Topic: Valuation of acquisitions and mergers

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  • 14 Marks

AFM – Nov 2016 – L3 – Q4a – Valuation of acquisitions and mergers

Calculate the NPV of Mama Ltd's acquisition of Papa Ltd and determine the value of the combined entity and an appropriate share exchange ratio.

a) The Directors of Mama Ltd (Mama), a large listed company, are considering an opportunity to
acquire all the shares of Papa Ltd (Papa), a small listed company with a highly efficient
production technology.
Mama has 10 million shares of common stock in issue that are currently trading at GH¢6.00
each. Papa Ltd has 5 million shares of common stock in issue, each of which is trading at
GH¢4.50.
If Papa is acquired and integrated into the business of Mama, the production efficiency of the
combined entity would increase and save the combined business GH¢600,000 in operating
costs each year to perpetuity.
Though Mama operates in the same industry as Papa, its financial leverage is higher than that
of Papa. Mama’s total debt stock is valued at GH¢40 million, and its after-tax cost of debt is
22%. The beta of Mama’s common stock is 1.2. The return on the risk-free asset is 20% and
the market risk premium is 5%.
Required:
Suppose Mama offers a cash consideration of GH¢25 million from its existing funds to the
shareholders of Papa for all of their shares.
i) Calculate the NPV of the acquisition, and advise the directors of Mama on whether to
proceed with the acquisition or not. (8 marks)
ii) Calculate the value of the combined entity immediately after the acquisition. (3 marks)
iii) Suppose Mama would like to acquire all the shares in Papa by offering fresh shares of its
own common stock to the shareholders of Papa. Advise the directors on the appropriate
share exchange ratio based on market price.

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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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  • 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.

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)

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  • 5 Marks

AFM – May 2019 – L3 – Q3b – Valuation of acquisitions and mergers

Evaluate whether Ape should proceed with the merger by assessing the financial impact and synergy benefits.

Ape has 2,500 shares outstanding at GH¢10 per share. Bee has 1,250 shares outstanding at GH¢5 per share. Ape estimates that the value of synergistic benefit from acquiring Bee is GH¢500. Bee has indicated that it would accept a cash purchase offer of GH¢6.50 per share.

Required:
Identify whether Ape should proceed with the merger

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  • 15 Marks

AFM – May 2019 – L3 – Q3a – Valuation of acquisitions and mergers

Use comparative analysis to value Alpha Ltd based on data from Beta Ltd and Gamma Ltd, and discuss factors for private company valuation.

At a meeting of the Directors of the Alpha Company Limited – a privately owned company – in May 1975, the recurrent question is raised as to how the company is going to finance its future growth and at the same time enable the founders of the company to withdraw a substantial part of their investment. A public quotation was discussed in 1974 but because of the depressed nature of the stock market at that time, consideration was deferred. Although the matter is not of immediate urgency, the Chairman of the company – one of the founders – produces the following information which he has recently obtained from a firm of financial analysts in respect of two publicly quoted companies, Beta Limited and Gamma Limited, which are similar to Alpha Limited in respect to size, asset composition, financial structure, and product mix.

The only information you have available at the meeting in respect of Alpha Limited is the final accounts for 1974, which disclose the following:
Alpha Limited
Share Capital (no variation for 8 years) 100,000 Ordinary GH¢1 Share
Post-Tax Earnings GH¢400,000
Gross Dividends GH¢100,000
Book Value GH¢3,500,000

From memory, you are of the view that the post-tax earnings and gross dividends for 1974 were at least one-third higher than the average of the previous five years.

Required:

i) Use the information provided to answer the Chairman’s question on what Alpha Ltd was worth in 1974.
ii) Discuss FOUR (4) factors to be taken into account in trying to assess the potential market value of shares in a private company when they are first offered for public subscription.

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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

AFM – Nov 2015 – L3 – Q5 – Valuation of acquisitions and mergers

Evaluate the acquisition of Anas-Expo Clothing Ltd by Two-Pack Fashion Ltd, analyzing its effect on EPS, shareholders' wealth, and sources of conflict.

You are the Finance Manager of a growing clothing company, Two-Pack Fashion Ltd (Two-Pack). Two-Pack has enjoyed significant growth in recent years using an internal growth strategy. Two-Pack is now seeking to acquire other companies to speed up its growth drive. It has identified Anas-Expo Clothing Ltd (Anas-Expo) as a suitable candidate for takeover. Both companies have the same level of risk.

Anas-Expo produces high-quality handmade clothes, with which it has earned several awards. The company has recorded considerable profits in the past, but its output has dwindled over the past two years due to increasing labour costs. Labour unions have pressured policymakers into amending labour regulations, particularly those relating to pensions and minimum wages, to provide more benefits and protection for workers. Directors of Two-Pack believe that production and profitability of Anas-Expo will be enhanced if its production process is mechanized.

