MERGER & ACQUISITIONS KHETAN EDUCATION

MERGER & ACQUISITIONS

1. The following information is relating to Fortune India Ltd. having two divisions, viz.
Pharma Division and Fast Moving consumer goods division (FMCG Division). Paid up
share capital of Fortune India Ltd. is consisting of 3,000 lakhs equity shares of Re. 1 each.
Fortune India Ltd. decided to demerge Pharma Division as Fortune Pharma Ltd w.e.f.
1.4.2005. Details of Fortune India Ltd as on 31.3.2005 and of Fortune Pharma Ltd as on
1.4.2005 are given below:
Fortune Pharma Ltd Fortune India Ltd.
(` Lakhs) (` Lakhs)
Outside Liabilities
Secured Loans 400 3000
Unsecured Loans 2,400 800
CL & Provisions 1,300 21,200
Assets
FA 7,740 20,400
Investments 7,600 12,300
CA 8,800 30,200
Loans and Advances 900 7,300
Deferred tax / Misc. Exps. 60 (200)
Board of directors of the company have decided to issue necessary equity shares of
Fortune Pharma Ltd of ` 1 each, without any consideration to the shareholders of Fortune
India Ltd for that purpose following points are to be considered:
1. Transfer of Liabilities & Assets at Book value.
2. Estimated Profit for the year 2005-06 is ` 11,400 lakh for Fortune India Ltd. &`
1,470 lakhs for Fortune Pharma Ltd.
3. Estimated Market price of Fortune Pharma Ltd is ` 24.50 per share.
4. Average P/E Ratio of FMCG sector is 42 & Pharma sector is 25, which is to be
expected for both the companies.
Calculate:
i. The Ratio in which shares of Fortune Pharma are to be issued to the shareholders
of Fortune India Ltd.
ii. Expected Market Price of Fortune India Ltd.
iii. Book Value per share of both the companies immediately after Demerger.
Sol. (i) Given,
*Fortune Pharma
PAT = ` 1,470 L
P/E = 25 times

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Prof. Archana Khetan MERGER & ACQUISITION

MPS = ` 24.50

*Fortune India
Nos. = 3,000
PAT = ` 11,400 L
P/E = 42 times
` 24.5
EPS = = ` 0.98
25
` 1, 470
No. of shares = = 1,500
0.98
1,500
ER = = 0.50
3, 000
This means every erstwhile shareholder of combined firm should get one share of pharma
for every 2 shares hold originally.
` 11, 400L
(ii) EPS = = ` 3.80/-
3, 000L
P/E = 42 times (given)
MPS = `3.80 × 42 = `159.60
(iii) Book value of combined firm
= ` 20,400 + ` 12,300 + ` 30,200 + ` 7,300 - ` 200 – ` 3,000 – ` 800 – ` 21,200
= ` 45,000L
` 45,000L
BVPS =
3,000L
= ` 15/-

Book value of pharma after demerger

= ` 7,740 + ` 7,600 + ` 8,800 + ` 900 + ` 60 - ` 400 - ` 2,400 – `1,300
= ` 21,000L
` 21,000L
BPVS =
1,500L
= ` 14/-

Book value of FMCG after demerger

= ` 45,000 – ` 21,000L
= ` 24,000L
` 24, 000L
BPVS = = ` 8.0/-
3, 000L
# Assume a shareholder hold 100 shares of Fortune India.

Before demerger After demerger

BV = 100 × ` 5 BV = (FMCG)
= ` 1,500 = 100 × ` 8 = ` 800 ….. (1)

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BV (Pharma )
= 50 × ` 14 = ` 700 ….. (2)

2. The CEO of Ganga Ltd. is considering the acquisition of Yamuna Ltd. The basic data of
the two companies are given as follows:
Ganga Ltd. Yamuna Ltd.
No. of shares 2,00,000 1,20,000
Share price ` 450 ` 100
Expected EPS ` 25 ` 7.50
Expected Dividend per share ` 15 ` 5.25
The above data assumes 5% p.a. growth in the earnings and dividends. However, under
the new management, the growth will be 7.5% without any further investment. The
exchange ratio of 1 for 3 is being considered. Find the cost of acquisition. What is the
gain from the acquisition?
Sol. Gain from acquisition = VAB – VA – VB
Cost of Acquisition = VABx × α - VB
NB × ER
α =
NA + NB × ER
VAB = VA + new VB
VA = ` 450 × 2L
= ` 900L
Computation of D1
D1 = D0(1 + g)
5.25 = D0(1.05)
D0 = ` 5.0
New D1 = 5(1.075) = ` 5.375
Computation of Ke
We assume that the risk perception of shareholders of Yamuna cannot change and hence
we use the historical ‘Ke’ to compute the new value.
D1
Ke = +g
P0
5.25
Ke = + 0.05 = 10.25%
100
5.375
P0 =
0.1025 - 0.075
= ` 195.45
\ New VB = ` 195.45 × 120.000
= ` 234.54 L
VAB = ` 900 L + ` 234.54 L

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Prof. Archana Khetan MERGER & ACQUISITION

= ` 1134.54 L
\ Gain = ` 1134.54 L - ` 450 × 2L – 100 × 1.2 L
Cost = VAB × α – VB
= ` 1134.54 × 16.67 % - ` 100 × 1.2 L
= ` 69.13 L
1
1, 20, 000 ×
α = 3 × 100
1
2, 00, 000 + 1,20,000 ×
3
= 16.67%

3. BA Ltd and DA Ltd both the companies operate in the same industry. The Financial
statements of both the companies for the current financial year are as follows:
Balance Sheet
Particulars BA Ltd. DA Ltd.
Current Assets 14L 10L
Fixed Assets (net) 10L 5L
Total (`) 24L 15L
Equity Capital (` 10 each) 10L 08L
Retained Earnings 2L -
14% Long term debt 5L 3L
Current Liabilities 7L 4L
Total (`) 24L 15L

Income Statement
Net Sales 34.50 L 17.00 L
Cost of goods sold 27.60 L 13.60 L
Gross Profit 6.90 L 3.40 L
Operating Expenses 2.00 L 1.00 L
Interest 0.70 L 0.42 L
EBT 4.20L 1.98L
EAT 2.10L 0.99L

Additional Information
No. of equity shares 1,00,000 80,000
Dividend Pay-out (D/P) 40% 60%
Market Price per Share ` 40 ` 15

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Assume that both companies are in the process of negotiating a merger through an
exchange of equity shares. You have been asked to assist in establishing equitable
exchange terms and you are required to:
i. Decompose the share price of both the companies into EPS and P/E components;
and also segregate their EPS figures into Return on Equity (ROE) and book value /
intrinsic value per share components.
ii. Estimate future EPS growth rates for each company.
iii. Based on expected operating synergies BA Ltd estimates that the intrinsic value of
DA’s equity shares would be ` 20 per share on its acquisition. You are required to
develop a range of justifiable equity shares exchange ratios that can be offered by
BA Ltd to the shareholders of DA Ltd. Based on your analysis in parts (i) and (ii)
would you expect the negotiated terms to be closer to the upper or the lower
exchange ratio limits and why?
iv. Calculate the post -merger EPS based on the exchange ratio of 0.4:1 being offered
by BA Ltd. Indicate the immediate EPS accretion or dilution, if any, that will occur
to each group of the shareholders.
v. Based on 0.4:1 exchange ratio and assuming that BA Ltd.’s pre-merger PE ratio
will continue after the merger, estimate the post-merger market price. Also show
the resulting accretion or dilution in pre-merger market prices.

Sol. BA Ltd. = A
DA Ltd. = B
PATA 2.10L
(i) EPSA = = = ` 2.10/-
NA 1L
PATB 0.99L
EPSB = = = ` 1.24/-
NB 0.8L
` 40
P/EA = = 19.05 times
` 2.10
` 15
P/EB = = 12.10 times
` 1.24
PATA ` 2.10L
ROEA = = × 100 = 17.50%
BV ` 10L + ` 2L
PATB ` 0.99L
ROEB = = × 100 = 12.38%
B.V ` 8L
Total BV ` 12L
BVPSA = = = ` 12.0/-
No of shares 1
` 8L
BVPSB = = ` 10.0/-
0.8L
(ii) g = b× r
b = Retention Ratio

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Prof. Archana Khetan MERGER & ACQUISITION

r = ROE
gA = (1 - 40%) × 17.5% = 10.50%
gB = (1 - 60%) × 12.38% = 4.95%

` 15
(iii) ER on the basis of B intrinsic value of B post- merger = = 0.375
` 40
` 20
ER as per intrinsic values of B post -merger = = 0.50
` 40
® Lower Range = 0.375
Higher Range = 0.50
On the basic of computation in (i) & (ii), We observe that the vital parameters like EPS,
ROE & growth ratio of B are lower in comparison to A, there by brining higher bargaining
power to acquirer and hence, we expect ER towards “Lower Range”.
` 2.10L + ` 0.99L
(iv) Post Merger EPS = = ` 2.34
1L + 0.80L ´ 0.4
Particulars A B
EPS Before ` 2.10 ` 1.24
EPS After ` 2.34 `2.34 × 0.4
= 0.94
Gain `0.24 (`0.30)
(v) Post -Merger MPS = ` 2.34 × 19.05 times = `44.58/-
Particulars A B
Wealth Before ` 40 ` 15
Wealth After ` 44.58 ` 44.58 × 0.4 = ` 17.832
Gain ` 4.58 ` 2.83

4. AS Ltd. is planning to acquire and absorb the running business of XY Ltd. The valuation
is to be based on the recommendation of merchant bankers and the consideration is to be
discharged in, the form of equity shares to be is used by AB Ltd. As on 31.3.2006, the
paid up capital of AS Ltd. consists of 80 Lakhs shares of ` 10 each. The highest and the
lowest market quotation during the last 6 months were ` 570 and ` 430. For the purpose
of the acquisition the price per share is to be reckoned as the average of the highest and
lowest market price during the last 6 months ended on 31.3.06.
XY Ltd.’s Balance Sheet as at 31.3.2006 is summarised below ` Lakhs
Sources 200
Share Capital 50
20 lakhs equity shares of ` 10 each fully paid 100
10 lakhs equity shares of ` 10 each, ` 5 paid
Loans
Total 350
Fixed Assets (Net) 150

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Net current Assets 200
350
An independent firm of merchant bankers engaged for the negotiation, have produced the
following estimates of cash flows from the business of XY Ltd.
Year ended By way of ` In lakhs
31.3.07 After tax earnings for 105
equity
31.3.08 do 120
31.3.09 do 125
31.3.10 do 120
31.3.11 do 100
Terminal value estimate 200
It is the recommendation of the merchant banker that the business of XY Ltd. may be
valued on the basis of the average of (1) Aggregate of discounted cash flows at 8% and
Oil Net assets value. Present value factors at 8% for years 1-5: 0.93 0.86 0.79 0.74 0.68
You are required to –
i. Calculate the total value of the business of XY Ltd.;
ii. The number of shares to be issued by AB Ltd.; and
iii. The basis of allocation of the shares among the shareholders of XY Ltd.
Sol.
(i) *Net Asset value = ` 350L (Assets) – ` 100L (Liabilities) = ` 250 L
Discounted cash flow method:
Values = Values in Explicit forecast period + Terminal value
Values in the Forecast Period
Year C.F( ` in Lakhs) P. V @ 8% P.V of Cash flows
1 105 0.93 97.65
2 120 0.86 103.20
3 125 0.79 98.75
4 120 0.74 88.80
5 100 0.68 68.00
` 456.40 L
PV of terminal values at t = 0
= ` 200 L × 0.68 = ` 136 L
# Value = ` 456.4 L +` 136 L = ` 592.4L
\ Average value of XY Ltd.
` 250L + ` 592.4L
= = ` 421.2L
2
(ii) Consideration = ` 421.20L
Average price of stock to be used to pay the consideration
` 570 + ` 430
= = ` 500
2

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Prof. Archana Khetan MERGER & ACQUISITION

\No. of shares by AS Ltd. to XY Ltd.

