Question Tag: Synergies

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  • 20 Marks

FM – May 2016 – L3 – Q4 – Mergers and Acquisitions

Estimating the additional equity value created by combining two companies and analyzing the impact of premium increases on shareholders.

Eko Product Plc (EP Plc) is a producer of a variety of vegetable oil and other household products in Lagos. The company presently faces significant competition in the market for one of its major raw materials – palm oil. To secure a regular flow of the raw material, the Directors of EP Plc are now considering making an offer for the entire share capital of Benin Oil Plc (BO Plc), a palm oil producing company in Benin.

The following financial information is provided for the two companies:

Parameter EP Plc BO Plc
Equity beta 1.2 1.2
Asset beta 0.9 1.2
Number of shares (million) 210 200
Current share price N29 N12

It is thought that combining the two companies will result in several benefits. It is estimated that combining the two companies will generate free cash flow to the firm (FCFF) of N1,080 million in current value terms, but these will increase by an annual growth rate of 5% for the next four years before reverting to an annual growth rate of 2.25% in perpetuity. In addition to this, combining the companies will result in cash synergy benefits of N100 million per year for the next four years. These synergy benefits are not subject to any inflationary increase, and no synergy benefits will occur after the fourth year.

The debt-to-equity ratio of the combined company will be 40:60 in market value terms and it is expected that the combined company’s cost of debt will be 4.55% before tax.

The income tax rate is 20%, the current risk-free rate of return is 2%, and the market risk premium is 7%. It can be assumed that the combined company’s asset beta is the weighted average of EP Plc’s and BO Plc’s asset betas weighted by their current market values.

EP Plc has offered to acquire BO Plc through a mixed offer of one of its shares for two BO Plc shares, plus a cash payment, such that a 30% premium is paid for the acquisition. Shareholders of BO Plc feel that a 50% premium would be more acceptable. EP Plc has sufficient cash reserves if the premium is 30%, but not if it is 50%.

You are required to:

(a) Estimate the additional equity value created by combining EP Plc and BO Plc based on the free cash flow to firm method. Comment on the results obtained and discuss briefly the assumptions made. (11 Marks)

(b) Estimate the impact on EP Plc’s equity holders if the premium paid is increased to 50% from 30%. (5 Marks)

c. Estimate the additional funds required if a premium of 50% is paid instead of 30% and discuss how this premium could be financed. (4 Marks)

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  • 20 Marks

FM – May 2021 – L3 – Q5 – Mergers and Acquisitions

Evaluate takeover bids from shareholder perspectives, assess failure to achieve synergies, and suggest risk minimisation steps.

Ponk Plc is a market research company. It has seen significant growth in recent years and obtained a stock market listing 5 years ago. Due to current economic and political turmoil in the country, there has been a significant drop in revenue and profit.

Ponk Plc is planning a takeover bid for XY, a rival market research company specialising in the telecommunication industry – an industry that has been very resistant to the current economic turbulence in the country. XY has an advanced information technology and information system which was developed in-house and which Ponk Plc would acquire the rights to use. Ponk Plc plans to adopt XY’s information technology and information system following the acquisition, and this is expected to be a major contributor to the overall estimated synergistic benefits of the acquisition. These benefits are believed to be worth ₦8 million (in cash flow) at the end of the first year of acquisition and growing annually at 5%.

Ponk Plc has 30 million shares in issue and a current share price of ₦69 before any public announcement of the planned takeover.
XY has 5 million shares in issue and a current share price of ₦128.40.
It is believed that the WACC of the combined company will be 15% p.a.

The directors of Ponk are considering 2 alternative bid offers:

  • Bid offer 1 – Share-based bid of 2 Ponk Plc shares for each of XY share.
  • Bid offer 2 – Cash offer of ₦135 per XY share.

