CHAPTER 6

MERGER AND ACQUISITIONS

1. Reasons for Merger

a) Synergy The primary motivation for most mergers is to increase the value of the combined
enterprise – the hope is that synergy exists, so that the value of the company formed by the
merger is greater than the sum of the values of the individual companies taken separately.
b) Tax Considerations Tax considerations have stimulated a number of mergers. For example, a
firm that is highly profitable and is in the highest corporate tax bracket could acquire a
company with large accumulated tax losses, and then use those losses to shelter its own income.
c) Purchase of assets below their replacement costs Sometimes a firm will become an acquisition
candidate because the replacement value of its assets is considerably higher than its market
value.
d) Diversification Managers often claim that the diversification helps to stabilize the firm’s
earnings and thus reduce corporate risk. Therefore, diversification is often given as a reason
for mergers.
e) Maintaining control Managers who own less than 51 percent of the stock in their firms look to
devices that will lessen the changes of their firms‟ being taken over. Mergers can serve as such
a device.
f) Avoidance of Competition Merged firm may have better pricing power and may enjoy better
market share in the industry.

2. Horizontal Merger and Vertical Merger

Horizontal Merger Vertical Merger
Horizontal merger takes place when two or more Vertical merger occurs when a firm
corporate firms dealing in similar lines of activity acquires firms upstream from it and/ or
combine together. firms downstream from it.
Benefits could be in the form of: Benefits could be in the form of:
• Elimination or reduction in competition • Lower buying cost of materials
• putting an end to price cutting • Lower distribution costs
• economies of scale in production, research • Assured supplies and market
and development, marketing and • Increasing or creating barriers to entry
management for potential competitors or placing
them at a cost disadvantage
Example: Merger of two different banks Example: Merger of Car manufacturing
company with tyre manufacturing
company.
3. Conglomerate Merger and Congeneric Merger
Conglomerate Merger Congeneric Merger
Conglomerate merger is a merger of two or more When the firms being merged are engaged
firms operating in different and unrelated in activities which are complementary but
industries. It is an expansion of a firm into areas
not directly competing, it is said to be a
unrelated to the existing line of business. congeneric merger.
Benefits could be in the form of some operating Benefits could be in the form of prior
knowledge and access of the target
and financial economies to the firm.
market.
Example: Merger of a tobacco firm with a textile Example: Shoe producing firm merging
firm. with socks producing firm.

4. Takeover by reverse bid (Reverse Merger)

✓ It is the act of a smaller company gaining control over a larger one.
✓ Generally, the company taken over is the smaller company. But in a ‘Reverse Takeover’, a
smaller takes over control of a larger one.
✓ Such mergers can be beneficial for revival of a large sick company through acquisition by a
smaller healthy company.
✓ Reasons for Reverse Takeover:
• Financial difficulties in large company.
• Large company’s market share is declining
• Company is losing trust and brand value and there is a need of establishment in new brand
name
✓ Example: Grand Bank and Prabhu Finance merged and established as Prabhu Bank.

5. Proxy fight
✓ A proxy fight is an unfriendly contest for the control over an organization.
✓ A proxy fight is when a group of shareholders are persuaded to join forces and gather enough
shareholder proxies to win a vote in corporate elections.
✓ This is also referred to also as a proxy battle.

6. Demerger
A demerger is a corporate restructuring in which a business is broken into components, either to
operate on their own, to be sold or to be liquidated. A demerger allows a large company, such as
a conglomerate, to split off its various brands or business units to invite or prevent an acquisition,
to raise capital by selling off components that are no longer part of the business's core product line,
or to create separate legal entities to handle different operations.
Demerger is used as a suitable scheme in the following cases:
• Restructuring of an existing business
• Division of family-managed business
• Management ‘buy-out’
Reasons for Demerger
• To pay attention on core areas of business;
• Better management of each business unit, especially when firm size is too large to handle
• Unlock shareholders’ value through better P/E and other market multiples
• Disposal of division/ business that is not sufficiently contributing to the revenues;
• Urgent cash requirement for other investment opportunities.

7. Divestiture
A divestiture is the partial or full disposal of a business unit through sale, exchange, closure or
bankruptcy. A divestiture most commonly results from a management decision to cease operating
a business unit because it is not part of a core competency. However, it may also occur if a business
unit is deemed to be redundant after a merger or acquisition, if the disposal of a unit increases the
resale value of the firm, or if a court requires the sale of a business unit to improve market
competition.

8. Spin off, split off and carve out

A spin-off, split off and carve-out are different methods that a company can use to divest certain
assets, a division or a subsidiary. While the choice of a specific method by the parent company
depends on a number of factors, the ultimate objective is to increase shareholder value.
In a spin-off, the parent company distributes shares of the subsidiary that is being spun-off to its
existing shareholders on a pro rata basis, in the form of a special dividend. The parent company
typically receives no cash consideration for the spin-off. Existing shareholders benefit by now
holding shares of two separate companies after the spin-off instead of one. The spin-off is a distinct
entity from the parent company and has its own management. The parent company may spin off
100% of the shares in its subsidiary, or it may spin off controlling interest to its shareholders and
hold a minority interest in the subsidiary.
In a split-off, shareholders in the parent company are offered shares in a subsidiary, but the point
is they have to choose between holding shares of the subsidiary or the parent company. A
shareholder has two choices: (a) continue holding shares in the parent company or (b) exchange
some or all of the shares held in the parent company for shares in the subsidiary. Because
shareholders in the parent company can choose whether or not to participate in the split-off,
distribution of the subsidiary shares is not pro rata as it is in the case of a spin-off.
In a carve-out, the parent company sells some or all of the shares in its subsidiary to the public
through an initial public offering (IPO). Unlike a spin-off, the parent company generally receives
a cash inflow through a carve-out. A carve-out effectively separates a subsidiary or business unit
from its parent as a standalone company. However, the parent company usually retains a
controlling interest in the new company and offers strategic support and resources to help the
business succeed.