` 421.2L
= = 0.8424 L Shares
` 500
(iii) 20L shares® Fully paid up
10L shares® Partly paid up ≈ 5L shares fully paid up
\ No of shares allotted to Fully paid up shareholder
20L
= 0.8424L × = 0.67392 L
25L
No of shares allotted to Partly paid up shareholder = 0.8424 L Shares - 0.67392 L
= 0.16848 L

5. T Ltd. and E Ltd. are in the same industry. The former is in negotiation for acquisition of
the latter. Important information about the two companies as their latest financial
statement given below:
T Ltd. E Ltd.
`10 Equity shares outstanding Debt 12 lakhs 6 lakhs
10% Debentures (` lakhs) 580 -
12.5% Institution Loan (`lakhs) - 240
Earnings Before interest, Depreciation and Tax-
(EBIDAT) (` lakhs) 400.68 115.71
Market Price/share (`) 220.00 110.00
T Ltd. plans to offer a price to E Ltd. business as a whole which will be 7 times EBIDAT
reduced by outstanding debt, to discharged by own shares at market price.
E Ltd. is planning to seek one share in T Ltd. for every 2shares in E Ltd. Based on the
market price. Tax rate for the two companies may be assumed as 30%.
Calculate and show the following under both alternatives - T Ltd.'s offer and E
Ltd.'s plan:
i. Net consideration payable
ii. No. of shares to be issued by T Ltd.
iii. EPS of T Ltd. after acquisition.
iv. Expected market price per share of T Ltd. after acquisition.
v. State briefly the advantages to T Ltd. from the acquisition
Calculate(except EPS) may be rounded off to 2 decimals in lakhs.
Sol. As per T’s Plan:
(i) Net consideration:
Computation of Gross value = 7 × ` 115.71L
7 × EBIDAT = ` 809. 97 L
(-) O/S Debt (` 240 L)
Net Consideration ` 569.97L
(ii) No. of shares to be issued by T to E

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` 569.97l
= 2.59 Lakhs
` 220
(iii) Computation of PAT
Particulars T (` in L) E (` in L)
EBIDAT 400.680 115.710
(-) Interest (58.000) (30.000)
EBT 342.680 85.710
(-) Tax @ 30% (102.804) (25.718)
PAT 239.876 60.000
` 239.876L + ` 60L
Post -Merger EPS = = ` 20.55/-
12L + ` 2.59L
#Since, T Ltd. would issue 2.59L shares of its owner to acquirer E in full
2.59 = NB × ER
(iv) Post Merger MPS:
= Post Merger EPS × P/E of Acquirer
= ` 20.55 × 11 times = ` 226.05
*Computation of P/E(T) :
` 239.876L + ` 60L
EPS = = ` 20
(12L + 3L)
MPS = ` 220 (given)
` 220
\ P/E = = 11 times
20
(v) Advantages of T Ltd:
(1) Synergy
(2) Economies of Scale
(3) Tax Benefits
(4) Increase in Market share

* As per E’S plan

(i) Net consideration
® As given, E Ltd. is expecting 1 shares of T Ltd. for every 2 shares, which means the total
no. of shares to be issued by T Ltd. to E Ltd.
= NB × ER = 6L × 0.5 = 3L
\ Consideration = 3L × ` 220 = ` 660L

1
(ii) No of shares = NB × ER= 6L × = 3L
2

239.876 + 60
(iii) Post merger EPS = = ` 20 [ ` 239.876 L + ` 60.000 L]
12L + 3L

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Prof. Archana Khetan MERGER & ACQUISITION

(iv) Post merger MPS = ` 20 × 11times = ` 220

6. 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. Dimple Ltd.
` Lakhs ` Lakhs
High Growth 0.20 820 1050
Medium Growth 0.60 550 825
Slow Growth 0.20 410 590
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.

Sol. For Simple Ltd.

High Growth Medium Growth Slow Growth
P Value P Value P Value
Debt 0.2 460 0.6 460 0.2 410
Equity 0.2 360 0.6 90 0.2 -
820 550 410

For Dimple Ltd.

High Growth Medium Growth Slow Growth
P Value P Value P Value
Debt 0.2 65 0.6 65 0.2 65
Equity 0.2 985 0.6 760 0.2 525
1, 050 825 590
Expected value of Debt of Merged firm = ` 450 + ` 65 = ` 515 L
Expected value of Equity of Merged firm = `126 + ` 758 = ` 884 L
Expected value of Merged firm = ` 515 L + ` 884 L = ` 1,399 L

7. There are two companies ABC Ltd. and XYZ Ltd. are in same in industry. On order to
increase its size ABC Ltd. made a takeover bid for XYZ Ltd.
Equity beta of ABC and XYZ is 1.2 and 1.05 respectively. Risk Free Rate of Return is
10% and Market Rate of Return is 16%. The growth rate of earnings after tax of ABC
Ltd. in recent years has been 15% and XYZ's is 12%. Further both companies had
continuously followed constant dividend policy.

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MERGER & ACQUISITIONS KHETAN EDUCATION
Mr. V, the CEO of ABC requires information about how much premium above the current
market price to offer for XYZ's shares.
Two suggestions have forwarded by merchant bankers.
i. Price based on XYZ's net worth as per B/S, adjusted in light of current value of
assets and estimated after tax profit for the next 5 years.
ii. Price based on Dividend Valuation Model, using existing growth rate estimates.
Summarised Balance Sheet of both companies is as follows.
ABC Ltd. XYZ Ltd. ABC XYZ Ltd.
Ltd.
Equity share Land & Building 5,600 1,500
capital 2,000 1,000 Plant & Machinery 7,200 2,800
General Reserves 4,000 3,000
Share Premium 4,200 2,200
Long term Loans 5,200 1,000
Current
Liabilities Current Assets
Sundry Creditors 2,000 1,100 Accounts 3,400 2,400
Bank Overdraft 300 100 Receivable
Tax Payable 1,200 400 Stock 3,000 2,100
Dividend Payable 500 400 Bank/Cash 200 400
19,400 9,200 19,400 9,200

Profit & Loss A/C

ABC XYZ ABC XYZ
Ltd. Ltd. Ltd. Ltd.
To Net Interest 1,200 220 By Net Profit 7,000 2,550
To Taxation 2,030 820
To Distributable - -
Profit 3,770 1,510
7,000 2,550 7,000 2,550
To Dividend 1,130 760 By Distributable 3,770 1,510
To Balance c/d 2,640 750 Profit - -
3,770 1,510 3,770 1,510
1. XYZ Ltd.'s land &building have been recently revalued. XYZ Ltd.'s have not been
revalued for4 years, and during this period the average value of land &building have
increased by 25% p.a.
2. The face value of share of ABC Ltd. is `10 and of XYZ Ltd. is ` 25 per share.
3. The current market price of shares of ABC Ltd. is ` 310 and of XYZ Ltd.’s ` 470
per share. With the help of above data and given information you are required to
calculate the premium per share above current share price by two suggested
valuation methods. Discuss which of these two values should be used for bidding
the XYZ's shares. State the assumptions clearly, you make.

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Prof. Archana Khetan MERGER & ACQUISITION

Sol.
(i) Value of XYZ on the basis of Net worth & Earnings:
Land & Building = 1,500 (1.25)4
= ` 3,662.11L
(+) P & M = 2,800
(+) Current Assets = 4,900
(-) Long term loans = (1,000)
(-) C L = (2,000)
` 8,362.10 L

Value of target as per Balance sheet and profits

= ` 8362.11 (+) ` 1,510 × (1.12)1(+) ` 1,510 × (1.12)2 (+) `1,510× (1.12)3
(+) ` 1,510 × (1.12)4(+) ` 1,510 × (1.12)5
= ` 19,106.04 L
` 100L
NOS O/S for XYZ = = 40 L
` 25
` 19,106.04L
\ Price Per Share = = ` 477.65
40L
` 477.65 - ` 470.00
% Premium = ´ 100
` 470.00
= 1.63%

(ii) gc = 12 %
As per DDM
D1 D (1 + g)
Po = = 0
ke - g ke - g
Total Dividend = ` 760 L
` 760L
D0 = = ` 19
40L
Ke = Rf + (Rm - Rf) B
= 10 + (16 -10) 1.05
= 16.30%
` 19 (1.12 ) 21.28
P0 = = = ` 494.8
0.1630 - 0.12 0.048
` 494.8 - ` 470.0
% Premium = ´ 100 = 5.29%
` 470.0
On the basis of above computation, we observe & conclude that the firm should go by
DDM Model due to two reasons.
(a) It considers time value of money.
(b) The premium is relatively more reasonable than the first method.

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8. M/s Tiger Ltd. wants to acquire M/s. Leopard Ltd. The balance sheet of Leopard Ltd. as
on 31st march, 2012 is as follows:
Liabilities ` Assets `
Equity capital (70,000 Cash 50,000
shares)
Retained earning 3,00,000 Debtors 70,000
12% Debenture 3,00,000 Inventories 2,00,000
Creditors and other 3,20,000 Plants & Equipment 13,00,000
liabilities
16,20,000 16,20,000
Additional Information:
i. Shareholder of Leopard Ltd. will get one share in Tiger Ltd. for every two shares. External
liabilities are expected to be settled at ` 5,00,000. Shares of Tiger Ltd. would be issued at
its current price of ` 15 per share. Debenture holders will get 13% convertible debenture
in the purchasing company for the same amount. Debtors and inventories are expected to
realize `2,00,000.
ii. Tiger Ltd. has decided to operate the business of Leopard Ltd. as a separate division. The
division is likely to give cash flows (after tax) to the extent of `5,00,000 per year for 6
years. Tiger Ltd. has planned that, after 6 years, this division would be demerged and
disposed of for `2,00,000.
iii. The company’s cost of capital is 16%.
Make a report to the Board of the company advising them about the financial feasibility
of this acquisition.
Net present values for 16% for `1 are as follows:
Years 1 2 3 4 5 6
PV .862 .743 .641 .552 .476 .410
Sol.
Note : In the sum we would need to compute the net value paid by Tiger in lieu of plant &
Machinery.
NPV of Acquisition = PV of inflows generated by operating the division
- Value paid to acquire the division
(a) Computation outflow
1
Value of shares = ` 15 × 70,000 × = ` 5,25,000
2
+ Values of Debentures = ` 3,00,000
+ Value of External liabilities settled = ` 5,00,000
-Cash received = (` 50,000)
-Inventories & debtors = (` 2,00,000)
` 10,75,000

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Prof. Archana Khetan MERGER & ACQUISITION

Computation of present value of inflows

Year Cash row PV
1 5,00,000 0.862 4,31,000
2 5,00,000 0.743 3,71,500
3 50,0,000 0.641 3,20,500
4 5,00,000 0.552 2,76,000
5 5,00,000 0.476 2,38,000
6 5,00,000 0.410 2,87,000
+2,00,000}
NPV = ` 19,24,000 – ` 10,75,000 = ` 8,49,000
* Since the NPV is positive, Tiger Ltd. must acquire Leopard Ltd., we recommend Tiger to
go ahead with acquisition.

