Topic: Mergers and acquisitions

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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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  • 15 Marks

FM – Nov 2016 – L3 – SC – Q7 – Mergers and Acquisitions

Advise on the benefits, drawbacks, alternatives, and target selection criteria for expansion through mergers or acquisitions.

One of the means by which companies expand is through mergers and acquisitions. However, there are other means of expansion aside from these methods.

Inkline Plc. is one of your client companies intending to expand its business by means of merger or acquisition. Your firm of management consultants has been asked to advise the management of the company on what steps to take while considering the merger and acquisition methods, and whether it should go ahead with the expansion programme or otherwise.

Required:

a. (i) FOUR benefits derivable from its proposed means of expansion. (4 Marks)
(ii) THREE probable demerits of employing its proposed method of expansion. (3 Marks)

b. TWO alternatives to merger and acquisition in your report. (2 Marks)

c. Where the company decides to go ahead with either of these methods, indicate THREE criteria the company may consider in choosing its target company. (6 Marks)

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  • 30 Marks

FM – May 2019 – L3 – Q1 – Mergers and Acquisitions

Evaluate the synergy expected from a proposed merger between Pako Plc. and RT Plc. using free cash flow analysis, and discuss limitations and alternatives.

Pako Plc. will soon announce a take-over bid for Ronke Tina (RT) Plc., a company in the same industry. The initial bid will be an all-share bid of four Pako shares for every five RT Plc. shares. The most recent annual data relating to the two companies are shown below:

The take-over is expected to result in cost saving in advertising and distribution, reducing the operating costs (including depreciation) of Pako from 76% of sales to 70% of sales. The growth rate of the combined company is expected to be 6% per year for four years and 5% per year thereafter. RT’s debt obligations will be taken over by Pako. The corporate tax rate is expected to remain at 30%.

Sales and costs relevant to the decision may be assumed to be in cash terms.

Required:

a. Estimate how much synergy is expected to be created from the take-over, using free cash flow to the firm analysis for each individual company and the potential combined company. State clearly any assumptions that you make.
Note: The weighted average cost of capital of the combined company is assumed to be 9%. (20 Marks)

b. Discuss any five limitations of the above estimates. (5 Marks)

c. Explain, generally, three advantages and two disadvantages of expansion through merger and acquisition rather than through organic growth. (5 Marks)
(Total: 30 Marks)

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  • 20 Marks

FM – Nov 2014 – L3 – SB – Q3 – Mergers and Acquisitions

Appraise Syntax Plc.'s proposed acquisition of Synapse Chemical Company based on forecast profits and provide a recommendation.

Syntax Plc., a fertilizer company, is concerned about fluctuating sales and earnings. This caused the management of the company to consider acquisition of another company in the same line of business.

In order to boost its sales and stabilize its earnings, Syntax Plc.’s management has identified Synapse Chemical Company Plc. as a possible target. Syntax proposed to acquire Synapse for a consideration of N20 million, which was agreed to by both companies.

Synapse’s expected future profits, as projected from its past financial records, are as follows:

Forecast Profits

Year Revenue (N’m) Cost of Sales (N’m) Other Expenses (N’m) Depreciation (N’m) Total Expenses (N’m) Profit Before Tax (N’m)
2015 60 30 15 5 50 10
2016 70 35 15 4 54 16
2017 78 39 15 4 58 20
2018 86 43 15 4 62 24
2019 94 47 15 4 66 28

The following information is relevant:

  1. The forecast profits have been limited to five years.
  2. All sales are for cash.
  3. The net book value of Synapse’s assets of N2 million is intended to be sold for N1 million in 2015. The expected loss from the disposal of these assets has been included in the depreciation for 2015. These assets currently have a tax written down value of N3 million. Capital allowances were claimed as at when due.
  4. Synapse currently has a tax liability of N4.5 million due for payment in 2015.
  5. The interest charges of N1 million of Synapse Plc. have been included in other expenses.
  6. In order to maintain the future earnings forecast of Synapse Chemical Company, Syntax Plc. needs to invest in capital expenditure.