9. Reasons for Spin-Offs

✓ Better management: While executives of a company may be well-suited to overseeing most of
its lines of business, perhaps there's a unit that doesn't quite match their expertise. In another
example, a specific unit may require more attention than it's getting from top management and
its performance suffers as a result. In either case, spinning off the unit and putting it under new
management may result in better performance in the unit-turned-independent company, while
the parent company’s managers can now redouble their focus on their remaining units.
✓ Separating growth strategies: A business unit that's slow to make money might prove a drag
on a sister unit that's experiencing robust growth, particularly if the parent company uses profits
from the latter to subsidize the former. But when two such units are no longer under the same
parent company, they can grow at their own pace and might even see more success in attracting
investors who specifically seek out fast-growing or mature companies.
✓ Better coverage from securities analysts: When a business is less complex, it's easier to
analyze. Demerge thus may attract coverage from analysts with specializations matching those
businesses that may provide more accurate forecasts about the corporation.
✓ Unlocking shareholder value: Perhaps the biggest factor driving spinoffs is the idea that the
parent company is undervalued — perhaps because of management or strategy issues described
above — and that its remaining business valuation would be higher if it spun off one or more
business units.

10. Sell Off

✓ A sell-off is the rapid selling of securities such as stocks, bonds, ETFs, commodities or
currencies.
✓ A sell-off may occur for many reasons, such as the sell-off of a company's stock after a
disappointing earnings report, the departure of an important executive or the failure of an
important product.
✓ Markets and stock indexes can also sell-off when interest rates rise or oil prices surge, causing
increased fear about the energy costs that companies will face. Sell-offs can also be caused by
political events, or terrorist acts.
✓ All financial trading instruments have sell-offs. They are a natural occurrence from profit-
taking, short-selling or portfolio turnover. Healthy price up trends require periodic sell-offs to
replenish supply and trigger demand. However, when a sell-off continues on an extensive
basis, it can be signs of a potentially dangerous market reversal leading to a correction or a
crash.
11. Slump Sale
✓ When a company sells or disposes the whole or substantially the whole of the undertaking for
a predetermined lumpsum amount as sale consideration is called "slump sale".
✓ While fixing the selling price, the value of assets are not individually counted and the liabilities
are not separately considered while fixing the slump price.
✓ Business transfer agreement will be entered into between the acquirer and seller and the hive-
off deal passes the title for both movable and immovable properties and the related liabilities
as a "going concern".

12. Financial restructuring (Internal reconstruction)

Financial restructuring, is carried out internally in the firm with the consent of its various
stakeholders. Financial restructuring is a suitable mode of restructuring of corporate firms that
have incurred accumulated sizable losses for / over a number of years.
As a sequel, the share capital of such firms, in many cases, gets substantially eroded / lost; in fact,
in some cases, accumulated losses over the years may be more than share capital, causing negative
net worth. Given such a dismal state of financial affairs, a vast majority of such firms are likely to
have a dubious potential for liquidation.
Financial restructuring is one such a measure for the revival of only those firms that hold
promise/prospects for better financial performance in the years to come. To achieve the desired
objective, such firms may need a restart with a fresh balance sheet, which does not contain past
accumulated losses and fictitious assets and shows share capital at its real/true worth.
 Merger Basics

Type 1 – Swap Ratio and its Impact

Question 1
You are given that:
Vendor Company Target Company
No of shares 2 Lakh 1.5 Lakhs
Book Value per share 125 150
Market value per share 300 250
Earnings per share 40 30
Compute the exchange ratio that Vendor company can offer to Target company without diluting
it’s:
(i) Market Price
(ii) Earnings
(iii) Book Value
Also verify your results.
Ans: (i) 5:6 (ii) 3:4 (iii) 6:5

Question 2
Bat Ltd. is being acquired by ball ltd. on a share exchange basis.
Particulars Ball Ltd. Bat Ltd.
Profit after tax (lac) 50 20
Number of shares (lac) 10 8
Earnings per share (Rs.) 5 2.5
Price-earnings ratio 12 times 6 times
Determine:
a) Pre-merger, market value per share, and
b) Maximum exchange ratio ball Ltd. should offer without the dilution of (i) EPS (ii) Market value
per share.
Ans: (a) Ball = Rs. 60; Bat = Rs. 15; (b) (i) 0.5 (ii) 0.25

Question 3
Cauliflower Limited is contemplating acquisition of Cabbage Limited. Cauliflower Limited has 5
lakh shares having market value of Rs. 40 per share while Cabbage Limited has 3 lakh shares
having market value of Rs.25 per share. The EPS for Cabbage Limited and Cauliflower Limited
are Rs. 3 per share and Rs.5 per share respectively. The managements of both the companies are
discussing two alternatives for exchange of shares as follows:
(i) In proportion to relative earnings per share of the two companies.
(ii) 1 share of Cauliflower Limited for two shares of Cabbage Limited.
Required:
(i) Calculate the EPS after merger under both the alternatives.
(ii) Show the impact on EPS for the shareholders of the two companies under both the alternatives.
Ans: (i) 5; 5.23 (ii) No impact, +0.23, - 0.385

Question 4
K. Ltd. is considering acquiring N. Ltd., the following information is available:
Company Profit after Number of Equity Market value
Tax shares per share
K. Ltd. 50,00,000 10,00,000 200.00
N. Ltd. 15,00,000 2,50,000 160.00
Exchange of equity shares for acquisition is based on current market value as above. There is no
synergy advantage available:
(i) Find the earning per share for company K. Ltd. after merger.
(ii) Find the exchange ratio so that shareholders of N. Ltd. would not be at a loss.
Ans: (i) Post merger EPS = 5.42 Per Share (ii) Exchange ratio = 1.2:1