9. Personal Computer Division of Distress Ltd., a computer hardware manufacturing

company has started facing financial difficulties for the last 2 to 3 years. The management
of the division headed by Mr. Smith is interested in a buyout on 1 April 2013. However,
to make this buy-out successful there is an urgent need to attract substantial funds from
venture capitalists. Ven Cap, a European venture capitalist firm has shown its interest to
finance the proposed buy-out. Distress Ltd. is interested to sell the division for `180 crore
and Mr. Smith is of opinion that an additional amount of `85 crore shall be required to
make this division viable. The expected financing pattern shall be as follows:
Amount (`
Source Mode
Crore)
Management Equity Shares of `10 each 60.00
Ven Cap VC Equity Shares of `10 each 22.50
9% Debentures with attached warrant of `100 each 22.50
8% Loan 160.00
Total 265.00
The warrants can be exercised any time after 4 years from now for 10 equity shares @
`120 per share.
The loan is repayable in one go at the end of 8th year. The debentures are repayable in
equal annual instalment consisting of both principal and interest amount over a period of
6 years.
Mr. Smith is of view that the proposed dividend shall not be kept more than 12.5% of
distributable profit for the first 4 years. The forecasted EBIT after the proposed buyout is
as follows:

Year 2013-14 2014-15 2015-16 2016-17

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 MERGER & ACQUISITIONS KHETAN EDUCATION
EBIT (` Crore) 48 57 68 82
Applicable tax rate is 35% and it is expected that it shall remain unchanged at least for 5-
6 years. In order to attract Ven Cap, Mr. Smith stated that book value of equity shall
increase by 20% during above 4 years. Although, Ven Cap has shown their interest in
investment but are doubtful about the projections of growth in the value as per projections
of Mr. Smith. Further Ven Cap also demanded that warrants should be convertible in 18
shares instead of 10 as proposed by Mr. Smith.
You are required to determine whether or not the book value of equity is expected to grow
by 20% per year. Further if you have been appointed by Mr. Smith as advisor then whether
you would suggest to accept the demand of Ven Cap of 18 shares instead of 10 or not.
Sol. Computation of EAI on 9% Debentures
PVA = A × PVA (r,n)
Loan Amount = EAI × PVA (9%, 6)
` 22.50 Cr. = EAI × 4.486
EAI = ` 5.02 Cr.
® Loan amortization table
Year O/S Int. @ 9% Principal EAI
a b c d
1 22.5000 2.0250 2.9950 5.02
2 19.5050 1.7550 3.2650 5.02
3 16.2400 1.4616 3.5584 5.02
4 12.6816 1.1413 3.8800 5.02
5 8.8000 0.7920 4.2300 5.02
6 4.5700 0.4100 4.2300 5.02

Comp of Book equity

Year 1 2 3 4
EBIT 48.000 57.000 68.00000 82.000
-Int. on T.L (12.800) (12.8000) (12.80000) (12.800)
-Int. on Debenture (2.025) (1.755) (1.46416) (1.143)
EBT 33.175 42.445 53.74000 68.060
PAT 21.560 27.590 34.92000 44.2390
Div. @ 12.5% (2.695) (3.448) (4.370) (5.560)
Amt C/F 18.865 24.142 30.550 (38.71)
+ Amt B/f 82.500 101.365 125.507 156.057
Book Equity 101.365 125.507 156.057 194.77

Computation Of Growth Of Book Of Equity

` 82.5(1 + g)4 = ` 194.77

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Prof. Archana Khetan MERGER & ACQUISITION

` 194.737 Cr
(1 + g)4 =
` 82.5 Cr
1 + g = (2.36)1/4
1 + g = 1.2394
g = 23.94% p.a.

® Demand of 18 shares / warrant

` 60 Cr
No. of shares hold by Management = 6 Cr=
` 10
` 22.5 Cr
No. of shares hold by VenCap originally = = 2.25 Cr
` 10
` 22.5 Cr
(+)No. of shares as a result of exercise of warrants = × 18 = 4.05 Cr
` 100
® The deal is completely acceptable on the basis of growth projections but a demand of 18
shares cannot be accepted, as it would lead to dilution of majority control for the
management.

10. Bank 'R' was established in 2005 and doing banking in India. The bank is facing DO OR
DIE Situation. There are problems of Gross NPA (Non Performing Assets) at 40% &
CAR/CRAR (Capital Adequacy Ratio/ Capital Risk Weight Asset Ratio) at 4%. The net
worth of the bank is not good. Shares are not traded regularly. Last week, it was traded
@ ` 8 per share.
RBI Audit suggested that bank has either to liquidate or to merge with other bank.
Bank 'P' is professionally managed bank with low gross NPA of 5%.It has Net NPA as
0% and CAR at 16%. Its share is quoted in the market @ ` 128 per share. The board of
directors of bank 'P' has submitted a proposal to RBI for take over of bank 'R' on the basis
of share exchange ratio.
The Balance Sheet details of both the banks are as follows:
Bank R (`In lakhs) Bank P (`In lakhs)
Paid up share capital 140 500
Reserves & Surplus 70 5,500
Deposits 4,000 40,000
Other liabilities 890 2,500
Total Liabilities 5,100 48,500
Cash in hand & with RBI 400 2,500
Balance with other banks - 2,000
Investments 1,100 15,000
Advances 3,500 27,000
Other Assets 100 2,000
Total Assets 5,100 48,500

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It was decided to issue shares at Book Value of Bank 'P' to the shareholders of Bank 'R'.
All assets and liabilities are to be taken over at Book Value.
For the swap ratio, weights assigned to different parameters are as follows:
Gross NPA 30% CAR 20%
Market price 40% Book value 10%
a. What is the swap ratio based on above weights?
b. How many shares are to be issued?
c. Prepare Balance Sheet after merger.
d. Calculate CAR & Gross NPA % of Bank 'P' after merger.
Sol.
Particulars P P
CAR 16% 4%
GNPA 5% 40%
MPS ` 128 `8
Book values `500L `140L
+ ` 5,500L + ` 70L
`6,000L `210L
NOS ` 500L ` 140L
= 50L = 14L
` 10 ` 10
BVPS ` 6, 000L ` 210L
= ` 120 = ` 15
` 50 ` 14L
5
ER (GNPA) = = 0.125
40
4
ER (CAR) = = 0.25
16
8
ER(MPS) = = 0.0625
128
15
ER(BVPS) = = 0.125
120
(a) Average ER = 0.30 × 0.125 + 0.20 × 0.25 + 0.40 × 0.0625 + 0.10 × 0.125
= 0.125
(b) How many shares to be issued
No. of shares to be issued to bank R = 14L × 0.125
= 1.75L
(c) The value of Paid Up for R Ltd. in the Books of P Ltd.
= 1.75L shares × ` 10 =` 17.5L
® Paid up already in the books of R Ltd. is ` 140L.
\ Release of Capital = ` 140L – ` 17.5L = ` 122.5L
Balance sheet
` `

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Prof. Archana Khetan MERGER & ACQUISITION

in Lakhs in Lakhs
Paid up capital 517.5 Cash in land with RBI 2,900.0
Reserve 5,570.0 Balance with other banks 2,000.0
Capital reserve 122.5 Investment 16,000
Deposit 44,000.0 Advances 30,500.0
Other liabilities 3,390.0 other Assets 2,100.0
53,600.0 53,600.00
(d) Computation of CAR & GNPA % after the Merger
Total capital
(i) CAR =
Risk weighted assets

Practical Bank P Bank R Total

Total capital ` 6,000L ` 210L ` 621
CAR 16% 4%
Risk weighted assets ` 37,500 ` 5,250 ` 4,275
` 6,210L
CAR of the Merged Firm = × 100 = 14.53%
42,750L

Gross NPA
(ii) GNPA = × 100
Advances
Particulars Bank p Bank R Total
GNPA 5% 40%
Advances ` 27,000 ` 3,500 ` 30,500
Gross NPA ` 1,350 ` 1,400 ` 2,750
2, 750
\ GNPA of merged firm = = 9.02%
30,500

11. M plc and C plc operating in same industry are not experiencing any rapid growth but
providing a steady stream of earnings. M plc’s management is interested in acquisition
of C plc due to its excess plant capacity. Share of C plc is trading in market at £4 each.
Other date relating to C plc is as follows:
Particulars M plc C plc Combined
Entity
Profit after tax £4,800,000 £3,000,000 £9,200,000
Residual Net Cash Flow per year £6,000,000 £4,000,000 £12,000,000
Required return on Equity 12.5% 11.25% 12.00%

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Balance Sheet of C PLC
Assets Amount Liabilities Amount
(£) (£)
Current Assets 27,300,000 Current Liabilities 13,450,000
Other Assets 5,500,000 Long Term Liabilities 11,100,000
Property Plants & Reserve & Surplus 24,750,000
Equipments 21,500,000 Share Capital 5,000,000
(5million common shares
@ £1each)
54,300,000 54,300,000
You are required to compute:
i. Minimum price per share Cplc should accept from Mplc.
ii. Maximum price per share Mplc shall be willing to offer to Cplc.
iii. Floor Value of per share of C plc. Whether it shall play any role in decision for its
acquisition by Mplc.
Sol. Working Notes:
Residual Cash Flow 4,000,000
Value of C PLC = = = £35,555,556
ke - g 0.1125 - 0
35,555,556
Value of per share of C plc = = £7.11
5,000,000
29,750,000
Book Value of per share of C plc = = £5.95
5,000,000
Residual Cash Flow 6,000,000
Value of M plc = = = £48,000,000
ke - g 0.125 - 0
12,000,000
Value of Combined Entity = = £100,000,000
0.12 - 0
Value of Synergy = Value of Combined Entity – Individual Value of M plc and Cplc
Value of Synergy = £100,000,000 – (£48,000,000 + £35,555,556) = £16,444,444

12. Hanky Ltd. and Shanky Ltd. operate in the same field, manufacturing newly born babies’s
clothes. Although Shanky Ltd. also has interests in communication equipments, Hanky
Ltd. is planning to take over Shanky Ltd. and the shareholders of Shanky Ltd. do not
regard it as a hostilebid.
The following information is available about the two companies.
Hanky Ltd. Shanky Ltd.
Current earnings `6,50,00,000 ` 2,40,00,000
Number of shares 50,00,000 15,00,000
Percentage of retained earnings 20% 80%

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Prof. Archana Khetan MERGER & ACQUISITION

Return on new investment 15% 15%

Return required by equity shareholders 21% 24%
Dividends have just been paid and the retained earnings have already been reinvested in
new projects. Hanky Ltd. plans to adopt a policy of retaining 35% of earnings after the
takeover and expects to achieve a 17% return on new investment.
Saving due to economies of scale are expected to be `85,00,000 per annum. Required
return to equity shareholders will fall to 20% due to portfolio effects.
Requirements:
a. Calculate the existing share prices of Hanky Ltd. and Shanky Ltd.
b. Find the value of Hanky Ltd. after the takeover
c. Advise Hanky Ltd. on the maximum amount it should pay for Shanky Ltd.
Sol. a. Existing share price of Hanky Ltd.
g = r ×b
r = 15%
b = 20%
g = 0.15 × 0.2
= 0.03
Next year's dividend
Ex dividend market value =
ke - g
6,50,00,000 × 0.8 × 1.03
= = 29,75,55,556
0.21 - 0.03
29,75,55,556
Value of one share = = 59.51 per share
50,00,000
Existing share price Shanky
g =r×b
= 0.15 × 0.8 = 0.12
Next year's dividend
Ex dividend market value =
ke - g
2,40,00,000 × 0.2 × 1.12
= 0.24 - 0.12 = 4, 48, 00, 000
4,48,00,000
Value of one share = = 29.87 per share
15,00,000
b. Value of Hanky Ltd. after the takeover
Care must be taken in calculating next year’s dividend and the subsequent growth rate.
Next year’s earnings are already determined, because both companies have already
reinvested their retained earnings at the current rate of return. In addition, they will get
cost savings of ` 85,00,000.
The dividend actually paid out at the end of next year will be determined by the new 35%
retention and the future growth rate will take into account the increased return on new

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 MERGER & ACQUISITIONS KHETAN EDUCATION
investment.
Growth rate for combined firm,
g = 0.17 × 0.35 = 0.06
New cost of equity = 20%
Next year’s earnings = `6,50,00,000× 1.03 + `2,40,00,000 ×1.12 + `85,00,000
= `10,23,30,000
Next year’s dividend = `10,23,30,000×0.65
= `6,65,14,500
6,65,14,500
Market value = = 47,51,03,571
0.20 - 0.06

c. Maximum Hanky Ltd. should pay for Shanky Ltd.

