current market price? What is the exchange ratio? What will XYZ Ltd. s post merger EPS be? (iii) What must the exchange ratio be for XYZ Ltd. s pre-merger and post-merger EPS to be the same? (8 Marks) (May 2005) Merger and EPS Company XYZ ABC Market price of equity shares No. of equity shares outstanding 2,00,000 1,00,000 Earning after tax 4,00,000 1,00,000 (i) EPS = ` 4,00,000, 2,00,000 shares ` 1,00,000 = 1,00,000 shares Rs. Rs P/E ratio = ` 25/2, 12.50/ (ii) (a) If ABC Ltd. P/E ratio is 8, its current market price will be ` 8 only (8 1). (b) Then the exchange ratio will be 8/25 i.e. 32/100. For every 100 shares of ABC, 32 shares of XYZ will be issued (1,00,000 32)/100 = 32,000 shares of XYZ will be issued to all the shareholders of ABC Ltd. (c) Post merger EPS of XYZ Ltd. = Total earning/total shares = 5,00,000/2,32,000 equity shares = ` (iii) Total earnings ` 5,00,000/EPS ` 2 = 2,50,000 equity shares i.e. 50,000 shares of XYZ will have to be issued to the shareholders of ABC i.e. one share of XYZ will be issued for every two shares held by ABC shareholders. Then pre-merger and post-merger EPS of XYZ will be same as follows: Pre-merger EPS of XYZ ` 2.00 Post-merger EPS of XYZ ` 5,00,000/2,50,000 equity shares = ` 2.00 Question 22 LMN Ltd is considering merger with XYZ Ltd. LMN Ltd's shares are currently traded at ` per share. It has 3,00,000 shares outstanding. Its earnings after taxes (EAT) amount to ` 6,00,000. XYZ Ltd has 1,60,000 shares outstanding and its current market price is ` per share and its earnings after taxes (EAT) amount to ` 1,60,000. The merger is

23 13.23 Strategic Financial Management decided to be effected by means of a stock swap (exchange). XYZ Ltd has agreed to a proposal by which LMN Ltd will offer the current market value of XYZ Ltd's shares. Find out: (i) (ii) The pre-merger earnings per share (EPS) and price/earnings (P/E) ratios of both the companies. If XYZ Ltd's P/E Ratio is 9.6, what is its current Market Price? What is the Exchange Ratio? What will LMN Ltd's post-merger EPS be? (iii) What should be the exchange ratio, if LMN Ltd's pre-merger and post- merger EPS are to be the same? (8 Marks) (May 2012) (i) Pre-merger EPS and P/E ratios of LMN Ltd. and XYZ Ltd. Particulars LMN Ltd. XYZ Ltd. Earnings after taxes 6,00,000 1,60,000 Number of shares outstanding 3,00,000 1,60,000 EPS 2 1 Market Price per share P/E Ratio (times) (ii) Current Market Price of XYZ Ltd. if P/E ratio is 9.6 = ` = ` Exchange ratio = 9.60 = Post merger EPS of LMN Ltd. 6,00, ,60,000 = 3,00,000 + (1,60,000/3.125) = 7,60,000 3,51,200 = 2.16 (iii) Desired Exchange Ratio Total number of shares in post-merged company Post - merger earnings = Pr e - merger EPS of LMN Ltd. = 7,60,000 = 3,80,000 2 Number of shares required to be issued to XYZ Ltd. = 3,80,000 3,00,000 = 80,000 Therefore, the exchange ratio should be 80,000 : 1,60,000