7. Company income tax is currently at 30 percent, and the tax delay is one year.

8. The after-tax weighted average cost of capital has been calculated at 22%.

The management of Syntax Plc. has asked you, as a Financial Expert, to appraise the intended acquisition of Synapse Chemical Company Plc. and advise on the reasonableness of the acquisition. Your advice should be in the form of a report to the Board of Directors of Syntax Plc.

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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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  • 15 Marks

FM – May 2023 – L3 – Q7 – Mergers and Acquisitions

Evaluate the share price of Obong plc under different growth scenarios and advise on the takeover bid. Explain EMH and its implications for the market.

Obong plc recently received a takeover bid from Abdul plc. If the bid for Obong plc is successful, it will provide Abdul plc the needed competitive edge in research and development to expand its laboratories into the production of the COVID-19 vaccine.

The shareholders of Obong plc will only accept an offer that meets a required return of 14% on their current shareholdings.

Obong plc recently paid a dividend of N20, and this is expected to grow at a rate of 7% for the foreseeable future.

Required:

a. Estimate the share price of Obong plc today. (2 Marks)

b. If Obong plc accepts the bid from Abdul plc, it is estimated that the new growth rate will rise to 12% for the first 3 years and thereafter stabilize at 7%. Calculate the new share price to the shareholders of Obong plc. (2 Marks)

c. As a financial advisor, recommend to the shareholders of Obong plc whether the offer from Abdul plc should be accepted. (2 Marks)

d. According to Efficient Market Hypothesis (EMH), it is believed that the market would react instantly and accurately to the merger announcement between Obong plc and Abdul plc.
Define briefly the THREE forms of EMH and their implications to the market. (9 Marks)

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  • 4 Marks

FM – May 2023 – L3 – Q1b – Mergers and Acquisitions

Discuss the typical factors included in takeover regulations across countries.

b. The regulation of takeovers varies from country to country.

Outline the typical factors that such a regulation includes. (4 Marks)

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  • 15 Marks

FM – Nov 2016 – L3 – Q7 – Mergers and Acquisitions

Advise Inkline Plc on expansion through mergers or acquisitions, potential benefits, demerits, alternatives, and target criteria.

One of the means by which companies expand is through mergers and acquisitions. However, there are other means of expansion aside from these methods.

Inkline Plc, one of your client companies, is intending to expand its business by means of a merger or acquisition. Your firm of management consultants has been asked to advise the management of the company on what steps to take while considering the merger and acquisition methods and whether it should go ahead with the expansion program or otherwise.

Required:

(a) Advise your client on:
(i) Four benefits derivable from its proposed means of expansion. (4 Marks)
(ii) Three probable demerits of employing its proposed method of expansion. (3 Marks)

(b) State two alternatives to merger and acquisition in your report. (2 Marks)

(c) Where the company decides to go ahead with either of these methods, indicate three criteria the company may consider in choosing its target company. (6 Marks)

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  • 20 Marks

FM – Nov 2021 – L3 – Q2 – Mergers and Acquisitions

Advise on financial synergies from KP's acquisition of TE and evaluate cash vs. share-for-share offers.

You run a financial consultancy firm and have been approached by a new client for advice on a potential acquisition. Kola Plc (KP) is a large engineering company that was listed on the stock market ten years ago, with the founders retaining a 20% stake in the business. KP initially experienced rapid growth in earnings before tax, but soon after listing, competition intensified, leading to a significant decline in growth, which currently stands at 4%. Concerned about limited future growth opportunities, the board has decided to adopt a market development strategy for growth by acquiring companies in less competitive regions using KP’s significant cash reserves. The board has identified Temidayo Engineering (TE) as a potential acquisition target.

Temidayo Engineering (TE):

TE is a private engineering company established eight years ago, with early accumulated losses that have now turned profitable, achieving an 8% annual growth in earnings before tax. Cash reserves remain low, and capital access has been a constraint on TE’s investment potential. The founders and their families own 70% of the shares, while a venture capitalist holds the remaining 30%.