Combined value = `47,51,03,571
Present Value of Hanky Ltd. = `29,75,55,556
= `17,75,48,015

13. Simpson Ltd. is considering a merger with Wilson Ltd. The data below are in the hands
of both Board of Directors. The issue at hand is how many shares of Simpson should be
exchanged for Wilson Ltd. Both boards are considering three possibilities 20,000, 25,000
and 30,000 shares. You are required to construct a table demonstrating the potential
impact of each scheme on each set of shareholders:
Simpson Wilson Combined
Ltd. Ltd. Post -Merger
Firm ‘A’
1. Current earnings per year 2,00,000 1,00,000 3,50,000
2. Share outstanding 50,000 10,000 ?
3. Earnings per share(`) (1÷ 2) 4 10 ?
4. Price per share (`) 40 100 ?
5. Price-Earnings ratio [4÷ 3] 10 10 10
6. Value of firm(`) 20,00,000 10,00,000 35,00,000
7. Expected Annual growth rate in 0 0 0
earnings in foreseeable future
Sol. The following table demonstrates the potential impact of the three possible schemes, on
each set of shareholders:-
Number of Exchange Number of Fraction of Value of Fraction of Value of
Simpson ratio [(1)/ Simpson Ltd. (Post shares Simpson shares
Ltd.'s shares 10,000 Ltd's merger) owned by Ltd. owned by
issued to shares of shares owned by Wilson (combined Simpson
shareholders outstanding Wilson Ltd.s' Post-merger Ltd.'s

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 Prof. Archana Khetan MERGER & ACQUISITION

of Wilson Wilson after Ltd.'s shareholders owned by shareholders

Ltd. Ltd.] merger shareholders [(4) × Simpson [(6) ×
[50,000 + [(1)/(3)] 35,00,000] Ltd.s’ 35,00,000]
(1)] shareholders
[50,000/ (3)]
(2) (3) (4) (5) (6) (7)

20,000 2 70,000 2/7 10,00,000 5/7 25,00,000

25,000 2.5 75,000 1/3 11,66,667 2/3 23,33,333
30,000 3 80,000 3/8 13,12,500 5/8 21,87,500
Thus from above it is clear that except case of exchange ratio of 20,000 shares, in
remaining cases the value of shares will increase for both companies.

14. Yes Ltd. wants to acquire No Ltd. and the cash flows of Yes Ltd. and the merged entity
are given below:
(`lakhs)
Year 1 2 3 4 5
Yes Ltd. 175 200 320 340 350
Merged Entity 400 450 523 590 620
Earnings would have witnessed 5% constant growth rate without merger and 6% with
merger on account of economies of operations after 5 years in each case. The cost of
capital is 15%.
The number of shares outstanding in both the companies before the merger is the same
and the companies agree to an exchange ratio of 0.5 shares of Yes Ltd. for each share of
No Ltd.
PV factor at 15% for years 1-5 are 0.870, 0.756; 0.658, 0.572, 0.497 respectively.
You are required to:
i. Compute the Value of Yes Ltd. before and after merger
ii. Value of Acquisition and
iii. Gain to shareholders of Yes Ltd.
Sol. i. Working Notes:
Present Value of Cash Flows (CF) up to 5 years
Year End CF of Yes PVF @ PV of CF CF of PV of CF of
Ltd. 15% (` lakhs) Merged Merged
(` lakhs) Entity Entity
(` lakhs) (` lakhs)
1 175 0.870 152.25 400 348.00
2 200 0.756 151.20 450 340.20
3 320 0.658 210.56 525 345.45

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MERGER & ACQUISITIONS KHETAN EDUCATION
4 340 0.572 194.48 590 337.48
5 350 0.497 173.95 620 308.14
882.44 1679.27
PV of Cash Flows of Yes Ltd. after the forecast period
CF (1 + g) 350(1 + 0.05) 367.50
TV = 5 = = = ` 3675 lakhs
ke - g 0.15 - 0.05 0.10
PV of TV5 = ` 3675 lakhs × 0.497 = `1826.475 lakhs
PV of Cash Flows of Merged Entity after the forecast period
CF5 (1 + g) 620(1 + 0.06) 657.20
TV5 = = = = 7302.22 lakhs
ke - g 0.15 - 0.06 0.09
PV of TV5 = ` 7302.22 lakhs × 0.497 = ` 3629.20 lakhs
i. Value of Yes Ltd.
Before merger (`lakhs) After merger (` lakhs)
PV of CF (1-5 years) 882.440 1679.27
Add: PV of TV5 1826.475 3629.20
2708..915 5308.47
ii. Value of Acquisition
= Value of Merged Entity – Value of Yes Ltd.
= ` 5308.47 lakhs – ` 2708.915 lakhs = ` 2599.555 lakhs
iii. Gain to Shareholders of Yes Ltd.
Share of Yes Ltd. in merged entity
1
= ` 5308.47 lakhs × = ` 3538.98 lakhs
1.5
Gain to shareholder
= Share of Yes Ltd. in merged entity – Value of Yes Ltd. before merger
= ` 3538.98 lakhs - ` 2708.915 = ` 830.065 lakhs

15. XY Ltd. Has two major operating divisions, furniture manufacturing and real estate,
with revenues of ` 2,600 crore and ` 6,200 crore respectively. Following financial
information is available.
Balance Sheet as on 31-3-2015
Liabilities Amount Assets Amount
(`Crore) (`Crore)
Ordinary shares (` 10 per share) 500 Land and Buildings 800
Reserves 1,300 Plant and Machinery 1,400
Secured Term Loans 600 Current Assets 2,500
13% Debenture (` 100 Par 500
Current Liabilities 1,800

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Prof. Archana Khetan MERGER & ACQUISITION

4,700 4,700

Summarised cash flow data for XY Ltd. is as follows:

Amount (`Crore)
Sales 8,800
Operating expenses 8,030
Head Office Expenses 80
Interest 110
Taxation 140
150
The company's current share price is ` 118.40, and each debenture is trading in
market at `131.
Projected financial data (in `Crore) in real terms (excluding depreciation) of the two
divisions is as follows:
Year 1 2 3 4 5 6
Onward
Furniture Manufacturing
Operating Profit before Tax 450 480 500 520 570 600
Allocated HO Overheads* 40 40 40 40 40 40
Depreciation 100 80 70 80 80 80
Real Estate
Operating Profit before Tax 320 400 420 440 460 500
Allocated HO Overheads* 40 30 30 30 30 30
Depreciation 50 50 50 50 50 50
* Allocated HO Overheads reflect actual cash flows.
Other Information:
• Applicable Corporate tax rate is of 30%, payable in the year, the relevant cash flow
arises.
• Inflation is expected to remain at approximately 3% per year.
• The risk free rate is 5.5% and the market return14%.
• XY Ltd.’s equity beta is1.15.
• The average equity betas in the Furniture Manufacturing and Realty Sectors are 1.3
and 0.9 respectively and the gearing levels in Furniture Manufacturing and Realty
sectors by market values are 70% equity 30% debt and 80% equity 20% debt
respectively.
• The current cost of the debentures and long term loan are almost identical.
• The debentures are redeemable at par in 15 years' time.
The company is considering a demerger whereby the two divisions shall be floated
separately on the stock market.
Terms of Demerger
1. The debentures would be serviced by the real estate division and the long term loans

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MERGER & ACQUISITIONS KHETAN EDUCATION
by the furniture manufacturing division.
2. The existing equity would be split evenly between the divisions, although new
ordinary shares would be issued to replace existing shares.
3. If a demerger occurs allocated overhead would rise to `60 crore per year for each
company.
4. Demerger would involve single one time after tax cost of `160 crore in the first
year which would be shared equally by the two companies. There would be no
other significant impact on expected cashflows.
Required:
Using real cash flows and time horizon of 15 year time and infinite period, evaluates
whether or not it is expected to be financially advantageous to the original shareholders
of XY Ltd. for the company to separately float the two divisions on the stock market.

Note : In any gearing estimates the Furniture Manufacturing division may be assumed to
comprise 55% of the market value of equity of XY Ltd, and Real Estate division 45%.

Year 1 2 3 4 5 6-15
PVAF @ 10% 0.909 0.821 0.751 0.683 0.621 3.815
PVAF @ 8.5% 0.922 0.849 0.783 0.722 0.665 4.364
Sln. To decide whether the XY Ltd. should go for the option of demerger i.e. floating two
companies for Furniture Manufacturing business and Real Estate we should compare their
values.
Working Notes:
i. Calculation of Discounting Rates
a. For Furniture Manufacturing
Market Value of Debt (Secured Loan) ` 600.00 crore
Market Value of Equity (` 118.40 × 50 crore × 55%) ` 3256.00 crore
Total × 3856.00 crore
Gearing Levels
Equity Debt
3256.00
= 84.44%
3856.00
600.00
= 15.56%
3856.00
Since this level of gearing differs from the gearing level of industry to find out the beta
we must re-gear the asset beta taking into account the current structure. Assuming Debt
to be risk free let us de-gear the beta as follows:
bL
bu =
[1 + (1 - T)D / E]
Accordingly,

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Prof. Archana Khetan MERGER & ACQUISITION

1.30
bu =
[1 + (1 - 0.30)30 / 70]
Re-gearing
βL = βU [1+ (1 – T) D / E]
βL = 1.00 [1+ (1 – 0.30) 15.56/ 84.44] = 1.129
Cost of Equity using CAPM
Ke = 5.50% + 1.129(14% - 5.50%) =15.10%
Cost of Debt using Short Cut Method
(100 - 131)
13(1 - 0.30) +
Kd = 15 = 0.0609 i.e. 6.0
100 + 31
2
WACC of Furniture Manufacturing Division
15.10% × 84.44% + 6.09% × 15.56% = 13.70%
(1 + No min al Rate) (1 + 0.1370)
Real WACC = -1 = - 1 = 10.39 say 10%
(1 + Inflation Rate) (1 + 0.03)
b. For Real Estate
Market Value of Debt (Secured Loan) ` 655.00crore
Market Value of Equity (` 118.40 × 50 crore × 45%) ` 2,664.00 crore
Total ` 3,319.00 crore
Gearing Levels
Equity Debt
2, 664.00 655.00
= 19.73%
3,319.00 3,319.00
Since this level of gearing is almost equal to the gearing level of industry the beta of
industry shall be the beta of Real Estate Division and Cost of Equity using CAPM will
be:
Ke = 5.50% + 0.90(14% - 5.50%) =13.15%
WACC of Real Estate Division
13.15% × 80.27% + 6.09% × 19.73% = 11.76%
(1 + No min al Rate) (1 + 0.1176)
Real WACC = -1 = = -1 = 0.085
(1 + Inflation Rate) (1 + 0.03)
ii. Calculation of Value of Both Division
a. Furniture Manufacturing
Year 1 2 3 4 5 6
Onward
Operating Profit 450 480 500 520 570 600
before Tax