24 Merger, Acquisition & Restructuring = 80,000 1,60,000 = 0.50 Question 23 K. Ltd. is considering acquiring N. Ltd., the following information is available : Company Profit after Tax Number of Equity shares Market value per share K. Ltd. 50,00,000 10,00, N. Ltd. 15,00,000 2,50, Exchange of equity shares for acquisition is based on current market value as above. There is no synergy advantage available : Find the earning per share for company K. Ltd. after merger. Find the exchange ratio so that shareholders of N. Ltd. would not be at a loss. (12 Marks) (November 2008) (S) (i) Earning per share for company K. Ltd. after Merger: Exchange Ratio 160 : 200 = 4: 5 That is 4 shares of K. Ltd. for every 5 shares of N. Ltd. Total number of shares to be issued = 5 4 2,50,000 = 2,00,000 shares (ii) Total number of shares of K. Ltd. and N.Ltd. = 10,00,000 K. Ltd. + 2,00,000 N. Ltd 12,00,000 Total profit after Tax = ` 50,00,000 K. Ltd. E.P.S. (Earning per share) of K. Ltd. after Merger = ` 65,00,000 12,00,000 = ` 5.42 Per Share ` 15,00,000 N Ltd. ` 65,00,000 To find the Exchange Ratio so that shareholders of N. Ltd. would not be at a Loss: Present Earnings per share for company K. Ltd. ` 50,00,000 = ` ` 10,00,000

25 13.25 Strategic Financial Management Present Earnings Per share for company N. Ltd. ` 15,00,000 = ` ` 2,50,000 Exchange Ratio should be 6 shares of K. Ltd. for every 5 shares of N Ltd. Shares to be issued to N. Ltd. 2,50,000 6 = = 3,00,000 Shares 5 Total No. of Shares of K.Ltd. and N. Ltd. = 10,00,000 K. Ltd. + 3,00,000 N. Ltd 13,00,000 E.P.S. After Merger 65,00,000 13,00,000 = ` 5.00 Per Share Total Earnings Available to Shareholders of N. Ltd. after Merger = ` 3,00,000 ` 5.00 = ` 15,00,000 This is equal to Earnings prior Merger for N. Ltd. Exchange Ratio on the Basis of Earnings per Share is recommended. Question 24 M Co. Ltd., is studying the possible acquisition of N Co. Ltd., by way of merger. The following data are available in respect of the companies: Particulars M Co. Ltd. N Co. Ltd. Earnings after tax (`) 80,00,000 24,00,000 No. of equity shares 16,00,000 4,00,000 Market value per share (`) (i) (ii) If the merger goes through by exchange of equity and the exchange ratio is based on the current market price, what is the new earning per share for M Co. Ltd.? N Co. Ltd. wants to be sure that the earnings available to its shareholders will not be diminished by the merger. What should be the exchange ratio in that case? (8 Marks) (November 2003) (i) Calculation of new EPS of M Co. Ltd. No. of equity shares to be issued by M Co. Ltd. to N Co. Ltd. = 4,00,000 shares ` 160/` 200 = 3,20,000 shares

26 Merger, Acquisition & Restructuring Total no. of shares in M Co. Ltd. after acquisition of N Co. Ltd. = 16,00, ,20,000 = 19,20,000 Total earnings after tax [after acquisition] = 80,00, ,00,000 = 1,04,00,000 ` 1,04,00,000 EPS = = ` ,20,000 equity shares (ii) Calculation of exchange ratio which would not diminish the EPS of N Co. Ltd. after its merger with M Co. Ltd. Current EPS: ` 80,00,000 M Co. Ltd. = = ` 5 16,00,000 equity shares ` 24,00,000 N Co. Ltd. = = ` 6 4,00,000 equity shares Exchange ratio = 6/5 = 1.20 No. of new shares to be issued by M Co. Ltd. to N Co. Ltd. = 4,00, = 4,80,000 shares Total number of shares of M Co. Ltd. after acquisition = 16,00, ,80,000 = 20,80,000 shares ` 1,04,00,000 EPS [after merger] = = ` 5 20,80,000 shares Total earnings in M Co. Ltd. available to new shareholders of N Co. Ltd. = 4,80,000 ` 5 = ` 24,00,000 Recommendation: The exchange ratio (6 for 5) based on market shares is beneficial to shareholders of 'N' Co. Ltd. Question 25 The following information is provided related to the acquiring Firm Mark Limited and the target Firm Mask Limited: Firm Mark Limited Firm Mask Limited Earning after tax (`) 2,000 lakhs 400 lakhs Number of shares outstanding 200 lakhs 100 lakhs P/E ratio (times) 10 5