Question 5
XYZ Ltd., is considering merger with ABC Ltd. XYZ Ltd.’s shares are currently traded at Rs. 20.
It has 2,50,000 shares outstanding and its earnings after taxes (EAT) amount to Rs. 5,00,000. ABC
Ltd., has 1,25,000 shares outstanding; its current market price is Rs. 10 and its EAT are Rs.
1,25,000. The merger will be affected by means of a stock swap (exchange). ABC Ltd., has agreed
to a plan under which XYZ Ltd., will offer the current market value of ABC Ltd.’s shares:
(i) What is the pre-merger earnings per share (EPS) and P/E ratios of both the companies?
(ii) If ABC Ltd.’s P/E ratio is 6.4, what is its current market price? What is the exchange ratio?
What will XYZ Ltd.’s post-merger EPS be?
(iii) What should be the exchange ratio; if XYZ Ltd.’s pre-merger and post-merger EPS are to be
the same?
Ans: (i) XYZ = Rs. 2; ABC = Rs. 1, P/E ratio = 10 times (ii) Current MPS =
6.40; Exchange ratio = 0.32; Post merger EPS = 2.16; (iii) Ratio = 0.5

Question 6
B Ltd. is a highly successful company and wishes to expand by acquiring other firms. Its expected
high growth in earnings and dividends is reflected in its PE ratio of 17. The Board of Directors of
B Ltd. has been advised that if it were to take over firms with a lower PE ratio than it’s own,
using a share-for-share exchange, then it could increase its reported earnings per share. C Ltd.
has been suggested as a possible target for a takeover, which has a PE ratio of 10 and 1,00,000
shares in issue with a share price of Rs. 15. B Ltd. has 5,00,000 shares in issue with a share price
of Rs.12.
Calculate the change in earnings per share of B Ltd. if it acquires the whole of C Ltd. by issuing
shares at its market price of Rs.12. Assume the price of B Ltd. shares remains constant.
Ans: Increase to 0.80 from 0.71

Question 7
P Ltd. is considering take-over of R Ltd. by the exchange of four new shares in P Ltd. for every
five shares in R Ltd. The relevant financial details of the two companies prior to merger
announcement are as follows:
Particulars P Ltd R Ltd
Profit before Tax (Crore) 15 13.50
No. of Shares (Crore) 25 15
P/E Ratio 12 9
Corporate Tax Rate 30% You are required to determine:
(i) Market value of both the company.
(ii) Value of original shareholders.
(iii) Price per share after merger.
(iv) Effect on share price of both the company if the Directors of P Ltd. expect their own pre-
merger P/E ratio to be applied to the combined earnings.
Ans: (i) 126 cr., 85.05 cr. (ii) 142.61 cr., 68.44 cr. (iii) Rs. 6.47
(iv) rise by 28.4%, decrease by 8.64%.

Type 2 – Some Popular Sums

Question 8
The following information relating to the acquiring Company Abhiman Ltd. and the target
Company Abhishek Ltd. are available. Both the Companies are promoted by Multinational
Company, Trident Ltd. The promoter’s holding is 50% and 60% respectively in Abhiman Ltd. and
Abhishek Ltd:
Abhiman Ltd. Abhishek
Ltd.
Share Capital (Rs.) 200 lakh 100 lakh
Free Reserve and Surplus (Rs.) 800 lakh 500 lakh
Paid up Value per share (Rs.) 100 10
Free float Market Capitalization (Rs.) 400 lakh 128 lakh
P/E Ratio (times) 10 4
Trident Ltd. is interested to do justice to the shareholders of both the Companies. For the swap
ratio weights are assigned to different parameters by the Board of Directors as follows:
Book Value 25%
EPS (Earning per share) 50%
Market Price 25%
a) What is the swap ratio based on above weights?
b) What is the Book Value, EPS and expected Market price of Abhiman Ltd. after acquisition
of Abhishek Ltd. (assuming P.E. ratio of Abhiman Ltd. remains unchanged and all assets and
liabilities of Abhishek Ltd. are taken over at book value).
c) Calculate:
(i) Promoter’s revised holding in the Abhiman Ltd.
(ii) Free float market capitalization.
(iii) Also calculate No. of Shares, Earnings per Share (EPS) and Book Value (B.V.), if after
acquisition of Abhishek Ltd., Abhiman Ltd. decided to:
a) Issue Bonus shares in the ratio of 1 : 2; and
b) Split the stock (share) as Rs.5 each fully paid.
Ans: (a) Swap ratio = .15; (b) BVPS = 457.14; EPS = 45.71; MPS = 457.10;
(c) (i) Revised holding = 54.29%; (ii) Mkt Cap = 731.36 Lakh; (iii)
No of sh. = 105 Lakh; EPS = 1.523; BVPS = 15.238

Question 9
The following information is provided relating to the acquiring company Efficient Ltd. and the
target Company Healthy Ltd.
Efficient Ltd. Healthy Ltd.
No. of shares (F.V. Rs.10 each) 10.00 lakhs 7.5 lakhs
Market capitalization 500.00 lakhs 750.00 lakhs
P/E ratio (times) 10.00 5.00
Reserves and Surplus 300.00 lakhs 165.00 lakhs
Promoter’s Holding (No. of shares) 4.75 lakhs 5.00 lakhs

