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In this topic we will discuss about:
.Data Verification Sources .Notice .Essential Guidelines .Discussions and cases about Merger and business valuations

Data Verification Sources
1 = Theories and problems in financial management by M.Y khan and P.K Jain third edition 2 = Wikipedia the free encyclopedia (http://en.wikipedia.org/) 3 = www.investopedia.com 4 = Financial Management ACCA paper F9 by Kaplan 5 = CA module F Paper F 19 Business Finance Decisions

The term merger refers to the combination of two or more firms. The analysis of financial aspects of merger covers three aspects 1. Determining the firm¶s value 2. Financing techniques for merger 3. Merger as capital budgeting decision Let us discuss each of them one by one

1. Determining the firm s value
It is first step in merger it is difficult as different factors are considered in conjunction with each other and book value itself is not an effective measure itself as it is useful in specific situations. The importance of appraisal value depends upon methods used to calculate it and nature of the business. The

market value is key element in evaluating the firm¶s worth particularly in large listed corporate firms. Another important criterion for merger decision is EPS. However worth of a firm should not be determined on basic of a single approach and a single figure but within a range after considering all the alternative approaches The EPS basic of determining the value of firm is based on the effect of merger on the future EPS, that is, the EPS of the merged firm (EPSm) see this procedure and its effect EPSm = EATA + EATT / NA + NT WHERE: EATA = Earning after tax of the acquiring firm EATT = Earning after tax of the target firm NA = Number of equity shares outstanding of the acquiring firm NT = Number of equity shares of the target firm Market value of the merged firm Vm= EPSm * P/EA

Total gain from merger: Vm = (VA ± VT) WHERE: VA = EPSA * P/EA VT = EPST * P/ET

Gain for Acquiring (GA) and Target (GT) firm GA = [Post-merger value of firm A less Pre-merger value of firm A] GA = [Post-merger value of firm T less Pre-merger value of firm T]

Approaches for valuations
There are three main approaches for business valuations mentioned under 1. DVM based on the return paid to the share-holders =

P 0 = [D 0 (1+g)] / [(K e

g)]

2. Income/earnings based - based on the returns earned by the firm

a. PE ratio method = value of the company = total earning (NP after tax) * P/E ratio b. Earning yield = v a l u e p e r s h a r e = E P S * ( 1 / e a r n i n g

y i e l d ) O R = v a l u e o f s h a r e = t o t a l e a r n i n g s

* ( 1 / e a r n i n g y i e l d ) While earning yield is simply inverse of P/E = EPS / price per share c. Discounted cash flow basic 3. Asset-based ± based on the tangible assets owned by the company 4. ARR valuation method (value = (estimated annual profits / require return on capital employed) 5. Supper profit valuation method = super profit = [actual profit - ( net book value of tangible assets * avg. industry return)] and the company willing to acquire mention that it will pay suppose for 3 years super profits in this case the results of the above formula is multiplied with 3. 6. Additional promised amounts based on achievement of a certain level of EAT

What is real worth of the company?
Valuation is described as an art not science; the real worth of the firm depends on the viewpoints of the various parties and qualitative factors: y y y The various methods of valuation will often give widely differing results It may be in interests of the investor to argue that either a high or low value is appropriate The final figure will be a matter for negotiation between the interested parties

2. Financing techniques for merger
Second aspect of the merger is Mode of Financing. In case of a firm having a high P/E ratio, issue of equity shares is better, both to acquiring and target firms. To meet the investment needs of investors, convertible securities can be issued yet another form of financing merger is the deferral payment plan Tender offer is another alterative to acquiring a firm. The firm directly approaches the shareholders of the target firm; this approach may be cheaper provided the management of the target firm does not attempt to block it.

