Mergers and Acquisition

17.
0 Mergers and Takeovers SAUD TARIQ

CFAP 4 Business Finance Decisions (BFD)
ST&Co
Free Cash flows
Free Cash flow to Company Free Cash flow to Equity
Cash flows freely available to all Finances Cash flows freely available to Equity/shareholders only
Discount Rate will be WACC Discount Rate will be cost of Equity (Ke)
Present value will give value of the whole Present value will give value of Equity only
Business i.e. Equity + Debt
Financing cash flows related to Debt (i.e. Interest, Tax
𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 𝐶𝐶𝐶𝐶𝐶𝐶ℎ𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 savings on interest, Issue/Prepayment of loan will be
Value of Company = considered in free cash flows
𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊
𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 𝐶𝐶𝐶𝐶𝐶𝐶ℎ𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 𝑡𝑡𝑡𝑡 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸

Value of Equity =
𝐾𝐾𝐾𝐾
Free Cash flow to the Company:

Cash Settled: Rs
Profit before Interest and tax (PBIT) xxx
Less: Taxation (xxx)
Add back: Depreciation and Loss/Gain xxx
Less: Cash needed for replacement of Asset (xxx)
Free cash flows xxx
Interest and tax savings on interest should not be part of Free Cash flow to the company.
Free Cash flows to Equity:

Rs
Free cash flows to the Company (As calculated above) xxx
Financing Cash flows related to Debt:
Less: Interest paid (xxx)
Add: Tax savings on Interest xxx
Less: Repayment of Loan (xxx)
Add: Receipt of Loan xxx
Free cash flows to Equity xxx
204
17.0 Mergers and Takeovers SAUD TARIQ
ST&Co
Q1) Bfd Kit
205
ST&Co
206
ST&Co
Q2) Winter 2006 Q1
207
ST&Co
Q3) Winter 2005 Q2)

Your company is in the process of making some investment decisions. In this respect, you are
performing an analysis of some companies, one of which is EatFree Ltd (EFL). It is a new franchise bakery
products, and is expected to be successful as a whole in the medium to long term. Following are some of
the collected historic and projected data:
2001-02 2002-03 2003-04 2004-05 2005-06
Estimated
Rupees in Million
Revenues 9.155 10.424 11.718 11.606 12.070
Operating Expenditure 8.556 9.764 10.946 10.750 11.017
Interest 151 147 133 340 310
Profit before tax 448 513 639 516 743
Taxation 181 188 229 209 297
Profit after Tax 267 325 410 307 446
Rupees
Average share price 32 46 44 52 -
Dividend per share 0.48 0.58 0.69 0.81 0.90
Number in Million
No. of shares (Avg.) 223.3 223.3 226.8 230 230
208
ST&Co
Some historic and projected information about the assets and funding is as follows:
2001-02 2002-03 2003-04 2004-05 2005-06
Estimated
Rupees in Million
Non-Current assets 2.765 3.075 4.061 4.334 4.510
Current assets 1.427 1.937 2.462 3.302 3.500
Total assets 4.192 5.012 6.523 7.636 8.010
Current liabilities 1.143 1.544 2.120 1.820 2.122

Long term floating rate 1.633 1.893 2.488 3.524 3.475
loan (currently at 9% pa)
Equity 1.416 1.575 1.915 2.292 2.413
Total liabilities and equity 4.192 5.012 6.523 7.636 8.010
Some additional information has been accumulated by you from the company’s budget for the year
2005-06. The estimated amount of depreciation is Rs 429 Million, Rs 37 Million more than the year
2004-05. The company is exposed to 40% rate of tax on accounting profit. Market has a risk premium of
6% with government bonds yielding 7%. Beta value of the equity of EFL is 1.3.
Required:
(a) Using the information provided, calculate the cost of capital for the company that is appropriate to
discount the free cash flows available to the company. (6)
(b) Compute the Free Cash flows available to EFL for 2005-06. (4)
(c) In addition to the free cash flow estimates by you in (b) above, the estimate for the cash flows for
2006-07 and 2007-08 is Rs 420 Million and Rs 500 Million respectively. Thereafter, free cash flows to
the company have been estimated to grow indefinitely at the rate of 7% p.a. Using only the
information provided so far, calculate the estimated value of the company as at June 30, 2005. (4)
(d) Estimate the value of EFL’s shares and state whether or not EFL’s shares are over-valued or under-
valued based on your analysis of Company’s value as in (c). (4)
(e) Compute the ‘Free Cash flows to Equity Holders’ of EFL for the year 2005-06. (2)
209
ST&Co
Merger and Acquisition
A = Acquirer or Predator
T = Target Co AT = Merged entity
Growth Organic
Inorganic
Benefits of Merger and Acquisition:

1. To gain Synergies
2. To reduce/eliminate competition in market
3. To reduce/eliminate supply chain threats
4. Remove entity barriers
5. Rapid and Speedy Growth
Synergies
Revenue Cost Financial
(Martin Dow Group!) Greater bargaining

Inc. in market size Power Cost of Capital Reduction
Attract economies
Of scale
Can afford experts (AKU)
Some examples of Exam Questions:

1. Compute Value of Target Company?
What is the maximum price Co can pay?
2. Revised Value/Earnings/No of shares of merged entity
3. Gain/Loss to shareholder of each Company from given scheme of merger
4. Designing the merger scheme
E.g. share exchange ratio to achieve particular merger effects/results.
Merger
Share Exchange Cash Payment
Target Co.’s shareholders Target Co.’s shareholders

may get shares of A receive Cash from Acquirer
210
ST&Co
Value of Merged Entity:
Value of A x
Value of T x
Add: Value of Synergy x
Value of Merged Entity *x
Where consideration in form of shares
*Need to deduct cash paid to Target Co if applicable (cash paid to shareholders of Target Co)
Share Exchange: Rs
Revised Earnings (A + T + Synergy) x
Revised P/E x
Revised Market Value of Merged Entity x
Revised Market
Value of Merged
Entity
Target
Company's Value of A
Value
Pre-merger value to be compared
Cash Settled:
Revised Earnings x
Revised P/E x
Revised Value (Earnings x P/E) x
Less: Cash Paid (Target valued out i.e. Value excluded) (x)
Revised Value of A x
Settled by issuance of Debt:

Revised Earnings x
Revised P/E x
Value of Merged entity x
Less: Payment in form of Debt (x)
Revised Value of A x
211
ST&Co
Question 4)
M Salik Ltd acquired Lahore Qalandars Ltd. Value of Salik Ltd was Rs 1,300m while value of Lahore
Qalandars was Rs 500m. This acquisition will bring synergies amounting Rs 300m. M Salik Ltd paid Rs 400m
for acquisition.
Required: Compute market value of merged entity and compute gain/loss to shareholders of M Salik Ltd.
Question 5)
Shayan Ltd (S Ltd) intends to acquire 100% shares of Bata Ltd (B Ltd). It offered 6m shares of S Ltd to
acquire all 10m shares of B Ltd.
S Ltd B Ltd
Earnings (Rs m) 20 8
P/E Ratio 15 10
Total Market Value 300 80
Number of Shares 20m 10m
Market Price per share 15 8
It is expected that synergy effects will be increase annual earnings (P&L) by Rs 3m and total expected
synergies will Rs 40m.
Required:
a) Compute total value of merged entity
b) Determine revised value per share
c) Compute revised P/E Ratio
d) Compute net gain or loss to shareholders of S Ltd and B Ltd.
Question 6)
Shayan Ltd (S Ltd) intends to acquire 100% shares of Bata Ltd (B Ltd). It offered 6m shares of S Ltd to
acquire all 10m shares of B Ltd.
S Ltd B Ltd
Earnings (Rs m) 20 8
P/E Ratio 15 10
Total Market Value 300 80
Number of Shares 20m 10m
Market Price per share 15 8
It is expected that synergy effects will be increase annual earnings (P&L) by Rs 3m and revised P/E Ratio
of merged entity will be 14.
Required:
a) Compute total value of merged entity
b) Determine revised value per share
c) Compute net gain or loss to shareholders of S Ltd and B Ltd.
212
ST&Co
Q7) ACCA P4 Kit BPP
d) Computation of proposed share exchange ratio if total synergy/gain needs to be divided

equally b/w shareholders of Olivine & Halite
e) Compute proposed share exchange ratio if shareholder of Halite wants 25% gain on their
current market value.
213
ST&Co
HW: Q8) Winter 2010 Q1 (Similar to P4 Question Olivine above)
214
ST&Co
Q9) Summer 2013 Q5
215
ST&Co
HW: Q10 Past Papers
Prodco Ltd is contemplating a bid for the share capital of Nordik Ltd. The following statistics are
available.
Prodco Ltd Nordik Ltd
Number of shares 14 million 45 million
Share price Rs 8.40 Rs 1.66
Latest equity earnings Rs 11,850,000 Rs 9,337,500
Prodco Ltd’s plan is to reduce the scale of Nordik Ltd’s operations by selling off a division which accounts
for Rs 1,500,000 of Nordik Ltd’s latest earnings, as indicated above. The estimated selling price is Rs 10.2
million.
Earnings in Nordik Ltd’s remaining operations could be increased by an estimated 20% on a permanent
basis by the introduction of better management and financial controls.
Prodco Ltd does not anticipate any alteration to Nordik Ltd’s price/earnings multiple as a result of these
improvements in earnings.
To avoid duplication, some of Prodco Ltd’s own property could be disposed of at an estimated price of
Rs 16 million. Redundancy costs are estimated at Rs 4.5 million.
Required:
(a) Calculate the effect on the current share price of each company, all other things being equal, of a
two for nine share offer by Prodco Ltd. (08)
(b) Assume now that Prodco Ltd, instead of making a two for nine share exchange offer, wishes to offer
an exchange which would give Nordik Ltd shareholders a 10% gain on the existing value of their
shares. Calculate what share exchange would achieve this effect, assuming the same synergy
forecasts as before. (06)
216
ST&Co
Q11) Winter 2012 Q3
217
ST&Co
Q12) Summer 2011 Q6
218
ST&Co
Q13) Winter 2011 Q3
219
ST&Co
Homework Questions
HW: Q14) Summer 2015 Q2
220
ST&Co
221
ST&Co
222

Mergers and Acquisition

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Mergers and Acquisition

Uploaded by

Copyright:

Available Formats

17.

0 Mergers and Takeovers SAUD TARIQ

Free Cash flow to Company Free Cash flow to Equity

𝐹𝐹𝐹𝐹𝐹𝐹𝐹𝐹 𝐶𝐶𝐶𝐶𝐶𝐶ℎ𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 𝑡𝑡𝑡𝑡 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸

Free Cash flow to the Company:

Free Cash flows to Equity:

Q3) Winter 2005 Q2)

Current liabilities 1.143 1.544 2.120 1.820 2.122

Benefits of Merger and Acquisition:

Revenue Cost Financial

(Martin Dow Group!) Greater bargaining

Can afford experts (AKU)

Some examples of Exam Questions:

Share Exchange Cash Payment

Target Co.’s shareholders Target Co.’s shareholders

Pre-merger value to be compared

Settled by issuance of Debt:

d) Computation of proposed share exchange ratio if total synergy/gain needs to be divided

You might also like