Required:

a. Assuming synergistic benefits are realised, evaluate bid offer 1 and bid offer 2 from the viewpoint of:
(i) Ponk’s existing shareholders
(ii) XY’s shareholders. (6 Marks available for calculations)

b. Advise the directors of Ponk Plc on:
(i) The potential impact on the shareholders of both Ponk and XY of not successfully realising the potential synergistic benefits after the takeover. (6 Marks)
(Up to 4 marks are available for calculations)

(ii) The steps that could be taken to minimise the risk of failing to realise the potential synergistic benefits arising from the adoption of XY’s information technology and information system. (4 Marks)

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  • 20 Marks

FM – Nov 2017 – L3 – Q2 – Mergers and Acquisitions

Calculate Raymond Plc.'s valuation, analyze Harold Limited's acquisition value, and assess the offer price from shareholders' perspectives.

Raymond Plc. is a successful IT services company incorporated 10 years ago. It was listed on the Stock Exchange 3 years ago. The company has a broad customer base mainly consisting of small and medium-sized companies. Raymond Plc. has achieved rapid growth in recent years by obtaining regular business from satisfied customers and also by acquiring other IT services companies.

The Directors of Raymond Plc. have identified Harold Limited, an unlisted company, as a possible acquisition target. Harold Limited has a number of large multinational clients, and, in general, its clients tend to be larger than those of Raymond Plc. If successful, the acquisition would go ahead on January 1, 2018.

Forecast financial data for Raymond Plc. and Harold Limited as of December 31, 2017, are summarized below:

Financial Item Raymond Plc. Harold Limited
Share capital (Ordinary ₦1 shares) ₦150m ₦40m
Market share price ₦4.90 N/A

N/A: Not applicable (not listed).

Additional information:

  1. If Harold Limited were to remain an independent company, its Directors estimate that reported Profit After Tax would be ₦15 million for 2018 and then grow by 2% yearly in perpetuity;
  2. If the acquisition were to go ahead, Raymond Plc.’s Directors estimate that Harold Limited’s profit after tax would be 5% higher for 2018 than if the company remains an independent company, and that profit after tax would then grow by 3% yearly in perpetuity;
  3. The average ungeared Cost of Equity for the industry is 8%;
  4. Both Raymond Plc. and Harold Limited are wholly equity financed; and
  5. Profit after tax can be assumed to be a good approximation of free cash flow attributable to investors.

The Directors of Raymond Plc. are considering offering to purchase Harold Limited at a price of ₦7.00 per share. It is estimated that transaction costs of ₦8 million would be payable on the acquisition and that ₦2 million would be required in the first year to cover the costs of integrating the two companies.

Required:

  • (a) Calculate:
    • i. The value of Raymond Plc. as at December 31, 2017.
    • ii. The value of Harold Limited as at December 31, 2017 before taking the possible acquisition of the company by Raymond Plc. into account.
    • iii. The overall increase in value created by the acquisition of Harold Limited by Raymond Plc. (8 Marks)
  • (b)
    • i. Explain how value might be created by the proposed acquisition. (2 Marks)
    • ii. Comment on the difficulties which Raymond Plc. is likely to face in realizing the potential added-value, after the acquisition. (2 Marks)
  • (c) Evaluate the proposed offer price of ₦7.00 per share for Harold Limited from the point of view of:
    • i. Harold Limited’s shareholders.
    • ii. Raymond Plc.’s shareholders. (8 Marks)

(Total 20 Marks)

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  • 4 Marks

AFM – May 2017 – L3 – Q3c – Valuation of acquisitions and mergers

Factors to be considered by the directors and shareholders in evaluating the worthiness of the takeover proposal.

Discuss briefly any other factors that the directors and shareholders of both companies might consider in assessing the worthwhileness of the proposed takeover. (4 marks)

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  • 16 Marks

AFM – May 2017 – L3 – Q3a & b – Valuation of acquisitions and mergers

Calculating the maximum and minimum prices for Jacobs Ltd's acquisition of Idowu Co Ltd based on future revenue and cost synergies.