3. Merger as capital budgeting decision
If NPV of the decision is positive then go to merger, if NPV is 0 then it make no difference in this case observe quantitative factors and if NPV is negative then do not go for merger NPV = P.V of all expected future cash inflows less P.V of cash paid

Cases:
Formulas to remember

P/E ratio = Price / EPS Price = (P/E ratio) * EPS

Comprehensive Case (Cases and solutions may contain
errors or omissions in such case please send feedback from home-page)

You have been provided the following financial data of the two companies Firm A Earning after taxes ($) Equity shares outstanding Earning par share ($) P/E ratio Market price per share ($) Firm T

500 200 2.50 14 35

350 100 3.50 10 35

Statement of financial position of the both companies is as under Assets Non-current Assets; Plant and machinery Furniture and fittings Current Assets; Cash Debtors Total Assets Equity and Liabilities Equity share capital ($1 each) Retained Earnings Liabilities Non Current Liabilities 14% Preference shares 13% debt ($ 5each) Total Equity and Liabilities Firm A ($) Firm T ($)

500 50

100 50

500 150 1200

250 100 500

200 1000

100 125

0 0 1200

25 250 500

Required: (Do not try to relate any requirement with other one until there is sure relationship as each case may be independent)

1. Determining the number of shares that will be issued for acquisition on market price basic 2. What will be the post merger EPS? 3. What is the change is EPS for shareholders of both companies? 4. Determine the market value of the post merger firm assuming P/E ratio of A remains unchanged 5. Ascertain the profit accruing to share-holders of both firms individually 6. What is the equivalent EPS for share-holders of T ltd if exchange ratio is 0.8 shares of firm A in exchange for 1 share of firm T? 7. If firm A did not issue its shares but pay cash amounting 36.5 for each share of T ltd then what will be the post-merger EPS? 8. What must be the exchange ratio so that Post and Pre-merger EPS of Firm A should be equal? 9. If currently the firms defers the payment until three years after issuing 0.8 shares for one share of T ltd and post mergers earnings after tax for Firm T are 300, 450 and 250 respectively then determine the number of shares that should be issued each year for share-holders of T ltd assuming P/E ratio for T ltd remains unchanged 10.Suppose firm T has unused losses of $3000 resulting from several loss of incurred in the previous years and for tax purposes these losses can be carried forward for 6 years and tax rate is 35% for income of both companies and cost of capital for firm A is 20% then what is the net tax benefit to firm A by acquiring Firm T assuming same earnings each year 11.Assuming 5% growth in EPS of Firm A and T is expected and Firm A is contemplating to issue its shares in exchange of shares of Firm T based on market price then what will be the exchange ratio? And how much shares will be issued , and assuming no synergic gain, construct a schedule of MPS with and without acquisition and determine that how long it take to eliminate the dilution in EPS for share-holders of T Ltd in the new firm? 12.What will be the capital structure after merger if A ltd issues shares based on market price? What percentage the debt will be in new firm¶s capital, has the merged firm¶s financial risk declined? And how much additional debt the merged firm can borrow to maintain 50% debt in capital structure? 13.If A ltd pays $2.50 for each share to share holders of firm T and also issue shares in (1:1) then what is the true cost of acquiring further if provided that the merger will result in cost savings of $1000 after 10 years and this saving will increase the market share price of merged firm suddenly after merger if cost of capital for the firm merged firm is