27 13.27 Strategic Financial Management Required: (i) What is the Swap Ratio based on current market prices? (ii) What is the EPS of Mark Limited after acquisition? (iii) What is the expected market price per share of Mark Limited after acquisition, assuming P/E ratio of Mark Limited remains unchanged? (iv) Determine the market value of the merged firm. (v) Calculate gain/loss for shareholders of the two independent companies after acquisition. (8 Marks) (November 2004) (i) Particulars Mark Ltd. Mask Ltd. EPS ` 2,000 Lakhs/ 200 lakhs ` 400 lakhs / 100 lakhs = ` 10 ` 4 Market Price ` = ` 100 ` 4 5 = ` 20 The Swap ratio based on current market price is ` 20 / ` 100 = 0.2 or 1 share of Mark Ltd. for 5 shares of Mask Ltd. No. of shares to be issued = 100 lakh 0.2 = 20 lakhs. (ii) EPS after merger = ` 2,000 lakhs ` 400 lakhs 200 lakhs 20 lakhs = ` (iii) Expected market price after merger assuming P / E 10 times. = ` = ` (iv) Market value of merged firm = ` market price 220 lakhs shares = crores (v) Gain from the merger Post merger market value of the merged firm Less: Pre-merger market value Mark Ltd. 200 Lakhs ` 100 = 200 crores Mask Ltd. 100 Lakhs ` 20 = 20 crores Gain from merger ` crores ` crores ` crores

28 Merger, Acquisition & Restructuring Appropriation of gains from the merger among shareholders: Question 26 Mark Ltd. Mask Ltd. Post merger value crores crores Less: Pre-merger market value crores crores Gain to Shareholders crores 1.82 crores Simple Ltd. and Dimple Ltd. are planning to merge. The total value of the companies are dependent on the fluctuating business conditions. The following information is given for the total value (debt + equity) structure of each of the two companies. Business Condition Probability Simple Ltd. ` Lacs Dimple Ltd. ` Lacs High Growth Medium Growth Slow Growth The current debt of Dimple Ltd. is ` 65 lacs and of Simple Ltd. is ` 460 lacs. Calculate the expected value of debt and equity separately for the merged entity. (8 Marks) (May 2011) Compute Value of Equity Simple Ltd. ` in Lacs High Growth Medium Growth Slow Growth Debit + Equity Less: Debt Equity Since the Company has limited liability the value of equity cannot be negative therefore the value of equity under slow growth will be taken as zero because of insolvency risk and the value of debt is taken at 410 lacs. The expected value of debt and equity can then be calculated as: Simple Ltd. ` in Lacs High Growth Medium Growth Slow Growth Expected Value Prob. Value Prob. Value Prob. Value Debt

29 13.29 Strategic Financial Management Equity Dimple Ltd. ` in Lacs High Growth Medium Growth Slow Growth Expected Value Prob. Value Prob. Value Prob. Value Equity Debt Expected Values ` in Lacs Equity Debt Simple Ltd. 126 Simple Ltd. 450 Dimple Ltd. 758 Dimple Ltd. 65 Question Longitude Limited is in the process of acquiring Latitude Limited on a share exchange basis. Following relevant data are available: Longitude Limited Latitude Limited Profit after Tax (PAT) ` in Lakhs Number of Shares Lakhs Earning per Share (EPS) ` 8 5 Price Earnings Ratio (P/E Ratio) (Ignore Synergy) You are required to determine: (i) (ii) Pre-merger Market Value per Share, and The maximum exchange ratio Longitude Limited can offer without the dilution of (1) EPS and (2) Market Value per Share

