Rapid rise in the price of crude oil is leading to a lot of corporate restructuring activities in

the oil industry. It is reflecting in the valuation front too. The market capitalization of
ONGC is in the tune of Rs.145,000 crore, which covers 14.5% of the total market
capitalization. However, mid-sized down-stream firms are eyeing on consolidation for
survival. One such company Indo-Gulf Petroleum (IGP) is considering the acquisition
of Gujrat Refineries Ltd. (GRL) in a stock-for-stock transaction in which GRL would
receive Rs.1680 for each share of its common stock. IGP expects an increase of 30% in
its P/E multiple after the merger and chooses to value the GRL conservatively by
assuming no earnings growth due to synergy.
With regard to this acquisition, following information of both the companies are
provided:
Particulars IGP GRL
Earnings Before Interest and Taxes
10,639,350,000 6,176,470,588
(Rs.)
Interest (Rs.) 1,773,225,000 926,470,588
Market Capitalisation (%) 4.44% 2.34%
Market Price per Share (Rs.) 1112.40 1250.00
Both the companies are enjoying tax holidays. You are required to
(a) Calculate
(i) Post-merger share price
(ii) Post-merger equity ownership distribution
(iii) Purchase price premium
(b) Comment on the decision taken by IGP.

3. (a) (i) Post merges share Price = Post merges EPS post Merges P/E
IGP will distribute its own shares of Rs.1680 for each share of GRL. This
1680
amounts to 1112.4
or 1.51 shares for every share of GRL.
Market cap for GRL = 2.34%
ONGC has a market capitalization of Rs.145,000crore equivalent to 14.5%
145, 000
So, the size of the total market is .145 = Rs.1000000 crore.
So the market capitalization of GRL = 1000 000 0.0234
= Rs.23,400 crore.
Market Price of GRL shares = Rs.1250
 23400
18.72crore
So, the number of shares outstanding for GRL = 1250

= 18,72,00,000.
So, total number of shares issued by IGP is = 18,72,00,000 1.51=
28,26,72,000.
Number of shares outstanding for IGP before merges is.
1000, 000 0.0444
39.9137crore 39,91,37, 000
1112.4
So, total shares outstanding of the combined company =39.9137 + 28.2672 =
68.1809crore

Post merges earnings of the combined company is

EBITIGP EBITGRL Interest IGP Interest GRL
= 10,639,350,000 + 6,176,470,588 1773225000 926470588 =
Rs.14,116,125,000
So, post merges EPS
14,116,125,000
20.70
= 68,18,09,000
Pre merger EPS of IGP
EBITIGP Interest IGP
No.of shares outs tan ding
=
10,639,350,000 1,773, 225,000
Rs22.21
= 39,91,37,000

1112.4
50.0855.
Pre merger P/E multiple = 22.21

Post merger P/E will increases by 30%

So, Post merger P/E = 50.0855 1.3 = 65.11
Post merges Price = Post merges EPS Post merger P/E
= 20.70 65.11
= 1347.78
So, post merger price of IGP is Rs.1347.78
(ii) Post merger equity ownership distribution
New shares received
Total nos. of shares of the combined company
Ownership of GRL =
28, 26,72,000
0.4146 41.46%
= 68,18,09,000

So, ownership of IGP =

1 0.4146 or 0.5854 or 58.54%
 Offer Price for target company'sshare
(iii) Purchase Price Premium = Market price per share of Target company

1680
1.344
= 1250

So, the purchase price premium = (1.344 1) or 34.4%.

(b) The acquisition results in Rs.235.38 or (1347.78 1112.4) increase in the share price
of the acquiring company in spite of Rs.1.51 or (22.21 20.70) decline EPS of the
combined companies. We must not forget that this is a conservative estimate where
no synergy benefit is considered. When two companies are merged in value chain
they should bring some benefits in earnings front too. However, the strength of the
decision depends upon what happens to the earnings of the combined company in
years to come. If the combined companys earnings grow more rapidly than the
acquiring companys earnings would have in absence of the acquisition may
contribute to the market value of the acquiring company. The acquiring company
expects a increase in P/E multiple,. This indicates that market sentiment on the
acquisition in bullish. The plausible reason could be a longterm benefit. However,
synergistic effect in short term is not visible, as a result, we witness IGP end up
paying around 34.4%. premium for a marginal decline in earnings per share.