20% then what is true cost of acquiring after considering further information assuming P/E ratio of A ltd remains unchanged 14.Keeping in mind requirement 13th what is the Net benefit to the shareholders of T ltd if market price is determined based upon P/E ratio of A Ltd assuming unchanged? 15.As the annual earnings of T ltd are 350 keeping in mind only capital structure of both companies and post merger weighted average cost of capital of A ltd as 15% determine the maximum price that A ltd will be willing to pay for one share of T ltd further assume that if the growth of earning of T ltd is 20% for 2 years after merger and after that will not grow further and each increase in cash flow will require $0.7 incremental investment in assets now based on the 12% pre-merger cost what maximum price A ltd will be willing to pay? (round off your answer to near decimal amount) 16.If firm A pays 50% dividend and firm T pays 60% dividend then determine growth rate in dividends of both firms 17.Based on the data given in the balance sheet determine if the merger is favorable or not while compiling after taking into considering that company A is expecting sales of T ltd @700 for 5 years and debentures will be settled by paying cash and cash amounting $1000 will be paid to shareholders of T ltd with issuing 0.5 share of AT ltd in exchange with one share in T ltd dissolution cost is $50 debtors are valued at $90 and cost of capital for the company is 20% and corporate tax is 30% for this case and salvage value of fixed assets is zero and P/E ratio for Firm A will remain unchanged 18.By using DVM valuation approach determine the value of the firm T if dividend this year is 50% of EPS and it was $1.496 before 4 years and firm beta (b) is 0.8 while current market required rate of return (Rm) is equal to 6% and risk free rate (Rf) is 5% 19.As in requirement 18th you are provided that current payout ratio is 50% and beta is 0.8, current market return (Rm) is 6% and risk free rate (Rf) is 5% if you were provided only these information along with another information that rate of return on assets is10% then how will you calculate value of the firm? (round off answer to nearest cent) 20.If you are provided that a firm similar to that T has earning yield of 12.5% then what is market value of firm T? 21.Suppose firm A is willing to acquire firm T on the super profit of 3 years and avg. return in industry for such type of firms is 50% then what will be the amount payable? Further suppose that at this price share-holders of T ltd are not willing to sell the shares then firm is deciding to pay the extra amount if firm T be able to achieve a certain level of EAT more details are as under 10% of average profit of 600 up to 800

12% of average profit of 800 up to 1000 15% of average profit of 1000 up to 1200 It is also estimated that probability of earnings are 30%, 15% and 5% respectively You are required to calculate total minimum and maximum gross amount payable and expected amount payable based on probability estimations

Solution:
1. Number of shares to be issued
= 100 (1:1 as MP is same)

2. Post merger EPS ($)

(500 + 350) / (100 + 200) = 850 / 300 = 2.83
3. Change is EPS for shareholders of both companies ($)

Firm Firm A Pre-merger EPS 2.50 Post-merger EPS 2.83 Change [increase/ (Decrease)] 0.33

Firm T 3.50 2.83 (0.67)

4. Market value of the post merger firm assuming P/E ratio of A remains unchanged ($)

Vm = EPS * P/E * S = 2.83*14*300 = 39.62 * 14 = 11886 WHERE:
S = Number of shares outstanding after issue

[(100 + (200 *1)]

5. Profit accruing to share-holders of both firms individually (Gain from merger) ($)
Post merger value of the firm Pre-merger value of the firm T Pre-merger value of the firm A Total Total Gain from merger Apportionment of gains Firm A Firm B New market value 3962 Less: Old market value 3500 Gain / (Loss) 462 = 1386 Alternatively: (New Share market price of firm A less old share market price of form A)* Number of shares (each firm) Firm A = (39.62 less 35) * 200 = 924 Firm B = (39.62 less 35) * 100 = 462 THIS IS CALLED NPV OF MERGER (MP * S) (39.62*200) (39.62*100) 7924 7000 924 11886 (35*100) (35*200) 3500 7000 10500 1386

6. Equivalent EPS for share-holders of T ltd if exchange ratio is (0.8:1)

Equivalent EPS = (Post-merger EPS * exchange ratio) = 3.04 * 0.8 = 2.43 WHERE: Post merger EPS = [(500 + 350)] / [(200) + (100*0.8) = 850 / 280 = 3.04

7. Post-merger EPS if cash amounting 36.5 is paid for each share of T Ltd.

Post merger EPS = [(500 + 350)] / [(100)] = 850 / 100 = 8.50

8. Exchange ratio so that Post and Pre-merger EPS of Firm T should be equal

Suppose X represents the total number of ordinary shares issued to acquire Firm T (350 / 100) = [(350+500)/100+X)] 3.5 = 850 / 100+X (100 + X)*3.50 = 850 3.50X = 850 less 350 X = 142.86 So total shares that should be issued are 142.86 for 200 shares and thus exchange ratio is 0.71 shares (142.86/200) of Firm A for 1 share of firm T