Jacobs Limited and Idowu Company Limited both manufacture and sell auto parts. The summarised profit and loss accounts of the two companies for 2014 are as follows:

Jacobs Ltd (GH¢’000) Idowu Co Ltd (GH¢’000)
Sale Revenue 1,500 800
Operating Expenses (800) (620)
Profit 700 180

Each company has earned a constant level of profit for a number of years, and both are expected to continue to do so. The policy of both companies is to distribute all profits as dividends to ordinary shareholders as they are earned. Neither company has any fixed interest capital. Details of the ordinary share capital of the two companies are as follows:

Jacobs Ltd (GH¢’000) Idowu Co Ltd (GH¢’000)
Authorised Ordinary Shares 2,500 2,000
Issued Ordinary Shares 2,000 1,000
Market Value per Share (Ex Div) 3.50 1.50

The directors of Jacobs Limited are considering submitting a bid for the entire share capital of Idowu Co Limited. They believe that, if the bid succeeds, the combined sales revenue of the two companies will increase by GH¢60,000 per annum, and savings in operating expenses, amounting to GH¢50,000 per annum, will be possible. Part of the machinery at present owned by Idowu Co Limited would no longer be required and could be sold for GH¢100,000. Furthermore, the directors of Jacobs Limited believe that the takeover would result in a reduction to 9% in the annual return required by the ordinary shareholders of Idowu Co Limited.

Required:
i) On the basis of the above information, calculate the maximum price that Jacobs Ltd should be willing to pay for the entire share capital of Idowu Co Limited. (6 marks)
ii) Calculate the minimum price that the ordinary shareholders in Idowu Co Ltd should be willing to accept for their shares. (4 marks)

Assume that the takeover price is agreed at the figure calculated in part (ii) above, and that the purchase consideration will be settled by an exchange of ordinary shares in Idowu Co Ltd for the ordinary shares of Jacobs Ltd. Show how the entire benefit from the takeover will accrue to all the present shareholders of Jacobs Ltd. (6 marks)

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  • 20 Marks

AFM – Nov 2017 – L3 – Q3 – Valuation of acquisitions and mergers

Calculating the valuation per share for minority and complete takeover of Fasco and Boscan, and discussing limitations of the approach.

Zed Ltd is considering the immediate purchase of some, or all, of the share capital of one of two firms—Fasco Ltd and Boscan Ltd. Both Fasco Ltd and Boscan Ltd have one million ordinary shares issued, and neither company has any debt capital outstanding.

Both firms are expected to pay a dividend in one year’s time—Fasco’s expected dividend amounting to 30p per share, and Boscan’s being 27p per share. Dividends will be paid annually and are expected to increase over time. Fasco’s dividends are expected to display perpetual growth at a compound rate of 6% per annum. Boscan’s dividend will grow at the high annual compound rate of 33⅓% until a dividend of 64p per share is reached in year 4. Thereafter, Boscan’s dividend will remain constant.

If Zed is able to purchase all the equity capital of either firm, then the reduced competition would enable Zed to save some advertising and administrative costs, which would amount to GH¢225,000 per annum indefinitely, and, in year 2, to sell some office space for GH¢800,000. These benefits and savings will only occur if a complete takeover is carried out. Zed would change some operations of any company completely taken over, the details are:

  • Fasco – No dividend would be paid until year 3. Year 3 dividend would be 25p per share, and dividends would then grow at 10% per annum indefinitely.
  • Boscan – No change in total dividends in years 1 to 4, but after year 4, dividend growth would be 25% per annum compound until year 7. Thereafter, annual dividends would remain constant at the year 7 amount per share.

An appropriate discount rate for the risk inherent in all the cash flows mentioned is 15%.

Required:
a) Calculate the valuation per share for a minority investment in each of the firms, Fasco and Boscan, which would provide the investor with a 15% rate of return. (6 marks)

b) Calculate the maximum amount per share which Zed should consider paying for each company in the event of a complete takeover. (8 marks)

c) Comment on any limitation of the approach used in part (a), and specify the other major factors which would be important to consider if the proposed valuations were being undertaken as a practical exercise. (6 marks)

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  • 20 Marks

FM – May 2016 – L3 – Q4 – Mergers and Acquisitions

Estimating the additional equity value created by combining two companies and analyzing the impact of premium increases on shareholders.