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Allocated HO 60 60 60 60 60 60
Overheads
Depreciation 100 80 70 80 80 80
290 340 370 380 430 460
Less: Tax @ 30% 87 102 111 114 129 138
203 238 259 266 301 322
Add: Depreciation 100 80 70 80 80 80
303 318 329 346 381 402
Less: One Time Cost 80 - - - - -
223 318 329 346 381 402
PVF @ 10% 0.909 0.826 0.751 0.683 0.621
202.71 262.67 247.08 236.32 236.60
402
Terminal Value = × 0.621 = 2496.42
0.10
Total Value of Furniture Manufacturing Division (Infinite Period)
= ` 3681.80 crore
Total Value of Furniture Manufacturing Division (15 years)
= `1185.38 crore + `402 crore× 3.815 = `2719.01 crore

b. Real Estate Business

Year 1 2 3 4 5 6
Onward
Operating Profit 320 400 420 440 460 500
before Tax
Allocated HO 60 60 60 60 60 60
Overheads
Depreciation 50 50 50 50 50 50
210 290 310 330 350 390
Less: Tax @ 30% 63 87 93 99 105 117
147 203 217 231 245 273
Add: Depreciation 50 50 50 50 50 50
197 253 267 281 295 323
Less: One Time Cost 80 - - - - -
117 253 267 281 295 323
PVF @ 8.5% 0.922 0.849 0.783 0.722 0.665 -
PV 107.87 214.80 209.09 202.88 196.18 -
323
Terminal value = 0.665 = 2527.00
0.085

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Prof. Archana Khetan MERGER & ACQUISITION

Total Value of Furniture Manufacturing Division (Infinite Period) = ` 3457.79 crore

Total Value of Furniture Manufacturing Division (15 years)
= ` 930.79 crore + ` 323 crore× 4.364 = ` 2340.36 crore
SUMMARY
Total of two divisions (Infinite Period)
= ` 3,681.80 crore + ` 3,457.79 crore – ` 1,255.00 crore
= ` 5,884.59 crore
Total of two divisions (15 years horizon)
= ` 2,719.01 crore + ` 2,340.36 crore – ` 1,255.00 crore
= ` 3,804.37 crore Current Market Value of Equity
= ` 118.40 × 50 crore
= ` 5,920.00 crore
Decision: Since the total of the two separate divisions with both time horizons (Infinite
and 15 years) is less than the Current Value of Equity demerger is not advisable.

16. Two companies Bull Ltd. and Bear Ltd. recently have been merged. The merger initiative
has been taken by Bull Ltd. to achieve a lower risk profile for the combined firm in spite
of fact that both companies belong to different industries and disclose a little co-
movement in their profit earning streams. Though there is likely to synergy benefits to
the tune of `7 crore from proposed merger. Further both companies are equity financed
and other details are asfollows:
MarketCapitalization Beta
Bull Ltd. `1000crore 1.50
Bear Ltd. `500 crore 0.60
Expected Market Return and Risk Free Rate of Return are 13% and 8% respectively.
Shares of merged entity have been distributed in the ratio of 2:1 i.e. market capitalization
just before merger. You are required to:
a. Calculate return on shares of both companies before merger and after merger.
b. Calculate the impact of merger on Mr. X, a shareholder holding 4% shares in Bull
Ltd. and 2% share of Bear Ltd.
Sln. a. Expected Return using CAPM
i. Before Merger
Share of Bull Ltd. 8% +1.50 (13% -8%) =15.50%
Share of Bear Ltd. 8% + 0.60 (13% - 8%) =11.00%

ii. After Merger

Beta of merged company shall be weighed average of beta of both companies as follows:
2
´ 1.50 + 0.60 = 1.20
3

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MERGER & ACQUISITIONS KHETAN EDUCATION
Thus, expected return shall be:
8% + 1.20 (13% - 8%) = 14%

b. Impact of merger on Mr. X

After merger his % holding in merged company shall be:
2 1 1
´ 4% + ´ 2% = 3 %
3 3 3
The value of Mr. X’s holdings before merger was:
Bull Ltd. 4% × `1000 crore ` 40crorecrorerore
Bear Ltd. 2% × `500 crore ` 10 crore
` 50 crore
To compute the value of holding of Mr. X, after merger first we have to compute the
value of merged entity as follows:
Bull Ltd. 4% × ` 1000 crore ` 155 crore
Bear Ltd. 11 % × ` 500 crore ` 55 crore
Synergy Benefits ` 7 crore
` 217 crore
217 crore
Market Capitalization of Merged Entity = = 1550 crore
0.14

Value of Mr. X’s holding = `51.67crore. æç ` 1550 crore × 3 % ö÷

1
è 3 ø

17. Teer Ltd. is considering acquisition of Nishana Ltd. CFO of Teer Ltd. is of opinion that
Nishana Ltd. will be able to generate operating cash flows (after deducting necessary
capital expenditure) of `10 crore per annum for 5years.
The following additional information was not considered in the above estimations.
i. Office premises of Nishana Ltd. can be disposed of and its staff can be relocated in
Teer Ltd.’s office not impacting the operating cash flows of either businesses.
However, this action will generate an immediate capital gain of ` 20 crore.
ii. Synergy Gain of ` 2 crore per annum is expected to be accrued from the proposed
acquisition.
iii. Nishana Ltd. has outstanding Debentures having a market value of ` 15 crore. It
has no other debts.
iv. It is also estimated that after 5 years if necessary, Nishana Ltd. can also be
disposed of for an amount equal to five times its operating annual cashflow.
Calculate the maximum price to be paid for Nishana Ltd. if cost of capital of Teer Ltd. is
20%. Ignore any type of taxation.
Sol. Calculation of Maximum Price to be paid for the acquisition of Nishana Ltd.
(` Crore)

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Prof. Archana Khetan MERGER & ACQUISITION

Year 0 1 2 3 4 5
Operating cash flow - 10.00 10.00 10.00 10.00 10.00
Gain on Sale of office 20.00 - - - - -
premises
Synergy Benefits - 2.00 2.00 2.00 2.00 2.00
Disposal of Nishana - - - - - 50.00
Ltd.
Net cash flow 20.00 12.00 12.00 12.00 12.00 62.00
PVF @ 20% 1 0.833 0.694 0.579 0.482 0.402
Present value 20.00 10.00 8.324 6.948 5.784 24.924

Total of Present value 75.984

Less: Market Value of Debentures (15.000)
60.984
Thus, the maximum price to be paid for acquisition of Nishana Ltd. ` 60.984 crore.

18. The following data pertains to XYZ Inc. engaged in software consultancy business as on
31 December 2010. ($ Million)
Income from consultancy 935.00
EBIT 180.00
Less: Interest on Loan 18.00
EBT 162.00
Tax @ 35% 56.70
105.30

Balance Sheet ($ Million)

Liabilities Amount Assets Amount
Equity Stock (10 million 100 Land and Building 200
share @ $ 10 each) Computers & Softwares 295
Reserves & Surplus 325 Current Assets:
Loans 180 Debtors 150
Current Liabilities 180 Bank 100
Cash 40 290
785 785
With the above information and following assumption you are required to compute.
a. Economic Value Added®
b. Market Value Added.

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MERGER & ACQUISITIONS KHETAN EDUCATION
Assuming that:
i. WACC is12%
ii. The share of company currently quoted at $ 50each
Sol. a. Determination of Economic value added(EVA) $ Million
EBIT 180.00
Less: Taxes @ 35% 63.00
Net Operating Profile after Tax Less: 117.00
Cost of Capital Employed [W.No.1] 72.60
Economic Value Added 44.40

b. $ Million
Market value of Equity Stock [W. No. 2] 500
Equity Fund [W. No. 3] 425
Market Value Added 75

Working Notes:
1. Total Capital Employed
Equity Stock $ 100 Million
Reserve and Surplus $ 325 Million
Loan $ 180 Million
WACC $ 605 Million
Cost of Capital employed $ 605Million х 12% 12%
2. Market Price per equity share (A) $ 72.60 Million
No. of equity share outstanding (B) $ 50
Market value of equity stock (A) х(B) 10 Million
3. Equity Fund $ 500 Million
Equity Stock
Reserves &Surplus $ 100 Million
$ 325 Million
$ 425 Million

19. The CEO of a company thinks that shareholders always look for EPS. Therefore he
considers maximization of EPS as his company's objective. His company's current Net
Profits are `80.00 lakhs and P/E multiple is 10.5. He wants to buy another firm which
has current income of `15.75 lakhs & P/E multiple of 10.
What is the maximum exchange ratio which the CEO should offer so that he could keep
EPS at the current level, given that the current market price of both the acquirer and the
target company are `42 and`105 respectively?

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Prof. Archana Khetan MERGER & ACQUISITION

If the CEO borrows funds at 15% and buys out Target Company by paying cash, how
much should he offer to maintain his EPS? Assume tax rate of30%.
Sol. i.
Acquirer Company Target Company
Net Profit ` 80 lakhs ` 15.75 lakhs
PE Multiple 10.50 10.00
Market Capitalization ` 840 lakhs ` 157.50 lakhs
Market Price `42 ` 105
No. of Shares 20 lakhs 1.50 lakhs
EPS `4 ` 10.50
Maximum Exchange Ratio 4 : 10.50 or 1 : 2.625.
Thus, for every one share of Target Company 2.625 shares of Acquirer Company.
ii. Let x lakhs be the amount paid by Acquirer company to Target Company. Then to
maintain same EPS i.e. ` 4 the number of shares to be issued will be:
(80 lakhs + 15.75 lakhs) - 0.70 ´ 15% ´ X
=4
20 lakhs
95.75 - 0.105x
=4
20
x = ` 150 lakhs
Thus, ` 150 lakhs shall be offer Edincashto Target Company to maintain same EPS.

20. 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.
Sol. Exchange ratio in proportion to relative EPS
Company Existing No. of shares EPS Total earnings
Cauliflower Ltd. 5,00,000 5.00 25,00,000
Cabbage Ltd. 3,00,000 3.00 9,00,000
Total earnings 34,00,000
No. of shares after merger 5,00,000 + 1,80,000 = 6,80,000

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MERGER & ACQUISITIONS KHETAN EDUCATION

æ 3.00 ö
Note : 1,80,000 may be calculated as = ç 3, 00, 000 ´ ÷
è 5.00 ø
34,00,000
EPS for Cauliflower Ltd. after merger Impact on EPS = = ` 5.00
6,80,000
`
Cauliflower Ltd. shareholders
EPS before merger 5.00
EPS after merger Increase/ 5.00
Decrease in EPS 0.00
Cabbage Ltd.' Shareholders
EPS before merger 3.00
EPS after the merger 5.00 × 3/5 3.00
Increase/ Decrease in EPS 0.00

Merger effect on EPS with share exchange ratio of 1 : 2

Total earnings after merger `
34,00,000.00
No. of shares post merger 5,00,000 + 1,50,000 (0.5 × 3,00,000) 6,50,000.00
EPS (34,00,000 ÷ 6,50,000) 5.23

Impact on EPS
`
Cauliflower Ltd. shareholders
EPS before merger 5.0000
EPS after merger 5.2300
Increase in EPS 0.2300
Cabbage Ltd.' Shareholders
EPS before merger 3.0000
EPS after the merger 5.23 × 0.5 2.6150
Decrease in EPS 0.3850

21. Longitude Limited is in the process of acquiring Latitude Limited on a share exchange
basis. Following relevant data are available:

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Prof. Archana Khetan MERGER & ACQUISITION

Longitude Latitude
Limited Limited
Profit after Tax (PAT) ` in Lakhs 140 60
Number of Shares Lakhs 15 16
Earning per Share (EPS) ` 8 5
Price Earnings Ratio (P/E Ratio) 15 10
(Ignore Synergy)
You are required to determine:
i. Pre-merger Market Value per Share, and
ii. The maximum exchange ratio Longitude Limited can offer without the dilution of
1. EPS and
2. Market Value per Share
Calculate Ratio/s up to four decimal points and amounts and number of shares up to two
decimal points.
Sol. i. Pre -Merger Market Value of Per Share P/E Ratio XEPS
Longitude Ltd. `8×15 = `120.00
Latitude Ltd. `5×10 = `50.00