9. Number of shares that should be issued for share-holders of T ltd if earnings are 300, 450 and 250

Number of shares = EAT * P/ET / MVA

As: P/E = EPS/P and P = EPS*P/E and EPS = EAT/S Now P = (EAT/S)*P/E and V = SP = (S*EAT/S)*P/E and V = EAT*P/E WHERE: P = Market Price per share, S = no. of ordinary shares and V = value of the firm Where P/ET is Price earning of target firm and MVA = share market value of acquiring firm In contrast total value of the target firm in each year divided by market price par share of acquiring firm in each year

Year no. of shares to be issued 1 85.71 2 128.57 3 71.43 (250*10) / 35 (450*10) / 35 (300*10) / 35

10. Net tax benefit to firm A by acquiring Firm T when tax rate is 35%
EBIT (865/0.65) 1307 1307 1307 1307 Accumulated Loss 3000 1693 386 Taxable Income 0 0 921 Tax 0 0 322.35 Tax on normal income 457.45 457.45 457.45

Gross Sav 457.45 457.45 135.1

Savings 457.45 457.45 135.1

PV IF @20% 0.833333333 0.694444444 0.578703704

P.V 381.2083333 317.6736111 78.18287037 777.0648148

11.

Exchange ratio based upon market price per share

Market price per share of T / market price per share of A = 35/35 = 1 total number of shares to me issued = 100*1 = 100 Total number of shares outstanding after issue = 200+100 = 300 New EPS = (350+500)/ (200+100) = 2.83

12.
Year

Schedule of EPS with and without Merger
Firm A EAT ($) 350.00 367.50 385.88 405.17 425.43 446.70 EPS ($) 3.50 3.68 3.86 4.05 4.25 4.47 Firm T EAT ($) 500.00 525.00 551.25 578.81 607.75 638.14 EPS ($) 2.50 2.63 2.76 2.89 3.04 3.19

0 1 2 3 4 5

Firm AT EAT ($) EPS ($) 850.00 2.8 892.50 2.9 937.13 3.1 983.98 3.2 1,033.18 3.4 1,084.84 3.6

13.

How long it take to eliminate the dilution in EPS?
A is 3.5 and after merger it will took approximately 5 years in EPS as in 4th year EPS will be 3.44 that is less than Merger) but in 5th year it becomes 3.62 that is greater than Merger) so it will be happen in 5th year

Current EPS of Firm to eliminate dilution current EPS (Before current EPS (Before

14. Capital structure after merger if A ltd issues shares based on market price? Percentage the debt will be in new firm s capital, has the merged firm s financial risk declined? And Additional debt the merged firm can borrow to maintain 50% debt in capital structure?
Total shares to be issued = 100 and total shares in the new firm = 300 New capital structure after issue Assets Non-current Assets; Plant and machinery Furniture and fittings Current Assets; Cash Debtors 750 250 600 100

Good will Total Assets Equity and Liabilities Equity share capital ($1 each) 14% Preference shares Share Premium Retained Earnings Liabilities Non Current Liabilities

3275 4975

300 25 3400 1000

13% debt ($ 5each) Total Equity and Liabilities

250 4975

In the new firm financial risk as referred to A ltd increased and as referred to T ltd decreases as to maintain 50% debt equity ratio company can increase debt to 2362.50 (50% of equity) but currently company has 250 of debt which means that company can issue $2112.50

15.

True cost of acquiring

True cost of acquiring = (Cash paid + Market value of shares issued) less market value of shares acquired (M.V of T firm) True cost of acquiring = ((2.5*100) + (100*35)) less (100*35) True cost of acquiring = $250

16.