Eko Product Plc (EP Plc) is a producer of a variety of vegetable oil and other household products in Lagos. The company presently faces significant competition in the market for one of its major raw materials – palm oil. To secure a regular flow of the raw material, the Directors of EP Plc are now considering making an offer for the entire share capital of Benin Oil Plc (BO Plc), a palm oil producing company in Benin.

The following financial information is provided for the two companies:

Parameter EP Plc BO Plc
Equity beta 1.2 1.2
Asset beta 0.9 1.2
Number of shares (million) 210 200
Current share price N29 N12

It is thought that combining the two companies will result in several benefits. It is estimated that combining the two companies will generate free cash flow to the firm (FCFF) of N1,080 million in current value terms, but these will increase by an annual growth rate of 5% for the next four years before reverting to an annual growth rate of 2.25% in perpetuity. In addition to this, combining the companies will result in cash synergy benefits of N100 million per year for the next four years. These synergy benefits are not subject to any inflationary increase, and no synergy benefits will occur after the fourth year.

The debt-to-equity ratio of the combined company will be 40:60 in market value terms and it is expected that the combined company’s cost of debt will be 4.55% before tax.

The income tax rate is 20%, the current risk-free rate of return is 2%, and the market risk premium is 7%. It can be assumed that the combined company’s asset beta is the weighted average of EP Plc’s and BO Plc’s asset betas weighted by their current market values.

EP Plc has offered to acquire BO Plc through a mixed offer of one of its shares for two BO Plc shares, plus a cash payment, such that a 30% premium is paid for the acquisition. Shareholders of BO Plc feel that a 50% premium would be more acceptable. EP Plc has sufficient cash reserves if the premium is 30%, but not if it is 50%.

You are required to:

(a) Estimate the additional equity value created by combining EP Plc and BO Plc based on the free cash flow to firm method. Comment on the results obtained and discuss briefly the assumptions made. (11 Marks)

(b) Estimate the impact on EP Plc’s equity holders if the premium paid is increased to 50% from 30%. (5 Marks)

c. Estimate the additional funds required if a premium of 50% is paid instead of 30% and discuss how this premium could be financed. (4 Marks)

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  • 20 Marks

FM – May 2021 – L3 – Q5 – Mergers and Acquisitions

Evaluate takeover bids from shareholder perspectives, assess failure to achieve synergies, and suggest risk minimisation steps.

Ponk Plc is a market research company. It has seen significant growth in recent years and obtained a stock market listing 5 years ago. Due to current economic and political turmoil in the country, there has been a significant drop in revenue and profit.

Ponk Plc is planning a takeover bid for XY, a rival market research company specialising in the telecommunication industry – an industry that has been very resistant to the current economic turbulence in the country. XY has an advanced information technology and information system which was developed in-house and which Ponk Plc would acquire the rights to use. Ponk Plc plans to adopt XY’s information technology and information system following the acquisition, and this is expected to be a major contributor to the overall estimated synergistic benefits of the acquisition. These benefits are believed to be worth ₦8 million (in cash flow) at the end of the first year of acquisition and growing annually at 5%.

Ponk Plc has 30 million shares in issue and a current share price of ₦69 before any public announcement of the planned takeover.
XY has 5 million shares in issue and a current share price of ₦128.40.
It is believed that the WACC of the combined company will be 15% p.a.

The directors of Ponk are considering 2 alternative bid offers:

  • Bid offer 1 – Share-based bid of 2 Ponk Plc shares for each of XY share.
  • Bid offer 2 – Cash offer of ₦135 per XY share.

