MERGERS, ACQUISITIONS

AND
FINANCIAL RECONSTRUCTION

1
Merger or Amalgamation:
 It is a combination of two or more companies into one company.

 It may be in the form of:

 one or more companies being merged into an existing company or

 a new company may be formed to merge two or more existing

companies

2
In a merger:

a) All the properties of the amalgamating (target) company or companies

immediately before the amalgamation becomes the property of the
amalgamated company by virtue of the amalgamation.

b) All the liabilities of the amalgamating (target) company or companies

immediately before the amalgamation become the liabilities of the
amalgamated company by virtue of the amalgamation.

c) Shareholders holding not less than nine-tenths in value of the shares in

the amalgamating (target) company or companies immediately before
the amalgamation become the shareholders of the amalgamated
company by virtue of the amalgamation.

3
Acquisition:

 It is an act of acquiring control over management of other companies

 The control over management of another company can be acquired

through

 Friendly takeover or

 Hostile takeover

4
FINANCIAL CONSIDERATIONS
IN
MERGERS AND ACQUISITIONS

5
 Financial consideration in a merger can be in the form of:

 Cash or
 Shares or
 Both

 When considering the financing of merger through shares, the relative

value of each firm’s share be evaluated and a particular exchange ratio be
determined.

 This exchange ratio reflects the relative weightage of the firms under
consideration.
6
Determination of Share Exchange Ratio (SER):

 Determination of exchange ratio is based on the value of the shares of the

companies involved in the merger.

 The objective of a merger is to maximize the owners wealth in the long run.

 A successful merger would be one that increases the earnings per share
(EPS) and market price of the shares of the amalgamated company.

 The approaches used for determining the exchange ratio are:

1. Earnings approach
2. Market value approach
3. Book value (net asset value) approach

7
1. Earnings approach:

 In this approach, the acquiring firm must consider the effect the merger will
have on the earnings per share (EPS) of the merged or amalgamated firm.

EPS of Target (acquired) firm

Share Exchange Ratio = ------------------------------------------------------
EPS of Acquiring firm

8
2. Market Value Approach:

 The exchange ratio is determined keeping in view the market values of the
companies’ shares involved in the merger.

Market price per share of Target company

Share Exchange Ratio = --------------------------------------------------------------------------------
Market price per share of Acquiring company

9
3. Book Value Approach:

 The exchange ratio is determined according to the book values of the

concerned companies’ shares.

Shareholders’ funds Net worth

Book value of share = --------------------------------------------- = --------------------------------------------
Number of equity shares Number of equity shares

Shareholders’ funds = equity share capital + reserves

Book value of Target company

Share exchange ratio = -------------------------------------------------------------
Book value of Acquiring company

10
Number of shares exchanged

= Share exchange ratio X Pre-merger number of shares of the target firm

Post-merger combined shares

= Number of shares of acquiring firm + (Share exchange ratio X Number of

shares of target firm)

Post-merger combined EPS

Post-merger combined PAT

Post-merger combined EPS = -------------------------------------------------------
Post-merger combined shares

Post-merger combined PAT = PAT of acquiring firm + PAT of target firm

11
Maximum number of shares to be exchanged without EPS dilution:

Acquiring firm’s post-merger earnings

= -------------------------------------------------------------------- --- Acquiring firm’s pre-merger shares
Acquiring firm’s pre-merger EPS

Acquiring firm’s post-merger earnings = PAT of acquiring firm + PAT of target firm

MARKET PRICE PER SHARE (MPS):

MPS = EPS X P/E ratio

P/E ratio = Price-Earning ratio

12
Post-merger Market Price per Share = Combined EPS X Weighted P/E ratio

Weighted P/E ratio = (P/Ea)(PATa/PATc) + (P/Eb)(PATb/PATc)

Where,

P/Ea = P/E-ratio of acquiring firm

P/Eb = P/E-ratio of target firm

PATa = Pre-merger earnings of acquiring firm

PATb = Pre-merger earnings of target firm

PATc = Post-merger combined earnings

13
OTHER MEASURES OF FINANCIAL PERFORMANCE OF PROJECTS

14
ECONOMIC VALUE ADDED (EVA)

 When accountants draw up an income statement, they start with revenues and then
deduct operating and other costs.
 But one important cost is not included - the cost of the capital the firm employs.
 Therefore, to see whether the firm has truly created value, we need to measure
whether it has earned a profit after deducting all costs, including the cost of its
capital.
 Economic value added measures the residual income for the business that remains
after all businesses costs including the opportunity cost of employed capital of the
project.
 EVA is an estimate of a business’s true and real economic profit for the year and it
differs significantly from the accounting profit.

15
EVA = Net operating profit after tax – [WACC X Book value of capital employed]
(NOPAT)

NOPAT = EBIT(1 – T)

Capital employed = Long-term debt + Equity Capital + Preference Capital +

Retained earnings

In calculation of WACC:
 Cost of debt is taken as after-tax cost of debt
 Cost of equity capital is taken as per CAPM

16
MARKET VALUE ADDED (MVA)

 Market Value Added (MVA) is the difference between the current market
value of a firm and the capital contributed by investors.

 If MVA is positive, the firm has added value. If it is negative, the firm has
destroyed value

MVA = V – K

Where,
V = market value of the firm, including the value of the firm's equity and debt
K = book value of capital invested in the firm

17
Any Questions ?

18
19