True cost of acquiring after considering further information
^-10

While calculating new share price the present value of the savings will be considered so 1000(1.2) = 161.51 so the new share price will be (Current earnings of firm A + current earnings of firm T + present value of savings) / number of shares after merger (350+500+162) /300 = 3.37 True cost of acquiring = (Cash paid + Market value of shares issued) less market value of shares acquired (M.V of T firm) True cost of acquiring = ((2.5*100) + (100*3.37*14)) less (100*35)

True cost of acquiring = $1472.67 Note: as the benefit is related to merger so its credit should be allocated to merged firm

17. Maximum price that A ltd will be willing to pay for one share of T ltd

Increase in CFAT from T ltd = 350 /0.15 Total net value per share 23.33

=

2333 2333/100 =

18. Maximum price that A ltd will be willing to pay for one share of T ltd at 20% growth and incremental investment
Year 1 2 3 3 CFAT 350 420 504 504 Incremental Investment Net CFAT 350 371 445.2 504 P.V.I.F @12% 0.892857143 0.797193878 0.711780248 8.333333333 P.V ($) 313 296 317 4200 5125

0 49 58.8 0 Maximum Value of the Firm

20.

Growth rate in dividend

Growth (G) = B*R (Retention ratio * ROI) Firm A Firm B = = (0.5 * 0.10) (0.4 * 0.07) = = 0.050 or 0.028 or 5% 2.8%

ROE of both firms ROE = (EAT / Value of Equity funds) ROE for firm A ROE for Firm T

= =

(350 / 3500) (500 / 7000)

= 0.10 = 0.07

In some books ROI is calculated as (EAT / Net Tangible Assets)

21.

Evaluation of merger considering balance sheet
($) 1000 250 50 2800 (see attached 4100 ($) 1496 (see attached 250 90 1836

Cost of merger; Cash payment Payment to debentures Cost of dissolution Market value of the shares issued notes) Total Financial Benefits from merger; Present value of cash flow after tax notes) Cash realized from T firm Debtors value Total Net benefit Total benefits Less: total cost Net

1836 (4100) 2264

No merger is not feasible, As present value is negative Attached Notes: Market value of the shares issued: Post merger combined earnings / total number of shares outstanding (500+500) / (50+200) = 4*14 = 56 Number of shares issued (100*0.5) = 50 Total value of the shares issued = 50*56 = 2800 Present value of net cash inflows Sales Less depreciation (100+50) /5 Less tax (30%) Net profit after tax Add back depreciation CFAT Present value of CFAT 2.991 = 1496

700 (30) 670 201 469 30 499 or approximately 500 = CFAT * PVIF@2% for 5 years = 500 *

22.

DVM valuation approach when two dividends are provided

Formula for current value of the share is

P 0 = [D 0 (1+g)] / [(K e g)] P 0 = [1.75 (1+0.04)] / [(0.058 P 0 = 101.11

0.04)]

Value of the firm = number of shares * value of share Value of the firm = 100 * 101.11 = 10111.11

We have D0 = (EPS*50%) = (3.5*0.5) =1.75 Will have to calculate Ke and growth rate (g)

By CAPM Ke = Rf + b(Rm ± Rf) Ke = 0.05 + 0.8 (0.06 ± 0.05) Ke = 5.8% And Growth (g) = [(current dividend / last mentioned dividend)] Growth (g) = [(1.75 / 1.496)]
^ 1/4 ^ 1/n

±1

± 1 = 4%

22. DVM valuation approach when payout ratio is provided
If payout ratio is provided then we can calculate growth by the formula BR (retention * return on assets) so Growth (g) = 0.5*0.1 = 0.05 And we know that Formula for current value of the share is

P 0 = [D 0 (1+g)] / [(K e g)] P 0 = [1.75 (1+0.05)] / [(0.058 P 0 = 230

0.05)]

Value of the firm = number of shares * value of share Value of the firm = 100 * 230 = 23000

23.

