Unit 1

Important Metrics for Synergy Valuation

Metrics for measuring Operating Synergy

1. Cash from Operating Activities
2. Operating Profit / Operating Expenses Ratio
3. Profitability Ratio
a. Net Profit Ratio
b. Return on Investment
c. Return on Capital Employed
d. Return on Equity
e. Earning per Share

Metrics for measuring Financial Synergy

1. Weighted Average Cost of Capital
2. Solvency Ratio > Debt Equity Ratio, Capital Gearing Ratio
3. Change in Revenue / Change in Revenue Growth
4. Reduced level of Fictitious Assets
5. Liquidity Position

Metrics for measuring Managerial Synergy

1. Asset Turnover Ratio
2. Fixed Assets Turnover Ratio
3. Working Capital Turnover Ratio
4. Debtors Turnover Ratio
5. Creditors Turnover Ratio
@ Evaluation of Managerial Synergy
Q.1 Comment on Managerial Synergy of Merger from the following data:
Particulars Company A Company B Merged Co.
Sales 50,000 80,000 1,40,000
Assets 20,000 40,000 55,000
Working Capital 10,000 20,000 15,000
Fixed Assets 15,000 30,000 40,000

Solution
Company Company Merged
Particulars
A B Co.
Asset Turnover Ratio 2.50 2.00 2.55
Working Capital Turnover Ratio 5.00 4.00 9.33
Fixed Assets Turnover Ratio 3.33 2.67 3.50

Note:
Formula >
Asset Turnover Ratio = Sales / Assets
Working Capital Turnover Ratio = Sales / Working Capital
Fixed Asset Turnover Ratio = Sales / Fixed Assets

Explanation:
As Efficiency ratios of Company B is lesser than Company A. However, the post-
merger efficiency ratios are better than standalone efficiency ratios. Hence, it can
be inferred that merger is creating managerial synergy. The merger is generating
maximum advantage of working capital utilization as the increment in ratio is very
high, other efficiencies have improved marginally.
@ Evaluation of Operating Synergy
Q.2 Standalone financial performance numbers of two companies engaging in
M&A Deal are as follows:

Particulars Company A Company B

Cashflow from Operating Activities 60,000 90,000
Operating Expenses 40,000 50,000
EBIT 20,000 25,000
Equity Earning 15,000 15,000
Equity Capital 1,50,000 1,80,000
Revenue 1,00,000 1,20,000

Additional Information
 Company A was merged with Company B for which Shareholders of
Company B are being given 1 share of Company A for every 2 shares held
in Company A.
 % Change in Combined Revenue is expected to be 25%
 Operating Expenses are expected to reduce by 40%
 Company is wishful to maintain the same level of earnings.

You are required to

 Prepare a deviation report if combined values are 1,20,000; 80,000; 35,000;
25,000; 2,55,000; and 2,40,000 respectively.
 Comment on Operating Synergy of the Merger (Expected Values)
Solution
Particulars Company Company Merged Company
A B
Cashflow from (60,000 + 90,000) x 1.65
60,000 90,000
Operating Activities = 2,47,500
(40,000 + 50,000) x 0.60
Operating Expenses 40,000 50,000
= 54,000
20,000 + 25,000
EBIT 20,000 25,000
= 45,000
15,000 + 15,000
Equity Earning 15,000 15,000
= 30,000
1,50,000 / 2 + 1,80,000
Equity Capital 1,50,000 1,80,000
= 2,55,000
(1,00,000 + 1,20,000) x
Revenue 1,00,000 1,20,000
1.25 = 2,75,000

Comment on Operating Synergy of Combined Entity

Particulars Company Company Merged
A B Company
Cashflow from Operating
60,000 90,000 2,47,500
Activities
Operating Expenses Ratio 40% 42% 20%
Operating Profit Ratio 60% 58% 80%
ROCE 13.33% 13.89% 17.65%
ROE 10% 8.33% 11.76%
EPS 1 0.83 1.17

Comment > All ratios are expected to rise, hence operating synergy is positive
and merger is expected to be beneficial.
Formula >
Operating Expenses Ratio = Operating Expenses / Sales
ROCE = EBIT / Capital Employed
ROE = EE / Equity Shareholders Fund

Note for Cash from Operating Activities

As Revenue is expected to increase by 25% and Operating Expenses are to be
reduced by 40%, hence combined expected benefit for operating cash flow is
65%.