Board of Directors of both the Companies have decided to give a fair deal to the shareholders and
accordingly for swap ratio the weights are decided as 40%, 25% and 35% respectively for Earning,
Book Value and Market Price of share of each company:
(i) Calculate the swap ratio and also calculate Promoter’s holding % after acquisition.
(ii) What is the EPS of Efficient Ltd. after acquisition of Healthy Ltd.?
(iii) What is the expected market price per share and market capitalization of Efficient Ltd. after
acquisition, assuming P/E ratio of firm Efficient Ltd. remains unchanged?
(iv) Calculate free float market capitalization of the merged firm.
Ans: (i) Swap ratio = 2.50; Promotor holding = 60%; (ii) EPS = 6.956 (iii) MPS =
69.56; Mkt. Cap = 1999.85 Lakh (iv) Free Mkt cap = 799.94 Lakh
Question 10
T Ltd. and E Ltd. are in the same industry. The former is in negotiation for acquisition of the latter.
Important information about the two companies as per their latest financial statements is given
below:
T Ltd. E Ltd.
Rs.10 Equity shares outstanding 12 Lakhs 6 Lakhs
Debt:
10% Debentures (Rs. Lakhs) 580 --
12.5% Institutional Loan (Rs. Lakhs) -- 240
Earnings before interest, depreciation 400.86 115.71
and tax (EBIDAT) (Rs. Lakhs)
Market Price/share (Rs. ) 220.00 110.00

T Ltd. plans to offer a price for E Ltd., business as a whole which will be 7 times EBIDAT reduced
by outstanding debt, to be discharged by own shares at market price.
E Ltd. is planning to seek one share in T Ltd. for every 2 shares in E Ltd. based on the market
price. Tax rate for the two companies may be assumed as 30%.
Calculate and show the following under both alternatives - T Ltd.'s offer and E Ltd.'s plan:
(i) Net consideration payable.
(ii) No. of shares to be issued by T Ltd.
(iii) EPS of T Ltd. after acquisition.
(iv) Expected market price per share of T Ltd. after acquisition.
(v) State briefly the advantages to T Ltd. from the acquisition. Calculations (except EPS) may be
rounded off to 2 decimals in lakhs.
Ans:
T Ltd offer E Ltd Plan
Net consideration payable 569.97 660
No of shares to be issued 2,59,000 3,00,000
EPS of T Ltd after 20.56 20
acquisition
Expected market price 226.16 220
per share of T Ltd after
acquisition
Question 11
BA Ltd. and DA Ltd. both the companies operate in the same industry. The Financial statements
of both the companies for the current financial year are as follows:

Balance Sheet
Particulars BA Ltd. DA Ltd.
Current Assets 14,00,000 10,00,000
Fixed Assets (Net) 10,00,000 5,00,000
Total (Rs.) 24,00,000 15,00,000
Equity capital (Rs. 10 each) 10,00,000 8,00,000
Retained earnings 2,00,000 --
14% long-term debt 5,00,000 3,00,00
Current liabilities 7,00,000 4,00,000
Total (Rs.) 24,00,000 15,00,000

Income Statement
BA Ltd. DA Ltd.
Net Sales 34,50,000 17,00,000
Cost of Goods sold 27,60,000 13,60,000
Gross profit 6,90,000 3,40,000
Operating expenses 2,00,000 1,00,000
Interest 70,000 42,000
Earnings before taxes 4,20,000 1,98,00
Taxes @ 50% 2,10,000 99,000
Earnings after taxes (EAT) 2,10,000 99,000

Additional Information:
No. of Equity shares 1,00,000 80,000
Dividend payment ratio (D/P) 40% 60%
Market price per share Rs. 40 Rs. 15

Assume that both companies are in the process of negotiating a merger through an exchange of
equity shares. You have been asked to assist in establishing equitable exchange terms and are
required to:
(i) Decompose the share price of both the companies into EPS and P/E components; and also
segregate their EPS figures into Return on Equity (ROE) and book value/intrinsic value per
share components.
(ii) Estimate future EPS growth rates for each company.
(iii) Based on expected operating synergies BA Ltd. estimates that the intrinsic value of DA’s
equity share would be Rs. 20 per share on its acquisition. You are required to develop a range
of justifiable equity share exchange ratios that can be offered by BA Ltd. to the shareholders
 of DA Ltd. Based on your analysis in part (i) and (ii), would you expect the negotiated terms
to be closer to the upper, or the lower exchange ratio limits and why?
(iv) Calculate the post-merger EPS based on an exchange ratio of 0.4: 1 being offered by BA Ltd.
and indicate the immediate EPS accretion or dilution, if any, that will occur for each group of
shareholders.
(v) Based on a 0.4: 1 exchange ratio and assuming that BA Ltd.’s pre-merger P/E ratio will
continue after the merger, estimate the post-merger market price. Also show the resulting
accretion or dilution in pre-merger market prices.
Ans: (i) BA Ltd: EPS = 2.10, P/E ratio = 19.05, BVPS = 12, ROE = 17.50% DA Ltd: EPS =
1.2375, P/E ratio = 12.12, BVPS = 10, ROE = 12.37% (ii) g (BA) = 10.50%; g (DA) = 4.95%
(iii) Range = 0.375 to 0.50; Negotiation close to Lower limit
(iv) EPS = 2.341, Accretion (BA = 0.241, Dilution (DA)= 0.301
(v) MPS = 44.60, Accretion (BA) = 4.6; Accretion (DA) = 2.84%