Value of firm based on earning yield

Value of firm = Total net earning * (1/earning yield) Value of firm = 350 * (1/0.125) = 2800

24.
Cost of merger;

Value firm based on earnings and flotation cost
($) 1000 250 50

Cash payment Payment to debentures Cost of dissolution

Market value of the shares issued notes) Total Financial Benefits from merger; Present value of cash flow after tax notes) Cash realized from T firm Debtors value Total Net benefit Total benefits Less: total cost Net Yes merger is feasible as present value is positive Attached Notes:

56 (see attached 1356 ($) 2028 (see attached 250 90 2368

2368 1356 1012

Market value of the shares issued: Post merger combined earnings / total number of shares outstanding (290+500) / (50+200) = 1.129 Number of shares issued (100*0.5) = 50 Total cost = 50*1.129 = 56 Present value of net cash inflows Sales Less depreciation (100+50) /5 Less tax (30%) Net profit after tax Add back depreciation CFAT Effective Ke (EKe) = Effective Ke (EKe) = Effective Ke (EKe) =

400 (30) 370 111 259 30 289 or approximately 290 = [(1+Ke) / (1+flotation rate)] - 1 = [(1+0.2) / (1+0.05)] - 1 = 14.29%

Present value of CFAT

= CFAT / EKe = 290 / 0.143 = 2028

25.

Supper profit valuation method

Super profit = [actual profit - (net book value of tangible assets * avg. industry return)] Super profit = [350 - (500 * 0.50)] = 100 Total payable amount = super profit * number of years for multiple Total payable amount = 100 * 3 = 300

26.

Total minimum and maximum gross amount payable

There are two probabilities 1st that firm will not achieve the target level on future 2nd that firm will be able to achieve the level weight of each probability is 50% so minimum total payable amount is 300 when no extra gross amount to be paid the maximum amount is that when firm succeed to achieve the maximum earning level i.e. of 1200 then amount of 180(1200*0.15) plus initial 300 total (480) will be payable

Expected amount payable based on probability estimations
First compute average expected amount with its probability and percentage of payment Lower Range 600 800 1000 Total Upper Range 800 1000 1200 Average 700 900 1100 Probability 0.3 0.15 0.05 Expected Earning 210 135 55 Payment Percentage 10% 12% 15% Total Estimated Payment 21 16.2 8.25 45.45

Valuation of debt and preference shares and other cases

Case 1:
A firm has issued $100 12% shares and required rate of return by invertors is 14% what is market value of debt?

Case 2:
A company has issued irredeemable loan notes with a coupon rate of 7% and par value of 100. If the required rate of return of investor is 4% what is the current market value of the debt?

Case 3:
A company issues 9% redeemable debt with 10 years to redemption. Redemption will be at par. The investors require a return of 16% what is the market value of the debt?

Case 4:
ABC company issue convertible loan notes with a coupon rate of 12%. Each $100 loan note may be converted into 20 ordinary shares at any time until the date of expiry and any remaining loan notes will be redeemed at $100 (Par value) The loan notes have five years left to run. Investors would normally require a rate of return of 8% p.a. on a five-year debt security should investor convert if current market price is 1. $4.00 2. $5.00 3. $6.00

Case 5:
Suppose ABC Company is planning to obtain listing on stock-exchange by offering 40% its existing shares to the public. No new share will be issued. Last statement of comprehensive income is as under Description Turn-over Earnings Amount 120,000 1,500

Number of shares

3,000

The company has 30% debt and 70% equity and it pays regularly pays 50% dividends and with reinvested earnings is expected to achieve 5% dividend growth each year summarized balance sheet of a company in the similar industry and same business as also as under Description Capital Debt Equity beta Amount 50% 50% 1.5

The current treasury bills yield is 7% a year. The average market return is estimated to be 12%. The new shares will be issued at discount of 15% to the estimated post issue price What will be the issue share price if company has in 30% tax bracket?