Deviation Report
Particulars Expected Actual Deviation
Value Value
Cashflow from
2,47,500 1,20,000 - 1,27,500 (Unfavorable)
Operating Activities
Operating Expenses 54,000 80,000 + 26,000 (Unfavorable)
EBIT 45,000 35,000 -10,000 (Unfavorable)
Equity Earning 30,000 25,000 -5,000 (Unfavorable)
Equity Capital 2,55,000 2,55,000 0 (-)
Revenue 2,75,000 2,40,000 -35,000 (Unfavorable)
Unit – 3
@ Basics of M&A Deals
Q.3
Particulars Acquiring Co. Target Co.
Number of Shares 10,00,000 6,00,000
Profit after Tax 50,00,000 18,00,000
Market Price per Share 42 28

You are required to determine

(i) Earning per Share of both the companies.
(ii) EPS of the merged company if Exchange Ratio is based on Current
Market Price of Shares
(iii) Determine the share exchange ratio if Target Company wants to ensure
the same level of EPS that was existing before Merger.

Solution
(i) Earning per Share of both the companies.
Particulars Acquiring Co. Target Co.
Profit after Tax 50,00,000 18,00,000
Number of Shares 10,00,000 6,00,000
EPS (PAT / No. of Shares) 5 3

(ii) EPS of the merged company if Exchange Ratio is based on Current

Market Price of Shares
# Number of Shares to be issued by Acquiring Company =
No. of Shares (Target Co.) x MPS (Target Co.) / MPS (Acquiring Co.)
= 6,00,000 x 28 / 42 = 4,00,000 Shares
# Earning per Share of Merged Company =
Earning after Merger / Total Shares of Acquiring Company
= (50,00,000 + 18,00,000) / (10,00,000 + 4,00,000)
= 68,00,000 / 14,00,000
= 4.86

Note: In this case, Share Exchange Ratio is 2:3 which implies that shareholders of
Target Company will get 2 shares of Acquiring Company for every 3 shares held
in the Target Company.

(iii) Determine the share exchange ratio if Target Company wants to ensure
the same level of EPS that was existing before Merger.

Computation of Total Number of Shares (Acquiring Co.)

# Earning per Share of Merged Company =
Earning after Merger / Total Shares of Acquiring Company
5 = 68,00,000 / Total Shares of Acquiring Company
Total Shares of Acquiring Company = 68,00,000 / 5 = 13,60,000

# Number of Shares issued to Target Company =

Total Shares after Merger – Total Shares before Merger
13,60,000 – 10,00,000 = 36,00,000

# Share Exchange Ratio =

Number of Shares issued to Target Company / Total Shares before Merger
(Target Company)
36,00,000 / 60,00,000 = 0.6 Times
@ Determining Cost of Merger
Q.4
Particulars Firm A Firm B
Market Price per Share 60 15
Number of Shares 1,00,000 50,000
Market Value of Firm 60,00,000 7,50,000

Firm A is planning to buy Firm B for Rs. 10,00,000. True Intrinsic Value of Firm B is
Rs. 9,00,000.

You are required to determine the cost of merger if

(i) Merger is financed by Cash

(ii) Merger is financed by Stock.

Solution
(i) If Merger is Finance by Cash
# Cost of Merger = Deal Premium - Intrinsic Value Premium
# Cost of Merger = Deal Premium + Intrinsic Value Discount
# Cost of Merger = - Deal Discount - Intrinsic Value Premium
# Cost of Merger = - Deal Discount + Intrinsic Value Discount
Or
# Cost of Merger = [Deal Price – Market Value (Target Co.)] +
[Market Value (Target Co.) – Intrinsic Value (Target Co.)]
= [10,00,000 – 7,50,000] + [7,50,000 – 9,00,000]
= 2,50,000 – 1,50,000

In short, here Acquiring Company is paying Deal Premium [Rs. 2,50,000] (Surplus
of Deal price over Market Value of Target Company) while Intrinsic Value of Target
Company is higher than its market value, which creates intrinsic value premium
(Rs. 1,50,000) for Acquiring Company, which reduces cost of merger.

(ii) When merger Is financed by Stock

# Cost of Merger = [α. PV Merged Co. – PV Target Co.]

+ [Market Value Target Co. – Intrinsic Value Target Co.]