30 Merger, Acquisition & Restructuring Calculate Ratio/s up to four decimal points and amounts and number of shares up to two decimal points. (8 Marks) (May 2013) (i) Pre Merger Market Value of Per Share P/E Ratio X EPS Longitude Ltd. ` 8 X 15 = ` Latitude Ltd. ` 5 X 10 = ` (ii) (1) Maximum exchange ratio without dilution of EPS Pre Merger PAT of Longitude Ltd. ` 140 Lakhs Pre Merger PAT of Latitude Ltd. ` 60 Lakhs Combined PAT ` 200 Lakhs Longitude Ltd. s EPS ` 8 Maximum number of shares of Longitude after merger (` 25 Lakhs 200 lakhs/` 8) Existing number of shares 15 Lakhs Maximum number of shares to be exchanged 10 Lakhs Maximum share exchange ratio 10:16 or 5:8 (2) Maximum exchange ratio without dilution of Market Price Per Share Pre Merger Market Capitalization of Longitude Ltd. ` 1800 Lakhs (` Lakhs) Pre Merger Market Capitalization of Latitude Ltd. ` 800 Lakhs (` Lakhs) Combined Market Capitalization ` 2600 Lakhs Current Market Price of share of Longitude Ltd. ` 120 Maximum number of shares to be exchanged of Longitude Lakhs (surviving company )(` 2600 Lakhs/` 120) Current Number of Shares of Longitude Ltd Lakhs Maximum number of shares to be exchanged (Lakhs) 6.67 Lakhs Maximum share exchange ratio 6.67:16 or :1 Note: Since in the question figures given of PAT of both companies are not matching with figures of EPS X Number of Shares. Hence, if students computed PAT by using this formula then alternative answer shall be as follows: (1) Maximum exchange ratio without dilution of EPS

31 13.31 Strategic Financial Management Pre Merger PAT of Longitude Ltd. Pre Merger PAT of Latitude Ltd. Combined PAT ` 120 Lakhs ` 80 Lakhs ` 200 Lakhs Longitude Ltd. s EPS ` 8 Maximum number of shares of Longitude after merger (` 200 lakhs/` 8) Existing number of shares Maximum number of shares to be exchanged Maximum share exchange ratio 10:16 or 5:8 (2) Maximum exchange ratio without dilution of Market Price Per Share Pre Merger Market Capitalization of Longitude Ltd. (` Lakhs) Pre Merger Market Capitalization of Latitude Ltd. (` Lakhs) Combined Market Capitalization 25 Lakhs 15 Lakhs 10 Lakhs ` 1800 Lakhs ` 800 Lakhs ` 2600 Lakhs Current Market Price of share of Longitude Ltd. ` 120 Maximum number of shares to be exchanged (surviving company )(` 2600 Lakhs/` 120) Current Number of Shares of Longitude Ltd. Maximum number of shares to be exchanged (Lakhs) Maximum share exchange ratio 6.67:16 or :1 of Longitude Lakhs Lakhs 6.67 Lakhs Question 28 Following information is provided relating to the acquiring company Mani Ltd. and the target company Ratnam Ltd: Mani Ltd. Ratnam Ltd. Earnings after tax (` lakhs) 2,000 4,000 No. of shares outstanding (lakhs) 200 1,000 P/E ratio ( No. of times) 10 5 Required: (i) What is the swap ratio based on current market prices? (ii) What is the EPS of Mani Ltd. after the acquisition? (iii) What is the expected market price per share of Mani Ltd. after the acquisition, assuming its P/E ratio is adversely affected by 10%?

32 Merger, Acquisition & Restructuring (iv) Determine the market value of the merged Co. (v) Calculate gain/loss for the shareholders of the two independent entities, due to the merger. (10 Marks) (June 2009) (M) (i) SWAP ratio based on current market prices: EPS before acquisition: Mani Ltd. : `2,000 lakhs / 200 lakhs: ` 10 Ratnam Ltd.: `4,000 lakhs / 1,000 lakhs: ` 4 Market price before acquisition: Mani Ltd.: `10 10 ` 100 Ratnam Ltd.: `4 5 ` 20 SWAP ratio: 20/100 or 1/5 i.e (ii) EPS after acquisition: ` (2,000 4,000) Lakhs ( ) Lakhs = `15.00 (iii) Market Price after acquisition: EPS after acquisition : `15.00 P/E ratio after acquisition Market price of share (` 15 X 9) ` (iv) Market value of the merged Co.: ` lakhs shares ` Crores or ` 54,000 Lakhs (v) Gain/loss per share: ` Crore Mani Ltd. Ratnam Ltd. Total value before Acquisition Value after acquisition Gain (Total) No. of shares (pre-merger) (lakhs) 200 1,000 Gain per share (`) 35 7 Question 29 P Ltd. is considering take-over of R Ltd. by the exchange of four new shares in P Ltd. for every five shares in R Ltd. The relevant financial details of the two companies prior to merger