Evaluation of Merger Proposal

Type 1 – NPV of Merger

Question 12
The following information is provided related to the acquiring Firm Mark Limited and the target
Firm Mask Limited:
Firm Mark Limited Firm Mask Limited
Earning after tax (Rs.) 2,000 lakhs 400 lakhs
Number of shares outstanding 200 lakhs 100 lakhs
P/E ratio (times) 10 5
Required:
(i) What is the Swap Ratio based on current market prices?
(ii) What is the EPS of Mark Limited after acquisition?
(iii) What is the expected market price per share of Mark Limited after acquisition, assuming P/E
ratio of Mark Limited remains unchanged?
(iv) Determine the market value of the merged firm.
(v) Calculate gain/loss for shareholders of the two independent companies after acquisition.
Ans: (i) Swap ratio = 0.20 (ii) EPS = Rs.10.91; (iii) MPS = 109.10 (iv)Value of Firm =
240.02 Crore. (v) Gain to Mark = 18.20 Crore, Gain to Mask = 1.82 crore.
Question 13
You have been provided the following financial data of two companies:
Krishna Ltd. Rama Ltd.
Earnings after taxes Rs. 7,00,000 Rs.10,00,000
Equity shares (outstanding) Rs. 2,00,000 Rs.4,00,000
EPS 3.5 2.5
P/E ratio 10 times 14 times
Market price per share Rs. 35 Rs. 35
Company Rama Ltd. is acquiring the company Krishna Ltd., exchanging its shares on a one- to-
one basis for company Krishna Ltd. The exchange ratio is based on the market prices of the shares
of the two companies.
Required:
(i) What will be the EPS subsequent to merger?
(ii) What is the change in EPS for the shareholders of companies Rama Ltd. and Krishna Ltd.?
(iii) Determine the market value of the post-merger firm. PE ratio is likely to remain the same.
(iv) Ascertain the profits accruing to shareholders of both the companies.
Ans: (i) Rs. 2.83 (ii) Krishna Ltd: -0.67, Rama Ltd. +0.33 (iii) Rs.
2,37,72,000 (iv) Rs. 18,48,000; Rs. 9,24,000

Question 14
Given is the following information:
Day Ltd. Night Ltd.
Net Earnings Rs. 5 crores Rs. 3.5 crores
No. of Equity 10,00,000 7,00,000
Shares
The shares of Day Ltd. and Night Ltd. trade at 20 and 15 times their respective P/E ratios. Day
Ltd. considers taking over Night Ltd. by paying Rs.55 crores considering that the market price of
Night Ltd. reflects its true value. It is considering both the following options:
(i) Takeover is funded entirely in cash.
(ii) Takeover is funded entirely in stock.
You are required to calculate the cost of the takeover and advise Day Ltd. on the best alternative.
Ans: (i) 2.5cr. (ii) 7.82 cr.
Question 15
Reliable Industries Ltd. (RIL) is considering a takeover of Sunflower Industries Ltd. (SIL). The
particulars of 2 companies are given below:
Particulars Reliable Industries Ltd Sunflower Industries Ltd.
Earnings After Tax (EAT) Rs. 20,00,000 Rs.10,00,000
Equity shares O/s 10,00,000 10,00,000
Earnings per share (EPS) 2 1
PE Ratio (Times) 10 5

Required:
(i) What is the market value of each Company before merger?
(ii) Assume that the management of RIL estimates that the shareholders of SIL will accept an
offer of one share of RIL for four shares of SIL. If there are no synergic effects, what is the
market value of the Post-merger RIL? What is the new price per share? Are the shareholders
of RIL better or worse off than they were before the merger?
(iii) Due to synergic effects, the management of RIL estimates that the earnings will increase by
20%. What are the new post-merger EPS and Price per share? Will the shareholders be better
off or worse off than before the merger?
Ans: (i) RIL: 200 Lakh; SIL: 50L; (ii) Mkt Value = 300 Lakh; Price per share = 24
(assuming P/E ratio will not change); Gain = Rs. 4 per share (iii) Post-merger EPS
= 2.88; Price per share = 28.80 (assuming P/E ratio = 10; Gain to RIL Sh holder =
8.80; Gain to SIL = 2.20

Question 16
Elrond Limited plans to acquire Doom Limited. The relevant financial details of the two firms
prior to the merger announcement are:
Particulars Elrond Limited Doom Limited
Market price per share 50 25
Number of outstanding shares 20 lakhs 10 Lakhs
The merger is expected to generate gains, which have a present value of Rs.200 lakhs. The
exchange ratio agreed to is 0.5.
What is the true cost of the merger from the point of view of Elrond Limited?
Ans: Rs. 40 Lakhs
 Type 2 – Maximum and Minimum Consideration

Question 17
C Ltd. & D Ltd. are contemplating a merger deal in which C Ltd. will acquire D Ltd. The relevant
information about the firms are given as follows:
C Ltd. D Ltd.
Total Earnings (E) (in millions) 96 30
Number of outstanding shares (S) (in 20 14
millions)
Earnings per share (EPS) (Rs.) 4.8 2.143
Price earnings ratio (P/E) 8 7
Market Price per share (P)(Rs.) 38.4 15
(i) What is the maximum exchange ratio acceptable to the shareholders of C Ltd., if the P/E ratio
of the combined firm is 7?
(ii) What is the minimum exchange ratio acceptable to the shareholders of D Ltd., if the P/E ratio
of the combined firm is 9?
Ans: (i) 0212: 1 (ii) 0.325:1

Question 18
ABC Ltd. and XYZ Ltd. planned to merge. The details were as follows:
Particulars ABC XYZ
Profit after tax Rs. 30 million Rs. 6 million
Market price per share Rs. 550 Rs. 100
P/E Ratio 25 16

The companies expect a revenue synergy of 15% above the combined revenues in the newly
merged entity. The expected P/E ratio was 24.