# α represents the proportion of shares of target company share holders in

Merged Company

𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑺𝒉𝒂𝒓𝒆𝒔 𝒓𝒆𝒄𝒆𝒊𝒗𝒆𝒅 𝒃𝒚 𝑻𝒂𝒓𝒈𝒆𝒕 𝑪𝒐𝒎𝒑𝒂𝒏𝒚 𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓𝒔

𝜶=
𝑻𝒐𝒕𝒂𝒍 𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑺𝒉𝒂𝒓𝒆𝒔 𝒐𝒇 𝑨𝒄𝒒𝒖𝒊𝒓𝒊𝒏𝒈 𝑪𝒐𝒎𝒑𝒂𝒏𝒚

# No. of Shares received by Target Co. Shareholders

= Deal Price / MPS Acquiring Company
= 10,00,000 / 60
= 16,667 Shares
α = 16,667 / (1,00,000 + 16,667)
= 0.143

# Cost of Merger = [α. PV Merged Co. – PV Target Co.]

+ [Market Value Target Co. – Intrinsic Value Target Co.]
= [0.143 x 67,50,000 – 7,50,000) + [7,50,000 – 9,00,000]
= 2,15,250 – 1,50,000
= Rs. 65,250/-
@ Determining Cost of Merger
Q.5
Particulars Firm A Firm B
Market Price per Share 75 30
Number of Shares 10,00,000 5,00,000
Market Value of Firm 7,50,00,000 1,50,00,000

Firm A is planning to buy Firm B by offering 2,50,000 shares in full settlement.

Present Value of Synergy Benefit = 1,50,00,000.

You are required to determine the cost of merger if Merger is financed by Stock.

Solution
# Cost of Merger = [α. PV Merged Co. – PV Target Co.]
+ [Market Value Target Co. – Intrinsic Value Target Co.]

𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑺𝒉𝒂𝒓𝒆𝒔 𝒓𝒆𝒄𝒆𝒊𝒗𝒆𝒅 𝒃𝒚 𝑻𝒂𝒓𝒈𝒆𝒕 𝑪𝒐𝒎𝒑𝒂𝒏𝒚 𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓𝒔

𝜶=
𝑻𝒐𝒕𝒂𝒍 𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑺𝒉𝒂𝒓𝒆𝒔 𝒐𝒇 𝑨𝒄𝒒𝒖𝒊𝒓𝒊𝒏𝒈 𝑪𝒐𝒎𝒑𝒂𝒏𝒚

α = 2,50,000 / (2,50,000 + 10,00,000)

= 0.20

# Cost of Merger = [α. PV Merged Co. – PV Target Co.]

+ [Market Value Target Co. – Intrinsic Value Target Co.]
= [0.20 x 10,50,00,000 – 1,50,00,000) + [0]
= Rs. 60,00,000

Note: PV Merged Co. = PV Acquiring Co. + PV Target Co. + Synergy

@ Determining Deal Price using Comparable Company Analysis

Q.6

Solution
@ Evaluating Acquirer’s Gain
Q.7

Solution
@ Determining Acquirer’s Gain (With Cost of Integration)
Q.8

@ HHI – Herfindahl Hirschman Index – A Measure of Market Concentration

Q.9

Solution
@ Accretion / Dilution Analysis
Q.10

Particulars Values (in Lacs)

Expected Post Merger Combined Profit of Acquirer Rs. 2,000

Pre-Merger Profit of Acquirer Rs. 1,200

Standalone Number of Shares of Acquirer 200

New Shares to be issued for Acquisition 50

Tax Rate 25%

Calculate
• Combined EPS
• Accretion / Dilution in Rs. & %
Solution
Computation of Combined EPS
= Combined Profit / Combined Number of Shares
= Rs. 2,000 / 250 = Rs. 8
Standalone Pre-Merger EPS
= Pre Merger Profit (Acquirer) / Pre-Merger No. of Shares (Acquirer)
= [1200 / 200] = Rs. 6
Accretion / (Dilution)
= Post-Merger EPS – Standalone Pre-Merger EPS = [8 – 6] = Rs. 2
(When Post Merger, EPS increases, it is called Accretion)
(When Post Merger, EPS decreases, it is called Dilution)
Accretion %
= Accretion / Standalone Pre-Merger = [2 / 6] = 33.33%