Below are summarized financial data for the two companies immediately before acquisition:

Two-Pack (GHS’m) Anas-Expo (GHS’m)
Sales revenue 285.8
Net operating income 85.8
Interest charges 14.2
Net income before tax 71.6
Corporate tax 15.8
Net income after tax 55.8
Dividends 22.3
Addition to retained earnings 33.5

Two-Pack has 40 million shares and a P/E ratio of 18, while Anas-Expo has 25 million shares and a P/E ratio of 12. Directors of Two-Pack have decided that Two-Pack takes up all the equity shares in Anas-Expo by offering to its shareholders one new share for every share they hold. They have also decided that Two-Pack mechanizes Anas-Expo’s production process immediately at the cost of GHS18 million, replacing work currently done by hand. It is estimated that operational efficiency arising from the acquisition and integration of the two companies would yield after-tax benefits of GHS25 million per year to perpetuity. The cost of capital of Two-Pack is 25%.

Required:

(a) Evaluate the acquisition proposal, and recommend whether the acquisition should go ahead.
(b) Analyze the effect of the acquisition on the earnings per share (EPS) of Two-Pack following the successful acquisition of Anas-Expo.
(c) Analyze the effect of the acquisition on the wealth of the shareholders of each company.
(d) Advise the directors of Two-Pack on three likely sources of conflict in relation to the acquisition of Anas-Expo and the mechanization of its production process, and suggest ways through which the conflict could be avoided or resolved.

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  • 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.

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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  • 12 Marks

AFM – May 2018 – L3 – Q3b – Valuation of acquisitions and mergers

Evaluating the favourability of a takeover and its impact on EPS and share price.

Okumkom Ltd has a current price of GH¢2.20 per share and a price/earnings ratio of 15. At present, it has 10 million, GH¢1.00 ordinary shares issued. Okumkom Ltd is considering the takeover of Dasco Ltd. The current price of each of Dasco’s 4 million issued shares is 330 pesewas. Dasco’s price/earnings ratio is 10. Okumkom Ltd expects to be able to purchase the shares at their current price and will pay for them with an issue of its own shares valued at their current price.

Okumkom Ltd wishes to know how many shares to offer for each of Dasco Ltd’s shares, and the effect of the takeover on Okumkom Ltd’s reported earnings per share and share price.

Required:
Evaluate the favourability of this takeover and comment on your computations. (12 marks)

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  • 14 Marks

AFM – Nov 2016 – L3 – Q4a – Valuation of acquisitions and mergers

Calculate the NPV of Mama Ltd's acquisition of Papa Ltd and determine the value of the combined entity and an appropriate share exchange ratio.

a) The Directors of Mama Ltd (Mama), a large listed company, are considering an opportunity to
acquire all the shares of Papa Ltd (Papa), a small listed company with a highly efficient
production technology.
Mama has 10 million shares of common stock in issue that are currently trading at GH¢6.00
each. Papa Ltd has 5 million shares of common stock in issue, each of which is trading at
GH¢4.50.
If Papa is acquired and integrated into the business of Mama, the production efficiency of the
combined entity would increase and save the combined business GH¢600,000 in operating
costs each year to perpetuity.
Though Mama operates in the same industry as Papa, its financial leverage is higher than that
of Papa. Mama’s total debt stock is valued at GH¢40 million, and its after-tax cost of debt is
22%. The beta of Mama’s common stock is 1.2. The return on the risk-free asset is 20% and
the market risk premium is 5%.
Required:
Suppose Mama offers a cash consideration of GH¢25 million from its existing funds to the
shareholders of Papa for all of their shares.
i) Calculate the NPV of the acquisition, and advise the directors of Mama on whether to
proceed with the acquisition or not. (8 marks)
ii) Calculate the value of the combined entity immediately after the acquisition. (3 marks)
iii) Suppose Mama would like to acquire all the shares in Papa by offering fresh shares of its
own common stock to the shareholders of Papa. Advise the directors on the appropriate
share exchange ratio based on market price.

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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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  • 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.

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)

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  • 5 Marks

AFM – May 2019 – L3 – Q3b – Valuation of acquisitions and mergers

Evaluate whether Ape should proceed with the merger by assessing the financial impact and synergy benefits.

Ape has 2,500 shares outstanding at GH¢10 per share. Bee has 1,250 shares outstanding at GH¢5 per share. Ape estimates that the value of synergistic benefit from acquiring Bee is GH¢500. Bee has indicated that it would accept a cash purchase offer of GH¢6.50 per share.

Required:
Identify whether Ape should proceed with the merger

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  • 15 Marks

AFM – May 2019 – L3 – Q3a – Valuation of acquisitions and mergers

Use comparative analysis to value Alpha Ltd based on data from Beta Ltd and Gamma Ltd, and discuss factors for private company valuation.