The management of ABC was ready to offer one share of ABC for every 10 shares of XYZ. XYZ
expects an exchange ratio of 2 shares of ABC for every 10 shares of XYZ. Determine the exchange
ratio favorable to both the companies after verifying whether a margin for bargaining exists.
Ans: 2:10 is favorable for both

Question 19
XYZ Ltd. wants to purchase ABC Ltd. by exchanging 0.7 of its shares for each share of ABC Ltd.
Relevant financial data are as follows:
Equity shares outstanding 10,00,000 4,00,000
EPS (Rs.) 40 28
Market price per share (Rs.) 250 160
(i) Illustrate the impact of merger on EPS of both the companies.
(ii) The management of ABC Ltd. has quoted a share exchange ratio of 1:1 for the merger.
Assuming that P/E ratio of XYZ Ltd. will remain unchanged after the merger, what will be
the gain from merger for ABC Ltd.?
(iii) What will be the gain/loss to shareholders of XYZ Ltd.?
(iv) Determine the maximum exchange ratio acceptable to shareholders of XYZ Ltd and minimum
exchange ratio that will be demanded by shareholders of ABC Ltd. Will the merger be viable?
Ans: (i) No impact (ii) 274.24 lakh (+68.56 per share) (iii) -214.4
Lakhs (-21.44 per share) (iv) 0.7:1, 0.32: 1, Viable

Question 20
Buster Ltd. is a fast-growing company. With its aggressive expansion plan, it is considering an
acquisition of Cluster Ltd. by way of exchange of its shares. Buster Ltd. plans to offer a premium
of 25% over the market price of Cluster Ltd. The following financial data for the companies are
available:

Buster Ltd. Cluster Ltd.

Earnings Rs. 800,000 Rs. 600,000

Market Price Per Share (MPS) Rs. 60 Rs. 20
Earning Per Shares (EPS) Rs. 4 Rs. 2
No. of Equity Shares of 100 each 200,000 units 300,000 units
Price Earnings Ratio (PE Ratio) 15 10

Required
i) Determine the exchange ratio of shares and the number of shares that must be issued by Buster
Ltd. to the shareholders of Cluster Ltd.
ii) Assuming 20% synergy benefits that will accrue due to the acquisition, calculate the EPS of
Buster Ltd. after acquisition.
iii) With synergy effect, calculate the break-even PE Ratio and the break-even exchange ratio after
acquisition.
iv) If the PE Ratio after acquisition with synergetic effect would be 22 times, what would be the
market price per share of the Buster Ltd.?
Ans: (i)25: 60 (ii) Rs. 5.17 (iii) 0.5333:1 (iv) Rs.113.74
Question 21
The chief executive of a company thinks that shareholders always look for the earnings per share.
Therefore, he considers maximization of the earnings per share as his company’s objective. His
company’s current net profits are 80 Lakhs and EPS is Rs. 4. The current market price is Rs. 42.
He wants to buy another firm which has current income of 15.75 lakhs, EPS of Rs. 10.50 and the
market price per share of Rs. 85.
What is the maximum exchange ratio which the chief executive should offer so that he could keep
EPS at the current level?
If the chief executive borrows funds at 15% rate of interest and buys out another company by
paying cash, how much should he offer to maintain his EPS?
Assume a tax rate to 52 Percent.
Ans: Max Exchange ratio = 2.625; Total offer Value = 218.75;
Offer price per share = 145.83

Question 22
The equity shares of XYZ Ltd. are currently being traded at Rs. 24 per share in the market. XYZ
Ltd. has total 10,00,000 equity shares outstanding in number; and promoters' equity holding in the
company is 40%.
PQR Ltd. wishes to acquire XYZ Ltd. because of likely synergies. The estimated present value of
these synergies is Rs. 80,00,000.
Top management with their families are promoters of XYZ Ltd. PQR feels that management of
XYZ Ltd. has been over paid. With better motivation, lower salaries and fewer perks for the top
management, will lead to savings of Rs. 4,00,000 p.a. Present value of these savings would add
Rs. 30,00,000 in value to the acquisition.
Following additional information is available regarding PQR Ltd.:
• Earnings per share: Rs.4
• Total number of equity shares outstanding: 15,00,000
• Market price of equity share: Rs.40
Required:
(i) What is the maximum price per equity share which PQR Ltd. can offer to pay for XYZ Ltd.?
(ii) What is the minimum price per equity share at which the management of XYZ Ltd. will be
willing to offer their controlling interest?
Ans: Rs. 35, Rs. 31.50
 Use of Equity Valuation Techniques in Mergers

Question 23
AFC Ltd. wishes to acquire BCD Ltd. The shares issued by the two companies are 10,00,000 and
5,00,000 respectively:
(i) Calculate the increase in the total value of BCD Ltd. resulting from the acquisition on the basis
of the following conditions:
Current expected growth rate of BCD Ltd. 7%
Expected growth rate under control of AFC 8%(without any additional capital investment
Ltd. and without any change in risk of operation)
Current Market price per share of AFC Ltd. Rs. 100
Current Market price per share of BCD Ltd. Rs. 20
Expected Dividend per share of BCD Ltd. Rs. 0.60
(ii) On the basis of aforesaid conditions calculate the gain or loss to shareholders of both the
companies, if AFC Ltd. were to offer one of its shares for every four shares of BCD Ltd.
(iii) Calculate the gain to the shareholders of both the Companies, if AFC Ltd. pays Rs.22 for each
share of BCD Ltd., assuming the P/E Ratio of AFC Ltd. does not change after the merger. EPS
of AFC Ltd. is Rs. 8 and that of BCD is Rs. 2.50. It is assumed that AFC Ltd. invests its cash
to earn 10%.
Ans: (i) 50 Lakh (ii) Gain to AFC = 22.22 Lakh; Gain to BCD = 27.78 Lakh
(iii) Gain to AFC = 18.75Lakhs; BCD = 10 Lakhs