Acquisition Information:

KP’s board prefers that TE’s founders remain as directors post-acquisition and has sufficient cash reserves to purchase TE outright. A cash offer of ₦13.10 per share is considered likely to encourage TE’s shareholders to approve the acquisition. Alternatively, KP’s board is exploring a share-for-share exchange to preserve cash for future acquisitions and dividends. Recent mergers in the industry have attracted a 25-30% acquisition premium, with TE’s shareholders expecting a premium towards the higher end for a share-for-share offer. KP has asked you to design a share-for-share offer scheme with a 30% premium.

Extracts from the Latest Financial Statements:

Additional Financial Information:

  • KP has ₦0.50 ordinary shares totaling ₦7,500 million, with each share trading at ₦5.28. It is expected that KP’s price-to-earnings (P/E) ratio will increase by 10% if the acquisition proceeds.
  • TE upgraded its main manufacturing facility last year, expecting annual pre-tax cost savings of ₦50 million from the current financial year. TE has ₦0.25 ordinary shares totaling ₦700 million. TE’s P/E ratio is estimated to be 20% higher than KP’s current P/E ratio based on comparable company analysis.
  • KP’s CEO estimates annual pre-tax revenue and cost synergies of ₦304 million post-acquisition, while the finance director anticipates additional pre-tax financial synergies of ₦106 million, though cautiously, following reports that many acquisitions overestimate synergies. The tax rate is 20%.

Required:

a. Discuss possible sources of financial synergy arising from KP’s acquisition of TE. (6 Marks)

b. Advise the directors on a suitable share-for-share exchange offer that meets TE’s shareholders’ criteria and calculate the impact of both cash and share-for-share offers on the post-acquisition wealth of KP’s and TE’s shareholders. (14 Marks)

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  • 20 Marks

FM – Nov 2020 – L3 – Q2 – Mergers and Acquisitions

Evaluates the acquisition impact of Yekin plc by Peter John plc, focusing on P/E ratio, EPS, market value, and strategic implications of a hostile takeover versus organic growth.

Peter John plc (PJP) is considering a takeover bid for Yekin plc (YP).

PJP’s board of directors has issued the following statement:
“Our superior P/E ratio and synergistic effects of the acquisition will lead to a post-acquisition increase in earnings per share and in the combined market value of the companies.”

Summarized financial data for the companies (N Million):

PJP YP
Sales 480.0 353.0
Profit before tax 63.0 41.0
Tax (18.9) (12.3)
Profit after tax 44.1 28.7
Dividends 20.0 11.0
Non-current assets (net) 284.0 265.0
Current assets 226.4 173.0
Total assets 510.4 438.0

Equity and Liabilities:

PJP YP
Ordinary shares (10 kobo par value) 40.0 30.0
Reserves 211.2 192.0
Medium and long-term borrowing 86.0 114.0
Current liabilities 173.2 102.0
Total 510.4 438.0

Notes:

  1. After-tax savings in cash operating costs of N7,500,000 per year indefinitely are expected as a result of the acquisition.
  2. Initial redundancy costs will be ₦10 million before tax.
  3. PJP’s cost of capital is 12%.
  4. Current share prices: PJP = N29, YP = N18.
  5. The proposed terms of the takeover are payment of 2 PJP shares for every 3 YP shares.

Required:

a. Calculate the current P/E ratios of PJP and YP. (2 Marks)
b. Estimate the expected post-acquisition earnings per share and comment upon the importance of increasing the earnings per share. (4 Marks)
c. Estimate the effect on the combined market value as a result of the takeover using:
i. P/E-based valuation
ii. Cash flow-based valuation
State clearly any assumptions that you make. (5 Marks)
d. Discuss the limitations of your estimates in (c) above. (3 Marks)
e. Evaluate the strategic implications of making a hostile bid for a company compared with an aggressive investment program of organic growth. (6 Marks)

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  • 15 Marks

FM – May 2024 – L3 – SC – Q7 – Mergers and Acquisitions

Discuss manager-shareholder conflicts with examples and reasons for synergy in mergers and acquisitions.