The following are the details on two potential merger candidates, All-time Products and
Any-time Products: (Rs. in crore)
Particulars All-time Products Any-time Products
Revenues 6,900 2,400
Depreciation 380 55
Capital Spending 400 60
Market Value of Equity 3,200 1,100
Outstanding Debt 80 50
Tax Rate 40.00% 40.00%
Working Capital 12% of Revenue 12% of Revenue
Cost of Goods Sold (without 83% of Revenue 87% of Revenue
Depreciation)
Revenues of All-time Products are expected to have a growth rate of 17% for the first
two years, 12% for the next three years and stabilize at 5% thereafter. Capital spending
and depreciation are expected to grow at 10% for the first three years and at 6% for the
next two years. From the sixth year onwards depreciation is expected to continue at the
same growth rate of 6% and the amount of capital spending is expected to be equal to
the amount of depreciation. The beta of the equity is 1.4 and the firm is rated as A by
a leading credit rating agency.
Revenues of Any-time Products are expected to have a growth rate of 15% for the first
three years, 10% for the next two years and stabilize at 5% thereafter. Capital spending
and depreciation are expected to grow at 8% for the first three years and 5% for the
next two years. From the sixth year onwards, depreciation is expected to continue at the
same growth rate of 5% and the amount of capital spending is expected to be equal to
 the amount of depreciation. The beta of the equity is 1.2 and the firm is rated as B by
the same credit rating agency.
The treasury bills are trading in the market at 6% and the market is expecting a
premium of 5% above the treasury bill rate.
As a result of the merger, the combined firm is expected to have a cost of goods sold of
only 79% of total revenues. The market perceives that there is more risk associated with
the combined entity; so it is supposed to be rated as B by the same credit rating agency
and the beta of its equity is expected to be 2.4. The growth rate of free cash flows
observed for the sixth year in the combined firm is expected to continue forever.
Rating Interest to be payable on
debt
AAA 8%
AA 9%
A 10%
B 11%
C 12%
You are required to
a. Estimate the value of All-time Products, operating independently.
b. Estimate the value of Any-time Products, operating independently.
c. Estimate the value of the combined firm.
d. Estimate the worth of the operating synergy.

SOLUTION 5.
a. Valuation of All-time Products: (Rs. In crore)
1 2 3 4 5 6
Revenues 8073 9445.41 10578.8611848.32 13270.12 13933.63
COGS @ 83% 6700.59 7839.69 8780.45 9834.11 11014.2 11564.9
Dep 418 459.8 505.78 536.13 568.29 602.39
= EBIT 954.41 1145.92 1292.63 1478.08 1687.63 1766.33
EBIT (1 t) 572.65 687.55 775.58 886.85 1012.58 1059.8
+ Depreciation 418 459.8 505.78 536.13 568.29 602.39
Capital 440 484 532.4 564.34 598.2 602.39
Expenditure
Change in WC 140.76 164.69 136.01 152.34 170.61 79.63
FCFF 409.89 498.66 612.95 706.3 812.06 980.17
Terminal Value 12518.14
WACC @ 12.83% 363.28 391.7 426.73 435.8 7289.77
Firm Value 8907.28
Cost of equity = 6+ 1.4(5) = 13%
Cost of debt = 10% ( since it is rated as A)

Changes in working capital (Rs. In crore)

0 1 2 3 4 5 6
 Working 828 968.76 1133.45 1269.46 1421.8 1592.41 1672.04
capital
(12% of
revenue)
Change 140.76 164.69 136.01 152.34 170.61 79.63
in
working
capital

Weighted average cost of capital = (Rs.3200 crore /Rs. 3280 crore ) 13% + (Rs.
80 crore /Rs.3280 crore) 10% (1 0.4) = 12.83%
Terminal value = Rs.980.17 crore /(0.1283 0.05) = Rs.7289.77 crore
The value of Alltime Products = Rs.8,907.28 crore

b. Valuation of Any-time Products:

(Rs. in crore)
1 2 3 4 5 6
Revenues 2,760 3174 3650.1 4015.11 4416.62 4637.45

COGS @ 87% 2401.2 2761.38 3175.59 3493.15 3842.46 4034.58

Dep 59.4 64.15 69.28 72.75 76.39 80.21
= EBIT 299.4 348.47 405.23 449.21 497.77 522.66
EBIT (1 t) 179.64 209.08 243.14 269.53 298.66 313.6
+ Depreciation 59.4 64.15 69.28 72.75 76.39 80.21
Capital 64.8 69.98 75.58 79.36 83.33 80.21
Expenditure
Change in WC 43.2 49.68 57.13 43.8 48.18 26.5
FCFF 131.04 153.57 179.71 219.12 243.54 287.1
Terminal Value 4240.77
WACC @ 117.24 122.93 128.71 140.40 2570.81
11.77%
Firm Value 3080.09
Cost of equity = 6+ 1.2(5) = 12%
Cost of debt = 11% ( Since it is rated as B)
Weighted average cost of capital = (1100/1150) 12% + (50/1150) 11%(1-0.4) =
11.77%
Chages in working capital
(Rs. In crore)
0 1 2 3 4 5 6
Working capital 288 331.2 380.88 438.01 481.81 529.99 556.49
(12% of revenue)
Change in working 43.2 49.68 57.13 43.8 48.18 26.5
capital

Terminal value = 287.1/(0.1177 0.05) = Rs.4240.77 crore

 The value of Any-time products = Rs.3,080.09 crore

c. Valuation of Combined firm (Rs. In crore)

1 2 3 4 5 6
Revenues 1083312619.4114228.96 15863.43 17686.74 18571.08
COGS @ 79% 8558.07 9969.3311240.88 12532.11 13972.52 14671.15
Dep 477.4 523.95 575.06 608.88 644.68 682.6
= EBIT 1797.53 2126.13 2413.02 2722.44 3069.54 3217.33
EBIT (1 t) 1078.52 1275.68 1447.81 1633.46 1841.72 1930.4
+ Depreciation 477.4 523.95 575.06 608.88 644.68 682.6
Capital 504.8 553.98 607.98 643.7 681.53 682.6
Expenditure
Change in WC 183.96 214.37 193.14 196.14 218.79 106.13
FCFF 867.16 1031.28 1221.75 1402.5 1586.08 1824.27
Terminal Value 65858.12
WACC @ 736.19 743.29 747.58 728.57 29744.21
17.79%
Firm Value 32699.84

Total debt in the combined firm = Rs.80 crore + Rs.50 crore = Rs.130 crore
Total equity in the combined firm = Rs.3,200 crore + Rs.1,100 crore = Rs.4,300
crore
Cost of equity = 6+ 2.4(5) = 18%
Cost of debt = 11% (since, the combined firm is rated as B)
Weighted average cost of capital = 11% [Rs.130 crore/(Rs.130 crore + Rs.4,300
crore)]
+ 18% [Rs.4,300 crore/(Rs.130 crore + Rs.4,300 crore)]
=0.3228+ 17.4718 = 17.79 %
Growth rate in free cash flows from the year 2006 onwards= (1824.27/1586.08) -1=
15.02%
Terminal value = Rs.1824.27 crore/(0.1779 - 0.1502) = Rs.65858.12 crore

Value of the combined firm = Rs. 32699.84crore

d. Synergy = Value of the merged firm Values of independent firms

= Rs. 32699.84 crore Rs. 8907.28 crore Rs.3080.09 crore =
Rs.20712.47crore.
7. i. Nova Industries had 250,000 shares outstanding, and the stock is traded at
Rs.84 on the stock market. The companys net income was Rs.7.5 lakh for the
year. If the company issues a 50% stock dividend, what is the new stock price?
ii. Subsequent to Bonus issue, Nova also announced a repurchase of 25% of its
outstanding shares after the stock dividend, at a 10% premium to the market price.
The buyback offer is fully subscribed and the wealth effect of the repurchase is
15%.
You are required to estimate:
a. The value of the outstanding shares.
b. The distribution of the wealth effect among the tendering and non-tendering
shareholders.
7. A 50% stock dividend is equivalent to issue of 1 bonus share for every two
equity shares

Before the 50% stock dividend

EPS = 750000/250000 = Rs.3
P/E = 84/3 = 28.

