STRATEGIC FINANCIAL MANAGEMENT WEEK 10 QUESTIONS TOPIC: BUSINESS VALUATION,MERGER AND ACQUISITION Kindly go through chapter 7 in the video lecture before you attempt the questions because the topic have been simplified and analyzed for easy understanding. AREAS COVERED Valuation of business Free cash flow model Economic value Added Other modern valuation techniques Merger and Acquisition REVIEW QUESTION QUESTION ONE The summary statement of financial position of Synergy Champions is as follows. Non-current assets N N N Land and buildings 160,000 STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 1
Plant and machinery 80,000 Motor vehicles 20,000 260,000 Goodwill 20,000 Current assets Inventory 80,000 Receivables 60,000 Short-term investments 15,000 Cash 5,000 160,000 Current liabilities Payables 60,000 Taxation 40,000 (100,000) 60,000 340,000 Non-Current Liability 12% bonds (60,000) Deferred taxation (10,000) 270,000 Represented by: Ordinary shares of N1 80,000 Reserves 140,000 220,000 4.9% preference shares of N1 50,000 270,000 What is the value of an ordinary share using the net assets basis of valuation? (b) assuming the company decides to value the business based on break up and replacement, calculate the value of the company using the information given below Realizable value Replacement cost Land and buildings 180,000 200,000 Plant and machinery 70,000 65,000 Motor vehicles 60,000 ----- Inventory 80,000 75,000 Payables 55,000 ----- STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 2
The 4% of the account receivable will be uncollectible QUESTION 2 The Directors of Actuarial Plc., a conglomerate, is targeting Minororia Plc., an engineering machinery manufacturer, for possible acquisition of its entire share capital. They believe that the takeover will not affect their business risks. The statement of financial position of Minororia Plc. as at 31st December, 2014 is expected to be as follows: Minororia Plc. Projected Statement of Financial Position as at 31st December, 2014. N 000 N 000 Non-current asset (net of depreciation) 651,600 Current assets: Inventory and W.I.P. 515,900 Receivables 745,000 Bank balance 158,100 1,419,000 Current liabilities: Payables 753,600 Representing: Capital and Reserves: 2,070,600 Bank overdraft 862,900 1,616,500 454,100 Issued ordinary shares of N1 each 50,000 Distributable Reserves 404,100 Five years financial summary Year ended 31st December 454,100 2010 2011 2012 2013 2014 STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 3
N 000 N 000 N 000 N 000 N 000 Profit before extraordinary items 30,400 69,000 49,400 48,200 53,200 Extraordinary items 2,900 (2,200) (6,100) (9,800) (1,000) Profit after extraordinary items 33,300 66,800 43,300 38,400 52,200 Dividend (20,500) (22,600) (25,000) (25,000) (25,000) 12,800 44,200 18,300 13,400 27,200 Additional information: (i) (ii) There have been no changes in the issued share capital of Minororia Plc. during the past five years. The estimated values of Minororia Plc s. non-current assets, inventory and work-inprogress for the year ended 31st December 2014 will be as follows: Replacement Value Realisable Value N 000 N 000 Non-current assets 725,000 450,000 Inventory and W.I.P 550,000 570,000 (iii) It is expected that 2% of Minororia Plc s. receivables at 31 December, 2014 will become uncollectable. (iii) The Cost of Capital of Actuarial Plc. is 9% while that of Minororia is 12%. (iv) The shareholders of the company expect a minimum return of 12% per annum on their investment in the company. (v) The current P/E ratio of Actuarial Plc. is 12. Companies within the industry having similar profit levels with those of Minororia Plc. have P/E ratio of approximately 10, although these companies tend to be larger than Minororia plc. Minororia has also identified the yield of other similar companies, which are as follows: Dividend yield Earnings yield Company A 16% 10% Company B 12% 8% You are required to calculate the value of the total equity of Minororia Plc. using each of the following methods: STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 4
i. Statement of Financial Position (net asset basis) ii. Replacement Costs iii. Realisable Value iv. Gordon s Dividend Growth Model and V. P/E Ratio Model vi. Dividend growth valuation method vii. Dividend yield viii. Earnings yield QUESTION 3 A decision has to be taken to value Kabira-Kabiru Plc using the free cash flow to the firm. You have been able to project the following financial statement. Projected income statement: Year 1 Year2 Year3 N m N m N m Net sales 33,388 35,884 38.018 Cost of goods sold (27,614) (29,514) (30,994) Expenses (5,204) (5,434) (5,696) EBIT 570 936 1328 Interest (216) (204) (172) Earnings before Tax 354 732 1,156 Taxes (106) (220) (367) Net profit 248 512 789 Projected statement of financial Position Year 0 Year2 Year3 Year3 N m N m N m N m Cash 480 506 566 624 Trade receivables 4,464 4580 4740 4820 Inventory 6284 6068 6072 6200 Non current asset 10,848 11,024 11,574 11,868 STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 5