(a) Discuss conflict of interest that may exist between managers and shareholders and give examples. (8 Marks)

(b) Explain why synergy might exist when one company merges with or takes over another company. (7 Marks)

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  • 15 Marks

FM – May 2018 – L3 – SC – Q6 – Mergers and Acquisitions

Key factors for target selection and consideration form in acquisition decisions for Okpara Plc.

Okpara Plc. is a large publicly quoted company in the eastern part of Nigeria. It operates in the home appliances industry with significant market share. In a recent strategy meeting, the directors decided to pursue aggressive growth through mergers in other parts of the country and along the ECOWAS sub-region.

Required:

Prepare a report to the Board of Directors of Okpara Plc. to address the following matters:

a. Six factors to be considered when choosing a target for acquisition.
(9 Marks)

b. Four factors which a bidding company should take into account in deciding the form of consideration to be offered.
(6 Marks)

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  • 30 Marks

FM – Nov 2023 – L1 – SA – Q1 – Mergers and Acquisitions

Evaluate Finkex Plc's acquisition strategy of Toba Plc, focusing on share-for-share impact, valuation methods, and shareholder implications.

Finkex Plc (FP) is a listed company that operates in the pharmaceutical sector, manufacturing a broad range of drugs under license in a number of countries along the ECOWAS sub-region. For a number of years, the company has grown organically.

Three years ago, the company acquired 20% of the issued share capital of Toba Plc (TP) for N110 million, as a route to both expansion and diversification. The acquisition was by private negotiation in exchange for an issue of its own shares.

Toba Plc is involved in a different area of the pharmaceutical sector from FP as it is primarily a research-driven company involved in the development of new drugs.

To expedite the realization of its diversification strategy, the directors of FP have now decided to acquire the remaining 80% of Toba’s share capital.

Extracts from the financial statements of Finkex Plc are given below:

Finkex Plc – Extracts from financial statements for the last two years

Year 2023 2022
N’m N’m
Non-current assets (including investment in Toba plc) 602.8 499.4
Current assets 265.0 180.4
Total Assets 867.8 679.8
Current liabilities 199.2 136.8
Total assets less current liabilities 668.6 543.0
Non-current liabilities 149.5 159.4
Net assets 519.1 383.6
Issued share capital (ordinary shares of ₦1 each) 100.0 73.6
Share premium 84.0 12.4
Profit or loss account 335.1 297.6
Total Equity 519.1 383.6
Sales revenue 1320.6 496.0
Earnings after tax 51.50 37.60
Dividend 14.0 14.0
Retained profits 37.5 23.6

All that is known about Toba Plc is that it has 114 million shares in issue; total share capital and reserves are N684 million; earnings after tax in the most recent year were ₦85.2 million on sales of N1,252.0 million, which were double those of the previous year; and that it has an investment valued at N80 million (book and market) in a type of enterprise which might not be of interest to Finkex Plc.

The current stock market prices per share are: Finkex Plc 300k; Toba plc 341k. Both companies pay tax at 50%.

Required:

a. At the above market prices, how many shares of Finkex Plc would have to be issued to buy the rest of Toba Plc on a share-for-share offer? (4 Marks)

b. With regard to earnings and also the book value of assets per share, how would the above share-for-share offer affect the position of:

i. Existing shareholders in Finkex Plc; (6 Marks)

ii. The 80% shareholders in Toba Plc whose shares were to be acquired? (4 Marks)

c. Assuming that the 80% shareholders in Toba Plc were prepared to accept ₦80 million 10% Loan Stock as part of the consideration:

i. What advantages might there be for Finkex Plc in this arrangement? (2 Marks)

ii. What total price could Finkex Plc afford to pay without diluting the earnings per share of its existing shareholders, as calculated in (b) (i) above? (6 Marks)

d. If the board of Toba Plc decided to advise its shareholders not to accept an offer from Finkex Plc, what arguments might they use – including any derived from the financial information available about Finkex Plc?