After the 50% stock dividend:

No. of shares = 250000 1.50 = 375,000
EPS = 750000/375000 = Rs.2.

Assuming the P/E ratio does not change

P/E = P/2 = 28
P = Rs.56 per share.

b. Stock Repurchase Model

PE NE = P0 N0 PT (N0 NE) + W
NE = 0.75 375000 = 281250
P0 = 56
N0 = 375000
PT = 56 + 5.6
= Rs.61.60 per share
W = 0.15 56 375000 = 3150000.
i. Value of outstanding shares = PE NE = Rs.56 375000 61.60 93750 +
315000
= 21000000 5775000 + 3150000 = Rs.1,8375000
Value per share = 18375000/281250 = Rs.65.33 per share.
ii. Share of tendering shareholders = 0.25 (61.60 56)/56 = 0.025 (or) 2.5%
Share of non-tendering shareholders = 0.75 (65.33 56)/56
= 0.125 (or) 12.5%
Suraj Technology Limited (STL) is in the development of software products.
STL is contemplating to merge with Chandraj Technology Limited (CTL),
which is involved in the same type of business.
The following are the details pertaining to two potential merger companies:
Particulars STL CTL
Revenues (Rs. in lakh) 6300 4250
Cost of Goods Sold 84% 88%
Depreciation (Rs. in 450 258
lakh)
Tax Rate 38% 38%
Working Capital (as % 15% 15%
of Revenue)
Outstanding debt (Rs. in 1350 1160
lakh)
Market value of equity 3450 2520
(Rs. in lakh)
Revenues and EBITs of both the firms are expected to grow at 12% a year in
the long term. Capital spending is expected to be offset by depreciation. The
betas of both the firms are 1.2 each and they are rated B with annual
interest rates of 11.5% on their debts. Treasury Bills are currently trading
in the market at 7% p.a and the market is able to generate 8% p.a more
return than the return on Treasury Bills.
As a result of merger, the combined firm is expected to get some operational
synergistic benefit, which will reduce the cost of goods sold to 80% of total
revenues.
Due to the financial synergistic benefit, the optimal equity multiplier of the
combined firm increases to 2 from current levels. The financial synergistic
benefit may influence the combined firm in two ways depending on the steps
taken on leverage front:
i. If it does not increase the debt, the combined firm is expected to be rated as
AA and interest rate on debt decreases by 2% from pre merger levels.
ii. If it increases the debt, at the optimal debt level, the combined firm will have
an A rating and interest rate on debt decreases by 1% from pre merger
levels.
You are required to
a. Estimate the value of STL operating independently.
b. Estimate the value of CTL operating independently.
c. Estimate the value of combined firm with no synergy.
d. Estimate the value of combined firm with only operational synergy.
e. Estimate the value of the combined firm, if it does not change its debt ratio
and enjoys the operational synergy.
f. Estimate the value of the combined firm, if it moves to optimal debt ratio
and enjoys the operational synergy.
g. Estimate the value of operational and financial synergies.
Solution

a. STL:
(Rs.lakh)
Revenues 6, 300
COGS (@84% of Revenue) 5,292
Depreciation 450
EBIT grows at 12% p.a 558 624.96
EBIT(1T) 387.48
Change in Working Capital 6300 1.12 0.15
113.4
6300 0.15 113.4
Free Cash Flow to Firm 274.08
Cost of Equity 7 1.2 8 16.6%
Cost of Debt (Post Tax) 11.5 (1 0.38) 7.13%
Weighted Average Cost of 16.6
3450
7.13
1350
13.94%
Capital 4800 4800
Firm Value 274.08
14,127.84
(0.1394 0.12)

b. CTL:
(Rs.lakh)
Revenues 4250
COGS (@88% of Revenue) 3740
Depreciation 258
EBIT grows at 12% p.a 252 282.24
EBIT(1T) 174.99
Change in Working Capital 4250 1.12 0.15
76.5
4250 0.15 76.5
Free Cash Flow to Firm 98.49
Cost of Equity 7 1.2 8 16.6%
Weighted Average Cost of
Capital
Cost of Debt (Post Tax) 11.5 (1 0.38) 7.13% 2520 1160
16.6 7.13
3680 3680
13.61%

