- 14 Marks
AFM – Nov 2016 – L3 – Q1b – Business reorganisation | Valuation of acquisitions and mergers
Calculate and analyze the effects of a proposed spin-off on shareholder wealth and discuss reasons and disadvantages of a spin-off.
Question
Last Chance Limited operates various manufacturing and retail operations throughout Ghana and has 400 million GH¢0.25 ordinary shares in issue. For the year that has just ended, the directors reported total after-tax profits of GH¢300 million and the P/E ratio of the company is 11.4 times.
The company has developed sophisticated computer software over the years and now considers ‘spinning-off’ its subsidiary, Ananse Systems Limited. Ananse Systems Limited has contributed GH¢40 million of the total after-tax profits of Last Chance Limited. After the spin-off, Last Chance Limited’s P/E ratio is expected to reduce to 11.0 times, while Ananse Systems Limited is expected to attract a P/E ratio of either 17 or 18 times.
Required:
i) Suggest THREE reasons why Last Chance Limited may wish to ‘spin-off’ part of its operations. (3 marks)
ii) Discuss THREE possible disadvantages of a ‘spin-off’ for the shareholders of Last Chance Limited. (3 marks)
iii) Calculate the likely effect of the proposed ‘spin-off’ on the wealth of a shareholder holding 10,000 ordinary shares in Last Chance, assuming that Ananse Systems Limited trades at a P/E ratio of 17 times and 18 times. (8 marks)
(Ignore taxation)
Find Related Questions by Tags, levels, etc.
- Tags: Corporate finance, P/E Ratio, Shareholder Wealth, Spin-off, Stock Market, Valuation
- Level: Level 3
- Topic: Business reorganisation, Valuation of acquisitions and mergers
- Series: NOV 2016