Question 24
You work in AB Ltd. Your Finance Director plans to acquire YZ Ltd. You are provided with the
following data:
AB Ltd. YZ Ltd.
Expected earnings per share Rs. 120 Rs. 50
Expected dividend per share Rs. 80 Rs. 20
No. of shares 2,00,000 1,20,000
Current market price Rs 1,800 Rs. 500
Your estimates about YZ indicate expected steady growth of earnings and dividend to the tune of
6% per annum. However, under the new Management, the growth rate is likely to go up to 8% per
annum without additional investment.
Required:
(i) Calculate the cost of acquisition by AB Ltd. if Rs. 600 is paid for each share of YZ Ltd.
(ii) Calculate the net cost if the agreed exchange ratio is one share of AB Ltd for every three
shares of YZ Ltd., in lieu of the cash acquisition as per (i) above.
(iii) Compute the gain from acquisition.
(iv) If the expected growth rate continues to be 6% per annum, how will the new share price as
well as cost be different?
Ans: (i)120 Lakhs (ii) True Cost = 200 Lakhs (iii)
Total gain =600 (iv) True Cost = 100 Lakhs

Question 25
AB Ltd. has recently approached the shareholders of CD Ltd. which is engaged in the same line
of business as that of AB Ltd with a bid of 4 new shares in AB Ltd. for every 5 CD Ltd shares or
a cash alternative of 360 per share. Past records of earnings of CD Ltd. had been poor and the
company’s shares have been out of favor with the stock market for some time.
Pre bid information for the year ended 31.3.2006 are as follows:
AB Ltd in lakhs CD Ltd. in lakhs
Equity share capital 60 170
Number of shares 2.4 1.7
Pre-tax profit 125 110
P/E Ratio 11 7
Estimated post tax cost of Equity 12% 10%
Capital per Annum
Both AB Ltd. and CD Ltd. pay income tax at 30%. Current earnings growth forecast is 4% for the
foreseeable future of both the Companies.
Assuming no synergy exists, you are required to evaluate whether proposed share to share offer is
likely to be beneficial to the shareholders of both the companies using merger terms available. AB
Ltd.’s directors might expect their own pre bid P/E ratio to be applied to combined earnings.
Also comment on the value of the two Companies from the constant growth form of dividend
valuation model assuming all earnings are paid out as dividends.
Ans: AB- Cash Offer; CD- Stock Offer

Question 26
ABC Company is considering acquisition of XYZ Ltd. which has 1.5 crores shares outstanding
and issued. The market price per share is Rs. 400 at present. ABC's average cost of capital is 12%.
Available information from XYZ indicates its expected cash accruals for the next 3 years as
follows:
Year Cr.
1 250
2 300
3 400
Calculate the range of valuation that ABC has to consider. (PV factors at 12% for years 1 to 3
respectively: 0.893, 0.797 and 0.712).
Ans: Min- 600 crore; Max - 747.15 crore

Question 27
Yes Ltd. wants to acquire No Ltd. and the cash flows of Yes Ltd. and the merged entity are given
below:
Rs. In Lakhs
Year 1 2 3 4 5
Yes Ltd. 175 200 320 340 350
Merged Entity 400 450 525 590 620
Earnings would have witnessed 5% constant growth rate without merger and 6% with merger on
account of economies of operations after 5 years in each case. The cost of capital is 15%.
The number of shares outstanding in both the companies before the merger is the same and the
companies agree to an exchange ratio of 0.5 shares of Yes Ltd. for each share of No Ltd.
PV factor at 15% for years 1-5 are 0.870, 0.756; 0.658, 0.572, 0.497 respectively. You are required
to:
(i) Compute the Value of Yes Ltd. before and after merger.
(ii) Value of Acquisition and
(iii) Gain to shareholders of Yes Ltd.
Ans: (i) 2708.92 Lakhs; 5308.47 Lakhs (ii) 2599.55 Lakhs (iii) 830 Lakhs

Question 28
A Ltd. is considering the purchase of T Ltd. The cash inflows after taxes for T Ltd are estimated to
be Rs. 15 lacs per year in the future. This forecast by A Ltd includes expected merger synergic
gains. T Ltd currently has total assets of Rs. 50 lacs with 20% of the total assets being financed
with debt funds. A Ltd 's pre-merger weighted average cost of capital is 15%.
a) Based on A Ltd. pre-merger cost of capital, what is the maximum purchase price that A Ltd.
would be willing to pay for acquiring T Ltd.?
b) Assume that by acquiring T Ltd., A Ltd. will move towards an optimal capital structure such
that its weighted average cost of capital will be 12% after the acquisition. Under these
conditions, what would be the maximum price A Ltd. should be willing to pay?
c) Assume that cash flows for T Ltd. estimated at Rs. 15 lacs for the coming year will grow at a
rate of 20% per year for the following two years, and will be on the level thereafter. Each rupee
increase in cash flows will require Re. 0.7 incremental investment in assets. Estimate the
maximum purchase price for T Ltd. based on a 12% cost of capital.
Ans: (a) 90 Lakhs (b) 115 Lakhs (c) 157.77 Lakhs
Question 29
H Ltd. agrees to buy over the business of B Ltd. effective 1st April, 2012.The summarized Balance
Sheets of H Ltd. and B Ltd. as on 31st March 2012 are as follows:
Balance sheet as at 31st March, 2012 (In Crores of Rupees)
Liabilities: H. Ltd B. Ltd.
Paid up Share Capital
-Equity Shares of Rs. 100 each 350.00
-Equity Shares of Rs. 10 each 6.50
Reserve & Surplus 950.00 25.00
Total 1,300.00 31.50
Assets:
Net Fixed Assets 220.00 0.50
Net Current Assets 1,020.00 29.00
Deferred Tax Assets 60.00 2.00
Total 1,300.00 31.50
H Ltd. proposes to buy out B Ltd. and the following information is provided to you as part of the
scheme of buying:
1. The weighted average post tax maintainable profits of H Ltd. and B Ltd. for the last 4 years
are 300 crores and 10 crores respectively.
2. Both the companies envisage a capitalization rate of 8%.
3. H Ltd. has a contingent liability of 300 crores as on 31st March, 2012.
4. H Ltd. to issue shares of 100 each to the shareholders of B Ltd. in terms of the exchange ratio
as arrived on a Fair Value basis. (Please consider weights of 1 and 3 for the value of shares
arrived on Net Asset basis and Earnings capitalization method respectively for both H Ltd.
and B Ltd.)
You are required to arrive at the value of the shares of both H Ltd. and B Ltd. under:
(i) Net Asset Value Method
(ii) Earnings Capitalization Method
(iii) Exchange ratio of shares of H Ltd. to be issued to the shareholders of B Ltd. on a Fair value
basis (taking into consideration the assumption mentioned in point 4 above.)
Ans: (i) Rs. 285.71, Rs. 48.46 (ii) Rs. 1071.43, Rs. 192.31 (iii) 0.1787:1