98.49
Firm Value 6117.39
(0.1361 0.12)

c. Combined Firm without any synergy:

(Rs.lakh)
Revenues 6300 + 4250 10550
COGS 5292+3740 9032
Depreciation 450+258 708
EBIT grows at 12% p.a 810 907.2
 EBIT(1T) 562.464
Change in Working Capital 113.4 + 76.5 189.9
Free Cash Flow to Firm 372.564
Cost of Equity 7 1.2 8 16.6%
Cost of Debt (Post Tax) 11.5 (1 0.38) 7.13%
Weighted Average Cost of 5970 2510
16.6 7.13 13.8%
Capital 8480 8480
372.564
Firm Value 20698
(0.138 0.12)

d. Combined Firm with Operational Synergy

(Rs.lakh)
Revenues 10550 10550
COGS (@80% of revenue) 10550 0.8 8440
Depreciation 450+258 708
EBIT grows at 12% 1402 1570.24
EBIT(1T) 1570.24 (1-0.38) 973.55
Change in Working Capital 189.9
Free Cash Flow to Firm 783.65
Cost of Equity 7 1.2 8 16.6%
Cost of Debt (Post Tax) 11.5 (1 0.38) 7.13%
Weighted Average Cost of 5970 2510
16.6 7.13 13.8%
Capital 8480 8480
783.65
Firm Value (0.138 0.12)
43536.11
e. Combined Firm without changing debt ratio but with Operational Synergy

(Rs.lakh)
Revenues 10550 10550
COGS (@80% of revenue) 10550 0.8 8440
Depreciation 450+258 708
EBIT grows at 12% p.a 1402 1570.24
EBIT(1T) 1570.24 (1-0.38) 973.55
Change in Working Capital 189.9
Free Cash Flow to Firm 783.65
Cost of Equity 7 1.2 8 16.6%
Cost of Debt (Post Tax) 9.5 (1 0.38) 5.89%
Weighted Average Cost of 5970 2510
16.6 5.89 13.43%
Capital 8480 8480
783.65
Firm Value 54800.7
(0.1343 0.12)
f. Combined Firm by changing debt ratio to optimal ratio and with Operational Synergy
Levered beta of the firm at the current leverage level is 1.2
 1.2
2510
1 0.62
So, the unlevered beta at the current level is 5970 = 0.9519
1
0.9519 1 0.62
When equity multiplier is raised to 2%, the levered beta will raise to 1 or
1.54
Revenues 10550 10550
COGS (@ 80% of Revenue) 10550 0.8 8440
Depreciation 450+258 708
EBIT grows at 12% p.a 1402 1570.24
EBIT(1T) 1570.24 (1-0.38) 973.55
Change in Working Capital 189.9
Free Cash Flow to Firm 783.65
Cost of Equity 7 1.54 8 19.32%
Cost of Debt (Post Tax) 10.5 (1 0.38) 6.51%
Weighted Average Cost of 19.32 0.5 6.51 0.5
12.915%
Capital
Firm Value 783.65
85644.81
(0.12915 0.12)
g. (i) Value of operational synergy = Value of the firm with operational Synergy
Value of the firm without operational synergy =43536.11 20698 = Rs. 22838.11
Lakh
(ii) Value of the financial synergy when debt ratio is maintained at current level
= 54800.7 43536.11 = Rs. 11264.59 Lakh
(iii) Value of the financial synergy when debt ratio is moved towards optimum
= 85644.81 43536.11 = Rs. 42108.7 lakh.