Required:

a. Assuming synergistic benefits are realised, evaluate bid offer 1 and bid offer 2 from the viewpoint of:
(i) Ponk’s existing shareholders
(ii) XY’s shareholders. (6 Marks available for calculations)

b. Advise the directors of Ponk Plc on:
(i) The potential impact on the shareholders of both Ponk and XY of not successfully realising the potential synergistic benefits after the takeover. (6 Marks)
(Up to 4 marks are available for calculations)

(ii) The steps that could be taken to minimise the risk of failing to realise the potential synergistic benefits arising from the adoption of XY’s information technology and information system. (4 Marks)

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  • 20 Marks

FM – Nov 2017 – L3 – Q2 – Mergers and Acquisitions

Calculate Raymond Plc.'s valuation, analyze Harold Limited's acquisition value, and assess the offer price from shareholders' perspectives.

Raymond Plc. is a successful IT services company incorporated 10 years ago. It was listed on the Stock Exchange 3 years ago. The company has a broad customer base mainly consisting of small and medium-sized companies. Raymond Plc. has achieved rapid growth in recent years by obtaining regular business from satisfied customers and also by acquiring other IT services companies.

The Directors of Raymond Plc. have identified Harold Limited, an unlisted company, as a possible acquisition target. Harold Limited has a number of large multinational clients, and, in general, its clients tend to be larger than those of Raymond Plc. If successful, the acquisition would go ahead on January 1, 2018.

Forecast financial data for Raymond Plc. and Harold Limited as of December 31, 2017, are summarized below:

Financial Item Raymond Plc. Harold Limited
Share capital (Ordinary ₦1 shares) ₦150m ₦40m
Market share price ₦4.90 N/A

N/A: Not applicable (not listed).

Additional information:

  1. If Harold Limited were to remain an independent company, its Directors estimate that reported Profit After Tax would be ₦15 million for 2018 and then grow by 2% yearly in perpetuity;
  2. If the acquisition were to go ahead, Raymond Plc.’s Directors estimate that Harold Limited’s profit after tax would be 5% higher for 2018 than if the company remains an independent company, and that profit after tax would then grow by 3% yearly in perpetuity;
  3. The average ungeared Cost of Equity for the industry is 8%;
  4. Both Raymond Plc. and Harold Limited are wholly equity financed; and
  5. Profit after tax can be assumed to be a good approximation of free cash flow attributable to investors.

The Directors of Raymond Plc. are considering offering to purchase Harold Limited at a price of ₦7.00 per share. It is estimated that transaction costs of ₦8 million would be payable on the acquisition and that ₦2 million would be required in the first year to cover the costs of integrating the two companies.

Required:

  • (a) Calculate:
    • i. The value of Raymond Plc. as at December 31, 2017.
    • ii. The value of Harold Limited as at December 31, 2017 before taking the possible acquisition of the company by Raymond Plc. into account.
    • iii. The overall increase in value created by the acquisition of Harold Limited by Raymond Plc. (8 Marks)
  • (b)
    • i. Explain how value might be created by the proposed acquisition. (2 Marks)
    • ii. Comment on the difficulties which Raymond Plc. is likely to face in realizing the potential added-value, after the acquisition. (2 Marks)
  • (c) Evaluate the proposed offer price of ₦7.00 per share for Harold Limited from the point of view of:
    • i. Harold Limited’s shareholders.
    • ii. Raymond Plc.’s shareholders. (8 Marks)

(Total 20 Marks)

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  • 4 Marks

AFM – May 2017 – L3 – Q3c – Valuation of acquisitions and mergers

Factors to be considered by the directors and shareholders in evaluating the worthiness of the takeover proposal.

Discuss briefly any other factors that the directors and shareholders of both companies might consider in assessing the worthwhileness of the proposed takeover. (4 marks)

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  • 16 Marks

AFM – May 2017 – L3 – Q3a & b – Valuation of acquisitions and mergers

Calculating the maximum and minimum prices for Jacobs Ltd's acquisition of Idowu Co Ltd based on future revenue and cost synergies.