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 (` 200 25 Lakhs
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. ` 1,800 Lakhs
(` 120 × 15Lakhs)
Pre -Merger Market Capitalization of Latitude Ltd. ` 800 Lakhs
(` 50 × 16Lakhs)
Combined Market Capitalization ` 2,600 Lakhs
Current Market Price of share of Longitude Ltd. ` 120
Maximum number of shares to be exchanged of Longitude 21.67 Lakhs

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(surviving company) (` 2600 Lakhs/` 120) 15.00 Lakhs
Current Number of Shares of Longitude Ltd. 6.67 Lakhs
Maximum number of shares to be exchanged (Lakhs)
Maximum share exchange ratio 6.67:16 or 0.4169:1

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

Pre -Merger PAT of Longitude Ltd. `120 Lakhs
Pre -Merger PAT of Latitude Ltd. ` 80 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 15Lakhs
Maximum number of shares to be exchanged 10Lakhs
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. ` 1,800 Lakhs
(` 120 × 15 Lakhs)
Pre-Merger Market Capitalization of Latitude Ltd. ` 800 Lakhs
(` 50 ×16 Lakhs)
Combined Market Capitalization ` 2,600 Lakhs
Current Market Price of share of Longitude Ltd. ` 120
Maximum number of shares to be exchanged of Longitude 21.67 Lakhs
(surviving company) (` 2600 Lakhs/` 120) 15.00 Lakhs
Current Number of Shares of Longitude Ltd 6.67 Lakhs
Maximum number of shares to be exchanged (Lakhs)
Maximum share exchange ratio 6.67:16 or 0.4169:1

22. AXE Ltd. is interested to acquire PB Ltd. AXE has 50,00,000 shares of ` 10 each,
which are presently being quoted at ` 25 per share. On the other hand PB has
20,00,000 share of `10 each currently selling at ` 17. AXE and PB have EPS of `
3.20 and ` 2.40 respectively.
You are required to:
a. Show the impact of merger on EPS, in case if exchange ratio is based on relative
proportion of EPS.

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Prof. Archana Khetan MERGER & ACQUISITION

b. Suppose, if AXE quote an offer of share exchange ratio of 1:1, then should PB
accept the offer or not, assuming that there will be no change in PE ratio of AXE
after the merger.
c. The maximum ratio likely to acceptable to management of AXE.
Sol.
` 240 ( EPS of PBLtd.)
a. Exchange Ratio =
`3.20 ( EPS of AXE Ltd.)
= 0.75
Earning of AXE Ltd. = ` 3.20 × 50,00,000 = `1,60,00,000
Earning of PB Ltd. = ` 2.40 × 20,00,000 = ` 48,00,000
Combined earnings after merger = ` 2,08,00,000
Total No. of shares to be issued to PB Ltd. 0.75 × 20,00,000 = 15,00,000
Existing No. of Shares of AXE Ltd. = 50,00,000
65,00,000
208, 00, 000
EPS after Merger =
65, 00, 000
= ` 3.20

Statement showing impact on EPS

AXE Ltd. ` PB Ltd. `
EPS before merger 3.20 2.40
EPS after merger (Equivalent in case of PB Ltd.) 3.20 2.40
Thus, there is will be no change in EPS for shareholder of both companies

b. No. of shares to be issued to AB Ltd. (1:1) 20,00,000

AXE Ltd. PB Ltd.
EAT (`) (A) 160,00,000 48,00,000
No. of Shares (B) 50,00,000 20,00,000
EPS (A)/(B) 3.20 2.40
Market Price Per Share 25 17
PE Ratio 7.8125 7.0833
Market Value of Company AXE Ltd. ` 1,250 ` 340
(50,00,000 × ` 25) lakh lakh
PB Ltd. (20,00,000 × `17)

Position after Merger

EAT after Merger(`160+`48)lakhs(C) 208,00,000

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MERGER & ACQUISITIONS KHETAN EDUCATION
No. of Shares(50,00,000+20,00,000)(D) 70,00,000
EPS after merger (C)/(D) =(E) 208/70
PE Ratio of merger company consuming same as a AXE Ltd. 7.8125
(F)
MPS (E) × (F) = (G) 23.21
Market Value of Merged Entity = (G) × (D) = (H) `1624.70lakh
Gain from Merger [(H) - `1,250 lakhs - ` 340 lakhs)] 34.70lakhs

Gain to Shareholders of PB Ltd.

` in lakh
Post-Merger Value of PB Ltd. (20,00,000 × ` 23.21) 464.20
Less: Pre-Merger Value 340.00
Gain to Shareholders of PB Ltd. 124.20
Thus PB Ltd. should accept the offer.

23. Given is the following information:

Day Ltd. Night Ltd.
Net Earnings ` 5 crores ` 3.5 crores
No. of Equity Shares 10,00,000 7,00,000

The shares of Day Ltd. and Night Ltd. trade at 20 and 15 times their respective P/E ratios.
Day Ltd. considers taking over Night Ltd. By paying ` 55 crores considering that the
market price of Night Ltd. reflects its true value. It is considering both the following
options:
i. Takeover is funded entirely in cash.
ii. Takeover is funded entirely in stock.
You are required to calculate the cost of the takeover and adivse Day Ltd. on the best
alternative.

Sol. Working Notes:

Day Ltd. Night Ltd.
Net Earnings ` 5 crores ` 3.5 crores
No. of Equity Shares 10,00,000 7,00,000
EPS 50 50
P/E 20 times 15 times
MPS ` 1000 ` 750
Market Value 1,00,00,00,000 52,50,00,000

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Prof. Archana Khetan MERGER & ACQUISITION

24. Longitude Limited is in the process of acquiring Latitude Limited on a share exchange
basis.
Following relevant data are available:
Longitude Latitude
Limited Limited
Profit after Tax (PAT) ` in Lakhs 140 60
Number of Share (EPS) Lakhs 15 16
Earnings Per Share (EPS) ` 8 5
Price Earnings Ratio (P/E Ratio) 15 10
(Ignore Synergy)

You are required to determine:

i. Pre-merger Market Value per Share, and
ii. The maximum exchange ratio Longitude Limited can offer without the dilution of
1. EPS and
2. Market Value per Share
Calculate Ratio/ s up to four decimal points and amounts and number of shares upto two
decimal points.
Sol.
i. Pre-Merger Market Value of Per Share = P/E Ratio × EPS
Longitude Ltd. ` 8 × 15 = ` 120.00
Latitude Ltd. ` 5 × 10 = ` 50.00
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 (` 200 25 Lakhs
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. (` 120 × ` 1,800 Lakhs
15 Lakhs)

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MERGER & ACQUISITIONS KHETAN EDUCATION
Pre-Merger Market Capitalization of Latitude Ltd. (` 50 × 16 ` 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 21.67 Lakhs
(surviving company) (` 2600 Lakhs/ ` 120)
Current Number shares of Longitude Ltd. 15.00 Lakhs
Maximum number of shares to be exchanged 6.67 Lakhs

Maximum share exchange ratio 6.67:16 or 0.4169:1

Note: Since in the question figures given of PAT of both companies are not matching with
figures of EPS × 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

Pre-Merger PAT of Longitude Ltd. ` 120 Lakhs
Pre-Merger PAT of Latitude Ltd. ` 80 Lakhs
Combined PAT ` 200 Lakhs
Longitude Ltd’s EPS `8
Maximum number of shares of Longitude after merger (` 200 lakhs/ 25 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. (` 120 × ` 1,800 Lakhs
15 Lakhs)
Pre-Merger Market Capitalization of Latitude Ltd. (` 50 × 16 ` 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 21.67 Lakhs
(surviving company) (` 2600 Lakhs/ ` 120)
Current Number shares of Longitude Ltd. 15.00 Lakhs
Maximum number of shares to be exchanged 6.67 Lakhs

Maximum share exchange ratio 6.67:16 or 0.4169:1

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Prof. Archana Khetan MERGER & ACQUISITION

25. The CEO of a company thinks the shareholders always look for EPS. Therefore, he
considers maximization of EPS as his company’s objective. His company’s current Net
Profits are ` 80.00 lakhs P / E multiple is 10.5. He wants to buy another firm which has
current income of ` 15.75 lakhs & P / E multiple of 10.
What is the maximum exchange ratio which the CEO should offer so that he could keep
EPS at the current level, given that the current market price of both the acquirer and the
target company are ` 42 and ` 105 respectively?
If the CEO borrows funds at 15% and buys out Target Company by paying cash, how
much should he offer to maintain his EPS? Assume tax rate of 30%
Sol.
i.
Acquirer Company Target Company
Net Profit ` 80 Lakhs ` 15.75 lakhs
PE Multiple 10.50 10.00
Market Capitalization ` 840 lakhs ` 157.50 lakhs
Market Price ` 42 ` 105
No. of Shares 20 Lakhs 1.50 lakhs
EPS `4 ` 10.50

Maximum Exchange Ratio 4: 10.50 or 1: 2.625

Thus, for every one share of Target Company 2.625 shares of Acquirer Company.

ii. Let x lakhs be the amount paid by Acquirer company to Target Company. Then to
maintain same EPS i.e. ` 4 the number of shares to be issued will be:
(80 lakhs + 15.75 lakhs) -0.70 × 15% × x
=4
20lakhs
95.75 - 0.105 x
=4
20
x = ` 150 lakhs
Thus, ` 150 lakhs shall be offered in cash to Target Company to maintain same EPS.

26. R Ltd. and S Ltd. operating in same industry are not experiencing any rapid growth but
providing a steady stream of earnings. R Ltd.’s management is interested in acquisition
of S. Ltd. due to its excess plant capacity. Share of S Ltd. is trading in market at ` 3.20
each. Other data relating to S Ltd. is as follows:
Balance Sheet of S Ltd.
Liabilities Amount (`) Assets Amount (`)
Current Liabilities 1,59,80,000 Current Assets 2,48,75,000
Long Term Liabilities 1,28,00,000 Other Assets 94,00,000

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MERGER & ACQUISITIONS KHETAN EDUCATION
Reserve & Surplus 2,79,95,000 Property plants 3,45,00,000
& Equipment
Share Capital ( 80 Lakhs shares 1,20,00,000
of ` 1.5 each)
Total 6,87,75,000 Total 6,87,75,00

Particulars R Ltd (`) S Ltd. (`) Combined

Entity (`)
Profit after Tax 86,50,000 49,72,000 1,21,85,000
Residual Net Cash Flows per 90,10,000 54,87,000 1,85,00,000
year
Required return on equity 13.75% 13.05 12.5%

You are required to compute the following:

i. Minimum price per share S Ltd. should accept from R Ltd.
ii. Maximum price per share R Ltd. shall be willing to offer to S Ltd.
ii. Floor Value of per share of S Ltd., whether it shall play any role in decision for its
acquisition by R Ltd.
Sol.
i. Calculation of Minimum price per share S Ltd. should accept from R Ltd.
Value of S Ltd. Residual cash flow 54,87,000
= = = 4,20,45,977
k e-g 0.1305 - 0
Value per share of S Ltd. 4, 20, 45,977
= = ` 5.26
80, 00, 000
Book Value of per share of S Ltd. 3,99,95, 000
= = ` 4.99 or ` 5
80, 00, 000

Therefore, the minimum price per share S ltd. should accept from R Ltd. is ` 5 (current
book value)

ii. Calculation of Maximum price per share R Ltd. shall be willing to offer to S Ltd.
Residual Cash Flow 90,10,000
Value of R Ltd. = = = ` 6,55,27,273
K e -g 0.1375 - 0
1,85,00,000
Value of combined entity = = ` 14,80,00,000
0.125 - 0
Value of synergy = Value of combined entity – individual values of R Ltd. and S
Ltd.

