- 10 Marks
AFM – May 2016 – L3 – Q3a – Valuation of acquisitions and mergers, Acquisitions and mergers versus other growth strategies
Calculate pre-acquisition market values of two companies and determine the maximum price for an acquisition.
Question
a) Plainview Farms Limited is considering acquiring Cottage Industries Limited. The extracts of the financial statements of the two companies are as follows:
Statement of Financial Position
| Plainview Farms Ltd (GH¢’m) | Cottage Industries Ltd (GH¢’m) | |
|---|---|---|
| Net Assets | 6,300 | 1,892 |
| Equity Capital | 2,000 | 1,000 |
| Income Surplus | 4,300 | 892 |
Income Statement
| Plainview Farms Ltd (GH¢’m) | Cottage Industries Ltd (GH¢’m) | |
|---|---|---|
| Profit after tax | 800 | 300 |
| Dividend | (600) | (100) |
| Retained earnings | 200 | 200 |
The two companies retain the same proportion of profits each year, and this is expected to continue in the future. Plainview Farms Limited’s return on investment is 16%, while Cottage Industries Limited’s is 21%. One year after the post-acquisition period, Plainview Farms will retain 60% of its earnings and expects to earn a return of 20% on new investment.
The dividends of both companies have been paid. The required rate of return for ordinary shareholders of Plainview Farms Limited is 12%, and for Cottage Industries Limited it is 18%. After the acquisition, the required rate of return will become 16%.
Required:
i) Calculate the pre-acquisition market values of both companies. (5 marks)
ii) Calculate the maximum price Plainview Farms Limited will pay for Cottage Industries Limited. (5 marks)
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