Case 6:
You have been provided the following statement of financial position about ABC Company that can earn $27.5 after tax at constant rate which you want to acquire and your undiscounted required rate of return is 20% Assets Sundry net Assets Amount 160 Liabilities Capital ($10) 7% Preference shares Reserves 8% Debentures Total Amount 50 40 25 45 160

Total

160

Debentures and preference shares are to be valued at par. Ignore Taxation

Case 7:

ABC Ltd is contemplating to acquire XYZ Ltd the following information are provided to you

Description Earnings Anticipated growth Cost of capital

ABC 100 4% 15%

XYZ 50 2% 18%

If total earnings of the merged firm will be the sum of current individual earnings and growth rate will be 5% then what minimum price share holders of ABC company will accept and what Maximum price share-holders of ABC will willing to pay? (round off figures to nearest cent)

Solutions

Case 1:
Using P0 = D / Ke = 12 / 0.14 = $85.71

Case 2:
M.V = 7 / 0.04 = $175

Case 3:

Time 1 to 10 10 esent value (Current Market value)

Cash flow ($) 9 100

PVIF @16% 4.833 0.227

PV($ 43.5 22.7 66.2

Case 4:

If the security is not converted there will be following benefits to the share-holder

n ayment form (1-5) years on at 5th year ent value Value of equity if security is converted

Amount ($) 12 100

PVIF @8% 3.993 0.681

P 4 6 11

Number of Market Value of Share Tota shares 20 4 8 20 5 10 20 6 12 luded that if the market value of the debt raise to 6 then security should be sold as present value of cash that will be received will be 12 $3.980 more than keeping security and break even share market price is 116.02 / 20 = 5.80 per share

Case 5:
As we know that

P0 = [(D0) (1+g) / (Ke-g)]
And for this formula Ke is required which is not provided in the question and for this first we will convert the beta provided for another company that is geared and also in the same industry but with different debt/ equity ratio into the beta of un-geared company the formula is as under

bu = [(bg) / (D/E (1-t))] bu = [(1.5) / (0.5/0.5 (1-0.3))] bu = 2.14 Now convert this beta to our current firms capital structure and as we know that bu = [(bg) / (D/E (1-t))]

2.14 = [(bg) / (0.3/0.7 (1-0.3))] bg = 2.4*0.3 = 0.642

According to CAPM model

Ke = rf + b (rm - rf) Ke = 0.07 + 0.642(0.12-0.07) Ke = 10.21%

And
P0 = [(D0) (1+g) / (Ke-g)] P0 = [(0.25) (1+0.05) / (0.1021-0.05)] D0 = EPS * 0.5 = (1500/3000) = 0.25 P0 = 5.04
And as it is mentioned that shares will be issued at 15% discount so new issue price will be 5.04(1-0.15) = 4.28

Case 6:
Income before interest Market value of the firm

27.50 + (45*0.08) 31.10 / (0.2) 155.50 j 40 j 45 70.50 / 5

=

31.10 = =

155.50
Value of the equity

70.50
Value per share

=

1.41

Case 7:

Minimum price share holders of XYZ Company will accept

P0 = [(D0) (1+g) / (Ke - g)] P0 = [(50) (1+0.2) / (0.18 j 0.02)] P0 = 319
Maximum price share-holders of ABC will willing to pay
As ABC Company will absorb XYZ Company share price of merged firm will change so share holders ABC Company will calculate the value of the company before merger and after merger and they will be willing to pay the difference if there is any gain but after merger cost of capital will also change so first we will have to calculate that figure. As we know that in the new firm 67% (1000/1500) shares will be of ABC and remaining 33% (500/1500) will be of XYZ ltd. So new weighted average cost of capital for merged firm will be

(0.15*0.67) + (0.18*0.33) = 16%
Thus value of new firm

P0 = [(D0) (1+g) / (Ke - g)] P0 = [(150) (1+0.05) / (0.16 j 0.05)] = 1432
Value of current firm

P0 = [(100) (1+0.04) / (0.15 j 0.04)] P0 = 946
Total Gain

= 1432 j 946 = 486

So the share-holders of ABC will be willing to pay maximum $486 as then there will be loss on merger
Note: All the Data and Cases are Uploaded for the public best interest in case of any error or omission please send feedback form home page as soon as possible to avoid further misconception

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