22076 22,178 22,940 23,512 Trade payables 7862 8108 8644 9230 Customers deposit for goods 2422 2386 2256 2100 Short term debt 1928 1662 1644 1130 Non current debt 2422 3930 3850 3780 Equity 5,872 6,092 6,546 7,262 22076 22,178 22,940 23,512 Required: Calculate the market value of the company assuming the free cash flow to the firm will grow by 2% QUESTION 4 KING Plc. and QUEEN Plc. both manufacture and sell household equipment. The summarised Income Statements of the two companies for the year 2012 are as follows: KING Plc. QUEEN Plc. N 000 N 000 Revenue 37,500 20,000 Operating expenses (20,000) (15,500) 17,500 4,500 Each company has earned a constant level of profit for a number of years and both are expected to continue to do so for the nearest future. The policy of both companies is to distribute all profits as dividend to ordinary shareholders as they are earned. None of the companies has any fixed interest capital. Details of the ordinary share capital of the companies are as follows: KING Plc. QUEEN Plc. N 000 N 000 Share Capital: Ordinary shares of N1 each Authorised 125,000 50,000 Issued 50,000 25,000 The ordinary shares of KING Plc. have a current market value of N3.50 each ex-div, and those of QUEEN Plc. a current market value of N1.50 each ex-div. The directors of KING Plc. are considering submitting a bid for the entire share capital of QUEEN Plc. They believe that if the bid succeeds, the combined sales revenue of the two companies will increase by N1,500,000 per annum and savings in operating expenses amounting to N1,250,000 per annum will be possible. Part of the machinery presently owned by KING Plc. would no longer be required and could be sold for N2,500,000. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 6
Furthermore, the directors of KING Plc. believe that the takeover would result in a reduction of the returns required by the Ordinary Shareholders to 10%. Required: a. As a financial consultant to KING Plc., advise on the maximum price that the company should be willing to pay for the entire share capital of QUEEN Plc. showing clearly the basis of your advice. b. Show how the entire benefit from the takeover will accrue to the present shareholders of KING Plc. assuming that the takeover price is agreed at half of the figure you advised, and that the purchase consideration will be settled by an exchange of ordinary shares in QUEEN Plc. c. Discuss briefly any other factors that the directors and shareholders of both companies might consider in assessing the acceptability of the proposed takeover. d. List any FIVE defence tactics that could be used by QUEEN Plc. to frustrate the takeover bid of KINGS Plc. QUESTION 5 Ayo is a holiday tour operator that is committed to a policy of expansion. The company has enjoyed record growth in recent years and is now seeking to acquire other companies in order to maintain its growth momentum. It has recently taken an interest in Lola, a charter airline business, as the board of directors of Ayo believes that there is a good strategic fit between the two companies have the same level of risk. Abbreviated financial statements relating to each company are set out below. Abbreviated profit and loss account for the year ended 30 November 2006 Ayo Lola Nm Nm Sales 182.6 75.2 Operating profit 43.6 21.4 Interest charges 12.3 10.2 Net profit before taxation 31.3 11.2 Company tax 6.3 1.6 Net profit after taxation 25.0 9.6 Dividends 6.0 4.0 Accumulated profits for the year 19.0 5.6 Summarized balance sheets as at 30 November 2006 Ayo Lola Nm Nm Non-current assets 135.4 127.2 Net current assets 65.2 3.2 200.6 130.4 Payables due after more than one year 120.5 104.8 80.1 25.6 N0.50 ordinary shares 20.0 8.0 Retained profit 60.1 17.6 80.1 25.6 Price/earnings ratio before the bid 20 15 STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 7
The Board of Directors of Ayo is considering making an offer to the shareholders of Lola of five shares in Ayo for every four shares held. It is believed that a rationalization of administrative functions arising from the merger would reap after tax benefits of N2.4m. Required (a) Calculate: (i) The total value of the proposed offer (ii) The earning per share of Ayo following the successful acquisition of Lola (iii) The share price of Ayo following acquisition, assuming that the benefits of the acquisition are achieved and that the price/earnings ratio declines by 5%. (b) Calculate the effect of the proposed takeover on the wealth of the shareholders of each company. Discuss your results in (a) and (b) above and state what recommendations, if any, you would make to the directors of Ayo. QUESTION 6 At the beginning of a financial year, ALLUH plc s balance sheet capital employed was 150 million (accounting measurements). During the year, the company s profits were as follows in the financial accounts: million million Profit before interest and tax 24.0 Interest 4.0 Taxation Tax on current year profits 6.0 20.0 Deferred tax 2.0 8.0 Profit after tax 12.0 Dividends 5.0 Retained profit for the year 7.0 The following additional information is available: STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 8
(1) For the first time, the company has invested in research and development. Expenditure during the year was 5 million and the full cost has been written off as an expense in the income statement. To measure EVA, it should be assumed that the amortisation charge for R&D for the year should be 1 million. (2) There was an increase in the allowance for doubtful debts from 1.5 million to 2 million. (3) Taxation is 30% of profits. (4) The company s weighted average cost of capital is 10%. Required (a) Calculate an estimate of economic value added for the year. Assume for the purpose of this Question that the capital charge is calculated using the yearend value of capital employed, before adding EVA for the year. (b) Calculate the economic value of the company s capital employed as at the beginning of the following financial year. STARRY GOLD ACADEMY +2348023428420, +2347038174484, info@starrygoldacademy.com, www.starrygoldacademy.com Page 9