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Prof. Archana Khetan MERGER & ACQUISITION

= `14,80,00,000 – (` 4,20,45,977 + ` 6,55,27,273)

= ` 4,04,26,750
Maximum price per share R Ltd. shall be willing to offer to S Ltd. shall be
computed as follows:
value of S Ltd.as per Residual cash flows + Synergy benefits No
=
No. of Shares
4, 20, 45,977 + 4,04, 26,750
=
80,00,000
= ` 10.31

iii. Floor value of per share of S Ltd shall be ` 3.20 (current market price) and it shall not
play any role in decision for the acquisition of S Ltd. as it is lower than its current book
value.

27. MS stones has different divisions of home interiors products. Recently, due to economic
slowdown, the Managing Director of the Company expressed it desire to divestiture its
ceramic tile business. The relevant financial details of this business are as follows:
Estimated Pre- Tax Cash Flow Next Year = ` 200 Crore
Book Value of Liabilities = ` 780 Crore
In an order to increase its share in the market, the Tripati Tiles Ltd. showed its interest in
the acquisition of this unit and offered a proceed of ` 950 Crore for the same to MS
Stones. The other data pertaining to the business are as follows:
Tax rate 30%
Growth Rate 4%
Applicable Discount Rate for Tile Business 12%
If market value of liabilities is ` 40 Crore more than book value, you are required to
advice MD whether she should go for divestiture of the tile business or not.
Sol. First of all we shall compute PV of Cash inflows as follows:
200 crore (1 - 0.30)
PVCF = = ` 1750 Crore
0.12 - 0.04
Market Value of Liabilities = ` 780 Crore + ` 40 core = ` 820 Crore
Net Asset Value = ` 930 Crore
Since, the Tripati Tiles is offering ` 950 Crore, more than Net Asset Value of ` 930 Crore,
the company should go further with decision of divesture of tile business.

28. XYZ, a large business house is planning to acquire ABC another business entity in similar
line of business. XYZ has expressed in interest in making a bid for ABC. XYZ expects
that after acquisition the annual earning of ABC will increase by 10%.

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MERGER & ACQUISITIONS KHETAN EDUCATION
Following information, ignoring any potential synergistic benefits arising out of
possible acquisitions, are available:
XYZ ABC Proxy entity for XYZ
& ABC in the same
line of business
Paid up capital ( ` Crore ) 1025 106 --
Face Value of Share is ` 10
Current share price ` 129.60 ` 55 -
Debt : Equity ( at market values ) 1:2 1:3 1:4
Equity Beta -- -- 1.1
Sol. b ungreared for the proxy company
= 1.1 × 4 / [4 + (1 – 0.3)] = 0.9362
0.9362 = b Geared of XYZ × 2/[2+(1-0.3)]
b Geared of XYZ = 1.264
0.9362 = b Geared of ABC × 3[3+(1-0.3)]
b Geared of ABC = 1.155
XYZ ABC Total
No. of Share (1) ` 1,025crore ` 106 crore --
= =
` 10 ` 10
102.50 crore 10.60 crore
Current share price ` 129.60 ` 55 --
(2)
Market Value (3) ` 13,284 crore ` 583 crore ` 13,867 crore
Equity beta (4) 1.264 1.155
Market Value × ` 61,790.976 crore ` 673.365 crore ` 17,464.341 crore
Equity beta
` 17,464.341 crore
Portfolio Beta after Merger = = 1.26
` 13,867 crore

29. Equity of KGF Ltd. (KGFL) is ` 410 Crores, its debt, is worth ` 170 Crores. Printer
Division segments value is attributable to 74%, which has an Asset Beta (bP) of 1.45,
balance value is applied on Spares and Consumables Division, which has an Asset Beta
(bSC) of 1.20 KGFL Debt beta (bD) is 0.24.
You are required to calculate:
i. Equity Beta (bE)
ii. Ascertain Equity Beta (bE), if KGF Ltd. decides to change its Debt Equity position
by raising further debt and buying back of equity to have its Debt Equity Ratio at
1.90. Assume that the present Debt Beta (bD1) is 0.35 and any further funds raised
by way of Debt will have a Beta (bD2) of 0.40.

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Prof. Archana Khetan MERGER & ACQUISITION

iii.Whether the new Equity Beta (bE) justifies increase in the value of equity an account
of leverage?
Sol. i. Equity Beta
To calculate Equity Beta first we shall calculate Weighted Average of Asset Beta as
follows:
= 1.45 × 0.74 + 1.20 × 0.26
= 1.073 + 0.312 = 1.385
Now we shall compute Equity Beta using the following formula:
é E ù é D(i - t) ù
bAsset = bEquity ê ú + β Debt ê ú
ë E+D(i - t) û ë E+D(i - t) û
Accordingly,
é 410 ù é 170 ù
1.385 = bEquity ê + β
ë 410 + 170 úû êë 410 + 170 úû
Debt

é 410 ù é 170 ù
1.3885 = bEquity ê + 0.24
ë 580 úû êë 580 úû

bEquity = 1.86

ii. Equity Beta on change in Capital Structure

Amount of Debt to be raised:
Particular Value
Total Value of Firm ( Equity ` 410 Cr + Debt ` 170 Cr ) ` 580 Cr
Desired Debt Equity Ratio 1.90 : 1.00
Desired Debt Level = ` 380 Cr
Less : Value of Existing Debt (` 170 Cr)
Value of Debt to be Raised ` 210 Cr

Equity after Repurchase = Total value of firm – Desired Debt Value

= ` 580 Cr - ` 380 Cr
= ` 200 Cr

Weighted Average Beta of KGFL:

Source of Investment Weight Beta of the Weighted Beta
Finance ( ` Cr ) Division
Equity 200 0.345 0.345x
Debt – 1 170 0.293 0.35 0.103
Debt - 2 210 0.362 0.40 0.145

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580 Weighted 0.248 + ( 0.345x)
Average Beta

bKGFL = 0.248 + 0.345x

1.385 = 0.248 + 0.345x
0.345x = 1.385 – 0.248
x = 1.137 / 0.345 = 3.296
bKGFL = 3.296

iii. Yes, it justifies the increase as it leads to increase in the Value of Equity due to increase
in Beta.

30. Following information is available of M / s TS Ltd.

PBIT 5.00
Less: Interest on Debt (10%) 1.00
PBT 4.00
Less: Tax @ 25% 1.00
PAT 3.00
No. of outstanding shares of ` 10 each 40 lakh
EPS (`) 7.50
Market price of share (`) 75.00
P / E ratio 10 times

TS Ltd. has an undistributed reserves of ` 8 crores. The company requires ` 3 crores for
the purpose of expansion which is expected to earn the same rate of return on capital
employed as present. However, if the debt to capital employed ratio is higher than 35%,
then P / E ratio is expected to decline to 8 Times and rise in the cost of additional debt to
14%. Given this data which of the following options the company would prefer, and
why?
Option I: If the required amount is raised through debt, and
Option II: If the required amount is raised through equity and the new shares will be
issued at a price of ` 25 each.
Sol. Working Notes :
i. Calculation of Return on Capital Employed (ROCE)
( ` in crores )
Capital Employed:
Share Capital (` 10 × 40 lakhs) 4
Reserve 8
Debt (` 1 cr. × 100 / 10) 10

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22
PBIT 5
ROCE 22.73%

ii. Revised PBIT

Existing Capital Employed 22
Additional 3
ROI 22.73%
Revised PBIT 5.6825

iii. New Debt / Equity

Existing Debt 10
Additional Under Option ( i ) 3
Total Debt 13
Total Equity 12
13
New Debt to Capital Employed Ratio = = 0.52
25
So, P / E Ratio to be reduced to 8 times

10
iv. Debt to Capital Employed Ratio in Option (ii) = = 0.40
25
So, P / E Ratio to be reduced to 8 times in this case also

v. Number of additional shares to be issued in case of Option (ii)

Funds to be raised = ` 3 crore
Price per share = ` 25
No. of additional shares to be issued ` 3 crore/` 25 = 12 lakhs

Particulars Option (I) Option (II)

PBIT (Revised) (` Crore) 5.6825 5.6825
Less : Interest on Debt 1.42 1.00
PBT (` crore) 4.2625 4.6825
Tax @ 25% (` Crore) 1.0656 1.1706
PAT (` Crore) 3.1969 3.5119
No. of share outstanding 40 lakhs 52 lakhs
EPS ` 7.99 ` 6.75
P / E Ratio 8 8

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New Share Price ` 63.92 ` 54.00

Decision: Since the MPS is expected to be more in the case of additional financing done
though debt (Option – 1) Option – 1 is preferred.

31. Strong Ltd., (SL), an all equity financed, conglomerate is in need to borrow `2,000 crore
to finance expansion of its crore current operations. However, SL is susceptible to raise the
amount from the market. The CFO has suggested for divesting one of the two nonprime units
to reduce the overall borrowings from the market. The following data, after internal due
diligence, has been placed for consideration of the Board:
(` in cores)
Particulars Unit Unit 2
Reported Profit After Tax 147 140
Extra Ordinary Gains 16 8
Extra Ordinary Losses 20 12
Expected Profit from the launch of the new product 56 12
Price Earnings Ratio 10 12.5
Corporate Tax Rate (%) 30 30
You are required to advise the Borad on the following:
(i) The price at which the units can be divested,
(ii) The unit which can be divested so as to minimise the borrowings from the market and
(iii) The amount of borrowing.(10 Marks)

(10 Marks)
Sol.
(i) Price at which units can be Divested
(` Crore)
Particulars Unit I Unit II
Reported Profit after Tax (a) 147 140
Reported profit before Tax [(a) /0.70] 210 200
Less: Extra Ordinary Gains 16 8
Add: Extra Ordinary Losses 20 12
214 204
Profit from New Product 56 12
Profit before Tax 270 216
Less : Tax @ 30% 81 64.80
Future Maintainable Profit after Tax (b) 189 151.20
PE Ratio 10 12.5

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Relevant Capitalization Factor æ 1 ö

(c) 10% 8%
ç ÷
è PE Ratio ø

Price of Unit [(b) / (c)] 1890 1890

(ii) The unit I can be divested as it has lower PE Ratio.