(8 Marks)

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  • 30 Marks

FM – Nov 2022 – L3 – Q1 – Mergers and Acquisitions

Evaluating the acquisition of Company K3 in Togo for business expansion purposes.

The following case relates to a business expansion decision for Abayomi Plc (AP):

Abayomi Plc (AP) is a major electrical company in Nigeria. The directors have recently identified Togo as a priority location for business expansion. Togo uses currency T$. Assume today is 30 August 2021.

Company K3, located in Togo, has been identified as a potential acquisition target. AP already manages two business units in Togo, named K1 and K2, and these have shown strong performance under AP’s ownership.

K3 is particularly attractive to AP because it has its own warehouse, distribution, and logistics network, all of which could be used by K1 and K2, if the acquisition goes ahead. Currently, K1 and K2 send goods to customers from AP warehouses located in Ghana. This involves considerable cost and delay in delivery.

K3 is a private company, and 100% of its shares are owned by the family that founded it. Many shareholders are keen to realize their investment by selling the company to AP.

Both companies are working towards an effective date for the sale of K3 to AP on 1 January 2022.

Financial Data for K3 for 2020:

The statement of financial position of K3 as at 31 December 2020 showed the following balances:

T$ Million
Long term borrowings 375
Share capital (T$1 ordinary shares) 90
Total liabilities 465
Net assets 180

Additional Data:

AP aims to maintain the same capital structure as AP. That is, gearing (debt/debt+equity) would be 25% based on market values. AP would guarantee K3’s new debt, which can be assumed to have the same risk profile as AP’s debt.

A proxy company has been identified which is also located in Togo and has a similar business model to K3.

Proxy company data:

  • P/E ratio of 12.
  • Equity beta of 1.7 and debt beta of 0.4.
  • Gearing (debt/debt+equity) based on market values of 35%.

Togo has a risk-free rate of 5% and a market risk premium of 4%.

Financial Data for AP:

Latest data available for AP shows:

  • P/E ratio of 14.
  • Equity beta of 1.5 and debt beta of 0.3.
  • Gearing (debt/debt+equity) based on market values of 25%.
  • AP pays 6.2% interest on its long-term borrowings.
  • Tax rate in Nigeria is 30%.

The spot rate for T$ against Naira today is T$7/₦ (i.e., ₦1 = T$7.00) and is not expected to change in the foreseeable future.

Assume that Nigeria has the same risk-free rate and market risk premium as Togo.

Required:
Assume you are the Finance Director of AP.

a. Advise on:
i. The types of synergistic benefit that might arise from the acquisition of K3. (8 Marks)
ii. Possible reasons why both one-off and ongoing synergistic benefits might not be achieved to the extent expected. (4 Marks)

b. Calculate:
i. A Weighted Average Cost of Capital (WACC) for use in valuing K3 based on the proxy company’s business and country risk and AP’s capital structure. (6 Marks)
ii. A range of values for the equity of K3 in T$ as at 1 January 2022 using the following methods:

  • Asset basis. (2 Marks)
  • P/E (including bootstrapping). (5 Marks)
  • DCF (with and without synergistic benefits). (5 Marks)

(Total 30 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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  • 20 Marks

FM – DEC 2023 – L2 – Q2 – Business valuations | Mergers and acquisitions

Business valuation techniques applied to a 70% acquisition using P/E ratio, balance sheet valuation, and discounted cash flow.

a) Panpana Ltd is in advanced negotiation with shareholders of Zanu Ltd to acquire 70% shares in that company. The following financial information is provided for Zanu Ltd:

  • Number of ordinary shares = 20 million
  • Net assets per share = GH¢8
  • Earning per share = GH¢15
  • Price Earnings ratio (P/E) = 10

The Finance Director who performed a due diligence review recommended the following:

  1. Fixed assets included in the net assets were overstated by GH¢6 million
  2. A key customer who owes GH¢4 million has gone bankrupt and debt considered irrecoverable
  3. A provision of GH¢10 million is made for a tax liability
  4. Panpana Ltd cost of capital is 16% and risk premium of 4% is added in the valuation of Zanu Ltd to take care of additional operational risk.
  5. The Finance manager provided a statement showing projected cash inflows for the next 5 years as follows:
Year Cash flow (GH¢ million)
1 125
2 60
3 150
4 200
5 110

Required:
Advise shareholders of Panpana Ltd on how much to pay for 70% of the shares of Zanu Ltd using the following valuation methods:
i) Price Earning (P/E) ratio. (4 marks)
ii) Balance sheet valuation basis. (5 marks)
iii) Cash flow valuation. (5 marks)

b) Explain THREE (3) reasons business valuation is undertaken in the corporate environment. (6 marks)

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  • 20 Marks

FM – May 2020 – L2 – Q2 – Business valuations | Mergers and acquisitions

Value Staygood Ltd using the Price/Earnings ratio, Gordon growth model, and Discounted cash flow methods for a potential takeover by Restwell Ltd.

Restwell Ltd (Restwell), a hotel and leisure company, is currently considering taking over a smaller private limited liability company, Staygood Ltd (Staygood). The board of Restwell is in the process of making a bid for Staygood but first needs to place a value on the company. Restwell has gathered the following data:

Restwell:

  • Weighted average cost of capital: 12%
  • P/E ratio: 12
  • Shareholders’ required rate of return: 15%

Staygood:

  • Current dividend payment (GH¢): 0.27
  • Past five years’ dividend payments (GH¢): 0.15, 0.17, 0.18, 0.21, 0.23
  • Current EPS: 0.37
  • Number of ordinary shares issued: 5 million

The required rate of return of the shareholders of Staygood is 20% higher than that of Restwell due to the higher level of risk associated with Staygood. Restwell estimates that cash flows at the end of the first year will be GH¢2.5 million and these will grow at an annual rate of 5%. Restwell also expects to raise GH¢5 million in two years’ time by selling off hotels of Staygood that are surplus to its needs.

Required:

Estimate values for Staygood using the following valuation methods:

i) Price/earnings ratio valuation. (6 marks)

ii) Gordon growth model. (8 marks)

iii) Discounted cash flow valuation. (6 marks)

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  • 20 Marks

FM – Nov 2023 – L2 – Q2 – Business valuations | Mergers and acquisitions

Evaluate the potential acquisition of Akwaaba Films by Lekker Inc, including valuation, cost of equity, and reasons for potential merger failures.

Lekker Inc (Lekker) is a film company located in South Africa. The company is planning to expand into other African countries. The research department of Lekker recommends Ghana as a good location for establishing a subsidiary due to its abundant talent and political stability. However, the company is unsure whether to establish a completely new subsidiary or acquire an existing film company in Ghana. You have been engaged as a consultant to guide Lekker in taking this decision.

Your preliminary assessment revealed the following:

i) You have identified a Ghanaian filmmaker who owns a fast-growing film company called Akwaaba Films (Akwaaba). You observed that the Ghanaian filmmaker is likely to sell Akwaaba if Lekker could pay GH¢450,000 as purchase consideration. Akwaaba is entirely self-financed, with the owner receiving all profits as dividends. You forecast that Akwaaba’s profit after tax will grow at a rate of 6% per year for the first two years, 4% per year for the next two years, and thereafter, grow at a constant rate of 2% per year in perpetuity. The financial information extracted from Akwaaba shows the following:

Description GH¢
Revenue 250,000
Operating Cost (140,000)
Administrative cost (30,000)
Profit before tax 80,000
Tax @ 25% (20,000)
Profit after tax 60,000

ii) If Lekker decides to set up the subsidiary in Ghana by itself with the same GH¢450,000 purchase consideration for Akwaaba, its after-tax cash flows will be as follows:

Year Cash Flow (GH¢)
Year 1 15,000
Year 2 26,000
Year 3 35,000
Year 4 33,000

The overall Price/Earnings (P/E) ratio for the film industry in Ghana is 15 times. The average cash flow risk for unquoted companies in Ghana is 20%. Lekker does not intend to list on the Ghana Stock Exchange.

iii) Lekker’s cost of capital is 16%.