33 13.33 Strategic Financial Management announcement are as follows: P Ltd R Ltd Profit before Tax (` Crore) No. of Shares (Crore) P/E Ratio 12 9 Corporate Tax Rate 30% You are required to determine: (i) Market value of both the company. (ii) Value of original shareholders. (iii) Price per share after merger. (iv) Effect on share price of both the company if the Directors of P Ltd. expect their own premerger P/E ratio to be applied to the combined earnings. (10 Marks) (November 2010) (M) P Ltd. R Ltd. Profit before Tax (` in crore) Tax 30% (` in crore) Profit after Tax (` in crore) Earning per Share (` ) = ` = ` 0.63 Price of Share before Merger (EPS x P/E Ratio) ` 0.42 x 12 = ` x ` 9 = ` 5.67 (i) Market Value of company P Ltd. = ` 5.04 x 25 Crore = ` 126 crore R Ltd. = ` 5.67 x 15 Crore = ` crore Combined = ` ` = ` Crores After Merger No. of Shares 25 crores P Ltd. 15x 5 4 = 12 crores R Ltd.

34 Merger, Acquisition & Restructuring Combined 37 crores % of Combined Equity Owned 25 x % 37 (ii) Value of Original Shareholders P Ltd. R Ltd. ` crore x 67.57% ` crore x 32.43% = ` = ` (iii) Price per Share after Merger EPS = `19.95crore 37crore = ` per share P/E Ratio = 12 Market Value Per Share = ` X 12 = ` 6.47 Total Market Value = ` 6.47 x 37 crore = ` crore Price of Share = MarketValue Number of Shares = crore = ` crore (iv) Effect on Share Price P Ltd. Gain/loss (-) per share = ` 6.47 ` 5.04 = ` i.e. 100 = or 28.4% 5.04 Share price would rise by 28.4% R Ltd. 12 x100 = 32.43% x 5 4 = ` 5.18 Gain/loss (-) per share = ` 5.18 ` 5.67 = (-` 0.49) i.e (-) or (-) 8.64% Share Price would decrease by 8.64%. Question 30 XY Ltd. which is specialized in manufacturing garments is planning for expansion to handle a new contract which it expects to obtain. An investment bank have approached the company and asked whether the Co. had considered venture Capital financing. In 2001, the company

35 13.35 Strategic Financial Management borrowed `100 lacs on which interest is paid at 10% p.a. The Company shares are unquoted and it has decided to take your advice in regard to the calculation of value of the Company that could be used in negotiations using the following available information and forecast. Company s forecast turnover for the year to 31 st March, 2005 is `2,000 lacs which is mainly dependent on the ability of the Company to obtain the new contract, the chance for which is 60%, turnover for the following year is dependent to some extent on the outcome of the year to 31 st March, Following are the estimated turnovers and probabilities: Year Year Turnover Prob. Turnover Prob. ` (in lacs) `(in lacs) 2, , , , , , , , , Operating costs inclusive of depreciation are expected to be 40% and 35% of turnover respectively for the years 31 st March, 2005 and Tax is to be paid at 30%. It is assumed that profits after interest and taxes are free cash flows. Growth in earnings is expected to be 405 for the years 2007, 2008 and 2009 which will fall to 105 each year after that. Industry average cost of equity (net of tax) is 15%. (10 Marks) (November 2007) Estimation of earnings for the years ended 31 st March, 2005 & 2006 (` In lacs) Prob. Turnover Expected Turnover Prob. Turnover Expected Turnover х x х х х х Operating Costs (40%) (708) (35%) (804)