At a meeting of the Directors of the Alpha Company Limited – a privately owned company – in May 1975, the recurrent question is raised as to how the company is going to finance its future growth and at the same time enable the founders of the company to withdraw a substantial part of their investment. A public quotation was discussed in 1974 but because of the depressed nature of the stock market at that time, consideration was deferred. Although the matter is not of immediate urgency, the Chairman of the company – one of the founders – produces the following information which he has recently obtained from a firm of financial analysts in respect of two publicly quoted companies, Beta Limited and Gamma Limited, which are similar to Alpha Limited in respect to size, asset composition, financial structure, and product mix.

The only information you have available at the meeting in respect of Alpha Limited is the final accounts for 1974, which disclose the following:
Alpha Limited
Share Capital (no variation for 8 years) 100,000 Ordinary GH¢1 Share
Post-Tax Earnings GH¢400,000
Gross Dividends GH¢100,000
Book Value GH¢3,500,000

From memory, you are of the view that the post-tax earnings and gross dividends for 1974 were at least one-third higher than the average of the previous five years.

Required:

i) Use the information provided to answer the Chairman’s question on what Alpha Ltd was worth in 1974.
ii) Discuss FOUR (4) factors to be taken into account in trying to assess the potential market value of shares in a private company when they are first offered for public subscription.

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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

AFM – Nov 2015 – L3 – Q5 – Valuation of acquisitions and mergers

Evaluate the acquisition of Anas-Expo Clothing Ltd by Two-Pack Fashion Ltd, analyzing its effect on EPS, shareholders' wealth, and sources of conflict.

You are the Finance Manager of a growing clothing company, Two-Pack Fashion Ltd (Two-Pack). Two-Pack has enjoyed significant growth in recent years using an internal growth strategy. Two-Pack is now seeking to acquire other companies to speed up its growth drive. It has identified Anas-Expo Clothing Ltd (Anas-Expo) as a suitable candidate for takeover. Both companies have the same level of risk.

Anas-Expo produces high-quality handmade clothes, with which it has earned several awards. The company has recorded considerable profits in the past, but its output has dwindled over the past two years due to increasing labour costs. Labour unions have pressured policymakers into amending labour regulations, particularly those relating to pensions and minimum wages, to provide more benefits and protection for workers. Directors of Two-Pack believe that production and profitability of Anas-Expo will be enhanced if its production process is mechanized.

Below are summarized financial data for the two companies immediately before acquisition:

Two-Pack (GHS’m) Anas-Expo (GHS’m)
Sales revenue 285.8
Net operating income 85.8
Interest charges 14.2
Net income before tax 71.6
Corporate tax 15.8
Net income after tax 55.8
Dividends 22.3
Addition to retained earnings 33.5

Two-Pack has 40 million shares and a P/E ratio of 18, while Anas-Expo has 25 million shares and a P/E ratio of 12. Directors of Two-Pack have decided that Two-Pack takes up all the equity shares in Anas-Expo by offering to its shareholders one new share for every share they hold. They have also decided that Two-Pack mechanizes Anas-Expo’s production process immediately at the cost of GHS18 million, replacing work currently done by hand. It is estimated that operational efficiency arising from the acquisition and integration of the two companies would yield after-tax benefits of GHS25 million per year to perpetuity. The cost of capital of Two-Pack is 25%.

Required:

(a) Evaluate the acquisition proposal, and recommend whether the acquisition should go ahead.
(b) Analyze the effect of the acquisition on the earnings per share (EPS) of Two-Pack following the successful acquisition of Anas-Expo.
(c) Analyze the effect of the acquisition on the wealth of the shareholders of each company.
(d) Advise the directors of Two-Pack on three likely sources of conflict in relation to the acquisition of Anas-Expo and the mechanization of its production process, and suggest ways through which the conflict could be avoided or resolved.

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  • 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.

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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  • 12 Marks

AFM – May 2018 – L3 – Q3b – Valuation of acquisitions and mergers

Evaluating the favourability of a takeover and its impact on EPS and share price.

Okumkom Ltd has a current price of GH¢2.20 per share and a price/earnings ratio of 15. At present, it has 10 million, GH¢1.00 ordinary shares issued. Okumkom Ltd is considering the takeover of Dasco Ltd. The current price of each of Dasco’s 4 million issued shares is 330 pesewas. Dasco’s price/earnings ratio is 10. Okumkom Ltd expects to be able to purchase the shares at their current price and will pay for them with an issue of its own shares valued at their current price.

Okumkom Ltd wishes to know how many shares to offer for each of Dasco Ltd’s shares, and the effect of the takeover on Okumkom Ltd’s reported earnings per share and share price.

Required:
Evaluate the favourability of this takeover and comment on your computations. (12 marks)

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