Jacobs Limited and Idowu Company Limited both manufacture and sell auto parts. The summarised profit and loss accounts of the two companies for 2014 are as follows:

Jacobs Ltd (GH¢’000) Idowu Co Ltd (GH¢’000)
Sale Revenue 1,500 800
Operating Expenses (800) (620)
Profit 700 180

Each company has earned a constant level of profit for a number of years, and both are expected to continue to do so. The policy of both companies is to distribute all profits as dividends to ordinary shareholders as they are earned. Neither company has any fixed interest capital. Details of the ordinary share capital of the two companies are as follows:

Jacobs Ltd (GH¢’000) Idowu Co Ltd (GH¢’000)
Authorised Ordinary Shares 2,500 2,000
Issued Ordinary Shares 2,000 1,000
Market Value per Share (Ex Div) 3.50 1.50

The directors of Jacobs Limited are considering submitting a bid for the entire share capital of Idowu Co Limited. They believe that, if the bid succeeds, the combined sales revenue of the two companies will increase by GH¢60,000 per annum, and savings in operating expenses, amounting to GH¢50,000 per annum, will be possible. Part of the machinery at present owned by Idowu Co Limited would no longer be required and could be sold for GH¢100,000. Furthermore, the directors of Jacobs Limited believe that the takeover would result in a reduction to 9% in the annual return required by the ordinary shareholders of Idowu Co Limited.

Required:
i) On the basis of the above information, calculate the maximum price that Jacobs Ltd should be willing to pay for the entire share capital of Idowu Co Limited. (6 marks)
ii) Calculate the minimum price that the ordinary shareholders in Idowu Co Ltd should be willing to accept for their shares. (4 marks)

Assume that the takeover price is agreed at the figure calculated in part (ii) above, and that the purchase consideration will be settled by an exchange of ordinary shares in Idowu Co Ltd for the ordinary shares of Jacobs Ltd. Show how the entire benefit from the takeover will accrue to all the present shareholders of Jacobs Ltd. (6 marks)

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  • 20 Marks

AFM – Nov 2017 – L3 – Q3 – Valuation of acquisitions and mergers

Calculating the valuation per share for minority and complete takeover of Fasco and Boscan, and discussing limitations of the approach.

Zed Ltd is considering the immediate purchase of some, or all, of the share capital of one of two firms—Fasco Ltd and Boscan Ltd. Both Fasco Ltd and Boscan Ltd have one million ordinary shares issued, and neither company has any debt capital outstanding.

Both firms are expected to pay a dividend in one year’s time—Fasco’s expected dividend amounting to 30p per share, and Boscan’s being 27p per share. Dividends will be paid annually and are expected to increase over time. Fasco’s dividends are expected to display perpetual growth at a compound rate of 6% per annum. Boscan’s dividend will grow at the high annual compound rate of 33⅓% until a dividend of 64p per share is reached in year 4. Thereafter, Boscan’s dividend will remain constant.

If Zed is able to purchase all the equity capital of either firm, then the reduced competition would enable Zed to save some advertising and administrative costs, which would amount to GH¢225,000 per annum indefinitely, and, in year 2, to sell some office space for GH¢800,000. These benefits and savings will only occur if a complete takeover is carried out. Zed would change some operations of any company completely taken over, the details are:

  • Fasco – No dividend would be paid until year 3. Year 3 dividend would be 25p per share, and dividends would then grow at 10% per annum indefinitely.
  • Boscan – No change in total dividends in years 1 to 4, but after year 4, dividend growth would be 25% per annum compound until year 7. Thereafter, annual dividends would remain constant at the year 7 amount per share.

An appropriate discount rate for the risk inherent in all the cash flows mentioned is 15%.

Required:
a) Calculate the valuation per share for a minority investment in each of the firms, Fasco and Boscan, which would provide the investor with a 15% rate of return. (6 marks)

b) Calculate the maximum amount per share which Zed should consider paying for each company in the event of a complete takeover. (8 marks)

c) Comment on any limitation of the approach used in part (a), and specify the other major factors which would be important to consider if the proposed valuations were being undertaken as a practical exercise. (6 marks)

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