(i) The amount of borrowing ` 2000 crore - ` 1890 crore = ` 110 crore

32. ICL is proposing to take over SVL with an objective to diversify. ICL's profit after tax (PAT)
has grown @ 18 per cent per annum and SVL's PAT is grown @ 15 per cent per annum. Both
the companies pay dividend regularly. The summarised Profit & Loss Account of both the
companies are as follows:
` in Crores
Particulars ICL SVL
Net Sales 4,545 1,500
PBlT 2,980 720
Interest 750 25
Provision for Tax 1,440 445
PAT 790 250
Dividends 235 125

ICL SVL
Fixed Assets
Land & Building (Net) 720 190
Plant & Machinery (Net) 900 350
Furniture & Fixtures (Net) 30 1,650 10 550
Current Assets 775 580
Less: Current Liabilities
Creditors 230 130
Overdrafts 35 10
Provision for Tax 145 50
Provision for dividends 60 470 50 240

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Net Assets 1,955 890
Paid up Share Capital (` 10 250 125
per share)
Reserves and Surplus 1,050 1,300 660 785
Borrowing 655 105
Capital Employed 1,955 890

Market Price Share (`) 52 75

ICL's Land & Buildings are stated at current prices. SVL's Land & Buildings are revalued
three years ago. There has been an increase of 30 per cent per year in the value of Land
& Buildings.
SVL is expected to grow @ 18 per cent each year, after merger.
ICL's Management wants to determine the premium on the shares over the current
market price which can be paid on the acquisition of SVL.
You are required to determine the premium using:
(i) Net Worth adjusted for the current value of Land & Buildings plus the estimated
average profit after tax (PAT) for the next five years.
(ii) The dividend growth formula.
(iii) ICL will push forward which method during the course of negotiations?
Period (t) 1 2 3 4 5
FVIF (30%, 1.300 1.690 2.197 2.856 3.713
t)
FVIF (15%, 1.15 2.4725 3.9938 5.7424 7.7537
t)
(12 Marks)
Sol.
(i) Computation of Premium (Net Worth Formula):

Amount ` in Crores
Total Assets (Fixed assets + Current Assets) = (550 + 580) 1130
Less: Liabilities (Current Liabilities + Borrowings) = (240 + 105) 345
Net Assets Value 785
Current Value of Land after growing for three years @ 30% = 190 × 2.197 417.43

Less: Book Value 190.00

Increase in the Value of land 227.43
Adjusted NAV (785 + 227.43) 1012.43
Current Profit after Tax (@15 % for 5 years i.e. 250 × 7.7537 1938.43
Average Profit for 1 year = 1938.43/5 387.69

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Total Value of Firm (1012.43 + 387.69) 1400.12

Total Market Value = No of shares × MPS = 12.50 × 75 937.50
Premium (Total Value – Market Value) 462.62
Premium (%) = 462.62/937.50 * 100 49.35%

(ii) Computation of Premium (Dividend Growth Formula):

Existing Growth Rate 0.15
125 10
DPS=
12.50
MPS 75
æ D1 ö 0.3033
Cost of Equity ç + g ÷ = [(10 × 1.15/75) + 0.15]
è MP ø
Expected growth rate after merger 0.18
Expected Market Price = 10 × [1.18 / (0.3033 - 0.18)] 95.70
Premium over current market price (95.70 - 75)/ 75 × 100 27.60%

Alternatively, if given figure of dividend is considered as D1 then Premium over Current

Market Price shall be computed as follows:

æ D1 ö æ 10 ö 0.2833
Cost of Equity ç + g÷ ç + 0.15 ÷
è P ø è 75 ø

Expected Growth Rate after Merger 0.18

Expected Market Price 10.00 / (0.2833 – 0.18) 96.81
Premium over Current Market Price
(96.81 - 75)/ 75 × 100 29.08%
During the course of negotiations, ICL will push forward valuation based on Growth Rate
Method as it will lead to least cash outflow.

33. Snake Ltd. is taking over Lizard Ltd, both are listed companies. The PE Ratio of Lizard
Ltd. has been low as 4 and high as 7 and is currently 5. Lizard Ltd.`s previous year EPS
was ` 3.40 and current expected EPS this year to be ` 4.00.
Determine the different range of values of shares using P/E Model. (6 Marks)
Sol. The range of values using P/E Ratio and EPS either historic or projected are as follows.
EPS Value (`) P/E Ratio Value Value of
Shares
Historic 3.40 Lowest 4 13.60
Historic 3.40 Current 5 17.00

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Historic 3.40 Highest 7 23.80
Expected 4.00 Lowest 4 16.00
Expected 4.00 Current 5 20.00
Expected 4.00 Highest 7 28.00

33. Long Ltd., is planning to acquire Tall Ltd., with the following data available for both the
companies:
Long Ltd. Tall Ltd.
Expected EPS ` 12 `5
Expected DPS ` 10 `3
No. of Shares 30,00,000 18,00,000
Current Market Price of Share ` 180 ` 50
As per an estimate Tall Ltd., is expected to have steady growth of earnings and dividends
to the tune of 6% per annum. However, under the new management the growth rate is
likely to be enhanced to 8% per annum without additional investment.
You are required to:
(i) Calculate the net cost of acquisition by Long Ltd., if ` 60 is paid for each share of
Tall Ltd.
(ii) If the agreed exchange ratio is one share of Long Ltd., for every three shares of Tall
Ltd., in lieu of the cash acquisition as per (i) above, what will be the net cost of
acquisition?
(iii) Calculate Gain from acquisition. (8 Marks)
Sol.
(i) Net cost of acquisition shall be computed as follows:
Cash Paid for the shares of Tall Ltd. (` 60 × 18,00,000) ` 10,80,00,000
Less: Value of Tall Ltd., as a separate entity (18,00,000 × ` 50) ` 9,00,00,000
Net Cost of acquisition of Tall Ltd. ` 1,80,00,000

(ii) Net Cost of acquisition in case of exchange of shares:

Exchange ratio = 1 share of long Ltd for every 3 shares of Tall Ltd.
Number of shares to be issued in Long Ltd. (18,00,000/3) = 6,00,000 shares
Total no. of shares in Long Ltd. after merger = 36,00,000
(30,00,000 + 6,00,000)
Calculation of cost of Equity of Tall Ltd. = D1/P0 + g
Growth rate under new management after acquisition = ` 3/50 + 0.06 = 12%
Value of Merged company assuming perpetual growth = 8%
Value of merged company
(` 180 × 30,00,000) + (` 3/ (0.12 - 0.08) × 18,00,000 = ` 67,50,00,000
= 54,00,00,000 + (75 × 18,00,000)

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Value per share of merged company = ` 187.50 per share

(67,50,00,000/36,00,000)
Calculation of net cost of acquisition
Gross cost of acquisition (6,00,000 × 187.50) 11,25,00,000
Less: CMP (18,00,000 × 50) 9,00,00,000
Net Cost of acquisition 2,25,00,000

Alternatively, Net Cost of Acquisition can also be computed as follows:

No. of shares issued to shareholders of Tall Ltd. in the ratio of 1:3 6,00,000
Existing price of one share of Long Ltd. ` 180
Value of consideration paid for acquisition of Tall Ltd. ` 10,80,00,000
Less: Existing Value of Tall Ltd., as a separate entity ` 9,00,00,000
Net Cost of acquisition of Tall Ltd. ` 1,80,00,000

(iii) Calculation of gain from acquisition:

Total Earnings of Long Ltd. (` 12 × 30,00,000) ` 3,60,00,000
Total Earnings of Tall Ltd. (` 5 × 18,00,000) ` 90,00,000
Combined Earnings ` 4,50,00,000
PE Ratio of Long Ltd. (180/12) 15
Value of Long Ltd. after acquisition ` 67,50,00,000
Less: Value of two companies separately
Long Ltd. (` 180 × 30,00,000) ` 54,00,00,000
Tall Ltd. (` 50 × 18,00,000) ` 9,00,00,000 ` 63,00,00,000
Gain from Acquisition ` 4,50,00,000

34. Teer Ltd. is considering acquisition of Nishana Ltd. CFO of Teer Ltd. is of opinion that
Nishana Ltd. will be able to generate operating cash flows (after deducting necessary
capital expenditure) of `10 crore per annum for 5years.
The following additional information was not considered in the above estimations.
i. Office premises of Nishana Ltd. can be disposed of and its staff can be relocated in
Teer Ltd.’s office not impacting the operating cash flows of either businesses.
However, this action will generate an immediate capital gain of ` 20 crore.
ii. Synergy Gain of ` 2 crore per annum is expected to be accrued from the proposed
acquisition.
iii. Nishana Ltd. has outstanding Debentures having a market value of ` 15 crore. It
has no other debts.
iv. It is also estimated that after 5 years if necessary, Nishana Ltd. can also be
disposed of for an amount equal to five times its operating annual cashflow.

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Calculate the maximum price to be paid for Nishana Ltd. if cost of capital of Teer Ltd. is
20%. Ignore any type of taxation.
Sol. Calculation of Maximum Price to be paid for the acquisition of Nishana Ltd.
(` Crore)
Year 0 1 2 3 4 5
Operating cash flow - 10.00 10.00 10.00 10.00 10.00
Gain on Sale of office 20.00 - - - - -
premises
Synergy Benefits - 2.00 2.00 2.00 2.00 2.00
Disposal of Nishana - - - - - 50.00
Ltd.
Net cash flow 20.00 12.00 12.00 12.00 12.00 62.00
PVF @ 20% 1 0.833 0.694 0.579 0.482 0.402
Present value 20.00 10.00 8.324 6.948 5.784 24.924
Total of Present value 75.984
Less: Market Value of Debentures (15.000)
60.984
Thus, the maximum price to be paid for acquisition of Nishana Ltd. ` 60.984 crore.

35. Alfa Ltd. wants to acquire Beta Ltd. and has offered a swap ratio of 1 : 2 (0.5 shares for
every one share of Beta Ltd.). Following information is provided:
Alfa Ltd. Beta 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
(i) You are required to determine:
(a) the number of equity shares to be issued by Alfa Ltd. for acquisition of Beta
Ltd.
(b) the EPS of Alfa Ltd. after the acquisition.
(c) the equivalent earnings per share of Beta Ltd.
(d) the expected market price per share of Alfa Ltd.* after the acquisition, if PE
increases to 12 times.
(e) the market value of the merged firm.
(ii) If you are the shareholder of Beta Ltd and holding 100 shares, will you be interested
to sell your stake ? Why? (8 Marks)
Sol.
(i)

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(a) The number of shares to be issued by Alfa Ltd.:

The Exchange ratio is 0.5
So, new Shares = 1,80,000 x 0.5 = 90,000 shares.
(b) EPS of Alfa Ltd. after acquisition:
Total Earnings (` 18,00,000 + ` 3,60,000) ` 21,60,000 ` 21,60,000
No. of Shares (6,00,000 + 90,000) 6,90,000 ` 6,90,000
EPS (` 21,60,000)/61901000) ` 3.13 ` 3.13
(c) Equivalent EPS of Beta Ltd.:
No. of new Shares 0.5 0.5
EPS ` 3.13 3.13
Equivalent EPS (` 3.13 x 0.5) ` 1.57 or ` 1.56 ` 1.57 or ` 1.56
(d) New Market Price of Alfa Ltd. (P/E = 12):
Revised P/E Ratio of Alfa Ltd. 12 times 12 times
Expected EPS after merger ` 3.13 ` 3.13
Expected Market Price (` 3.13 x 12) ` 37.56 ` 37.56
(e) Market Value of merged firm:
Total number of Shares 6,90,000 6,90,000
Expected Market Price ` 37.56
Total value (6,90,000 x 37.56) ` 2,59,16,400

(ii)
Present market Value of share of Beta Ltd. (100 × ` 14) ` 1,400
Revised market price of each share of Alfa Ltd. after Merger ` 37.56
Equivalent No. of Alfa Ltd. share in exchange of Beta Ltd. (0.50 × 100) 50
Equivalent Value of Alfa Ltd. share in exchange of Beta Ltd. ` 1,878
(100 × 0.50 × ` 37.56)
Increase in Market Value (` 1,878 - ` 1,400) ` 478
2,136.61
= ` 30,523 Cr.
0.15 - 0.08

No, I am not agreed to sell the stake as there is increase in market value.

36. Big Ltd. (BL), a listed company, is enjoying a price earnings ratio (PER) of 15 on an
Earnings Per Share (EPS) of? 5. The Total number of outstanding shares are 2,00,000.
BL is proposing to acquire Small Pvt. Ltd. (SPL) an unlisted company by issuing shares
in the ratio 4:5 i.e. for 5 shares of SPL 4 shares of BL will be issued. The outstanding
shares of SPL are 50,000. SPL will be listed before the actual merger to discover its value.
The EPS of the merged entity will be 5.5. *
No other information is available for SPL.

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You are required to calculate :
(i) Pre-merger EPS of SPL.
(ii) Expected Market Price per Share of SPL at the time of listing, if it expects a PER
of 10 and,
(ii) Number of shares of BL to be issued to SPL if pre-merger EPS of BL is to be maintained.
(MAY 23

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