Required:
a) Enumerate THREE (3) advantages of expansion through acquisition over organic expansion to the owners of Lekker. (6 marks)
b) Compute the value of Akwaaba using the dividend valuation method and advise Lekker whether it should acquire Akwaaba at the purchase consideration of GH¢450,000. (8 marks)
c) Using the P/E ratio method, estimate the expected value of Lekker’s subsidiary in Ghana without the acquisition. (4 marks)
d) State TWO (2) reasons mergers and acquisitions may fail to achieve the expected outcomes. (2 marks)

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  • 20 Marks

FM – July 2023 – L2 – Q2 – Mergers and acquisitions

Calculate the value of a combined business after a merger, determine the maximum and minimum acceptable prices for the merger, and evaluate the type of merger.

Amanfi Ltd manufactures cooking oil for the local markets in Ghana. The management of Amanfi Ltd believes that by merging with one of their input suppliers, Aseebu Ltd, the company will be able to control supply, thus giving the Amanfi Group a low-price advantage in the market. Aseebu Ltd is a key supplier of inputs to companies in the cooking oil industry. The financial statements of the two companies are shown below:

Income Statement for the past Five Years (Amanfi Ltd)

Year (Million GH¢) 2018 2019 2020 2021 2022 (current year)
Sales 3,720 4,092 4,500 4,950 5,442
Cost of Sales (1,674) (1,841) (2,025) (2,228) (2,449)
Operating Profit 2,046 2,251 2,475 2,722 2,993
Finance Cost (252) (278) (305) (336) (369)
Earnings Before Tax 1,794 1,973 2,170 2,386 2,624
Tax @ 30% (538) (592) (651) (716) (787)
Earnings After Tax 1,256 1,381 1,519 1,670 1,837

Income Statement for the past Five Years (Aseebu Ltd)

Year (Million GH¢) 2018 2019 2020 2021 2022 (current year)
Sales 1,860 2,046 2,250 2,475 2,496
Cost of Sales (837) (921) (1,013) (1,114) (1,123)
Operating Profit 1,023 1,125 1,237 1,361 1,373
Finance Cost (126) (139) (153) (168) (169)
Earnings Before Tax 897 986 1,084 1,193 1,204
Tax @ 30% (269) (296) (325) (358) (361)
Earnings After Tax 628 690 759 835 843

Additional Information:
Amanfi Ltd and Aseebu Ltd have beta of 1.6 and 1.1 respectively. The government treasury bill rate pays a yield of 8% and risk premium on the market is 17%. If the merger goes through, the combined company’s earnings after tax will grow at the same rate as Amanfi Ltd. The merger will lead to annual cost savings of GH¢850 million in perpetuity.

Required:
a) As a Finance Manager, calculate the value of the combined business based on the present value of expected earnings. (8 marks)
b) What is the maximum amount that Amanfi Ltd should pay for Aseebu Ltd? (4 marks)
c) What is the minimum bid that Aseebu Ltd shareholders should be prepared to accept? (4 marks)
d) Calculate the gain/loss from the merger. (2 marks)
e) Identify and explain the type of merger between Amanfi Ltd and Aseebu Ltd. (2 marks)

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  • 6 Marks

FM – March 2023 – L2 – Q2b – Mergers and acquisitions

Explain three defensive strategies that a target company can adopt to ward off a hostile takeover.

In a hostile takeover, management and staff of target companies go through a lot of psychological and mental trauma causing management of target companies to resist the takeover. There are certain defensive strategies that are usually used by management of the target company to ward off the predator.

Required:
Explain THREE (3) defensive strategies that can be adapted by the target company to ward off predators. (6 marks)

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