Question 30
AB Ltd., is planning to acquire and absorb the running business of XY Ltd. The valuation is to be
based on the recommendation of merchant bankers and the consideration is to be discharged in the
form of equity shares to be issued by AB Ltd. As on 31.3.2006, the paid-up capital of AB Ltd.
consists of 80 lakhs shares of Rs. 10 each. The highest and the lowest market quotation during the
last 6 months were Rs. 570 and Rs. 430. For the purpose of the exchange, the price per share is to
be reckoned as the average of the highest and lowest market price during the last 6 months ended
on 31.3.06.
XY Ltd.’s Balance Sheet as at 31.3.2006 is summarized below:
Sources Rs. Lakhs
Share Capital
20 lakhs equity shares of Rs. 10 each fully paid 200
10 lakhs equity shares of Rs. 10 each, Rs. 5 paid 50
Loans 100
Total 350
Uses
Fixed Assets (Net) 150
Net Current Assets 200
Total 350
An independent firm of merchant bankers engaged for the negotiation, have produced the
following estimates of cash flows from the business of XY Ltd:
Year ended By way of Rs. Lakhs
31.3.07 After tax earnings for equity 105
31.3.08 Do 120
31.3.09 Do 125
31.3.10 Do 120
31.3.11 Do 100
Terminal value estimate 200
It is the recommendation of the merchant banker that the business of XY Ltd. may be valued on
the basis of the average of
(a) Aggregate of discounted cash flows at 8% and
(b) Net assets value.
Present value factors at 8% for years
1-5 0.93 0.86 0.79 0.74 0.68
You are required to:
(i) Calculate the total value of the business of XY Ltd.
(ii) The number of shares to be issued by AB Ltd.; and
(iii)The basis of allocation of the shares among the shareholders of XY Ltd.
Ans: (i) Rs. 421.20 (ii) 84,240 (iii) Fully paid up - 67,392
shares; Partly paid-up -16,848 shares
Question 31
An all-equity company is expected to generate 48.5 million in dividends per annum in perpetuity
and has a beta coefficient of 1.85. Another company, also all-equity, is expected to generate 37.8
million in perpetuity and has a beta coefficient of 0.68. The risk-free rate of return is 7.5% and the
expected return on the market is 13.8%.
If the two firms were to merge, and if no scale economies or managerial synergies were expected
from the merger, what would be the value of the combined firm?
If the merger of the two firms were to result in that are expected to increase the annual dividends
of the combined firm by 3.85 million, what would be the value of the combined firm?
Ans: (a) 573.97 mill (b) 599.8 mill.

Question 32
ABC, a large business house is planning to sell its wholly owned subsidiary KLM. Another large
business entity XYZ has expressed its interest in making a bid for KLM. XYZ expects that after
acquisition the annual earning of KLM will increase by 10%.
Following information, ignoring any potential synergistic benefits arising out of possible
acquisitions, are available:
(i) Profit after tax for KLM for the financial year which has just ended is estimated to be Rs.10
crore.
(ii) KLM's after-tax profit has an increasing trend of 7% each year and the same is expected to
continue.
(iii) Estimated post tax market return is 10% and risk-free rate is 4%. These rates are expected to
continue.
(iv) Corporate tax rate is 30%.
XYZ ABC Proxy entity for KLM in
the same line of business
No. of shares 100 lakhs 80 lakhs --
Current share price Rs. 287 Rs. 375 --
Dividend pay out 40% 50% 50%
Debt: Equity at market values 1: 2 1: 3 1: 4
P/E ratio 10 13 12
Equity beta 1 1. 1 1.1
Assume gearing level of KLM to be the same as for ABC and a debt beta of zero. You are required
to calculate:
(a) Appropriate cost of equity for KLM based on the data available for the proxy entity.
(b) A range of values for KLM both before and after any potential synergistic benefits to XYZ of
the acquisition.
Ans: (a) Cost of equity = 10.93%; (b) Pre- Synergic range = 100 crore to 136
crore; post synergic range = 110 crore to 150 crore
Question 33
Ntell Ltd. (a listed company) is considering to acquire Nbell Ltd., an unlisted company, which has
three departments. Department A manufactures machineries for industrial companies, Department
B produces electrical goods for the retail market and Department C operates in the construction
industry. Upon acquisition, Department A will become part of Ntell as it contains new technology
which Ntell is seeking, Department B will be spun off into a new company called Nwell Ltd. and
Department C will be sold.
Given below are the extracts of financial information for the two companies for the year ended on
31 Ashadh 2074.
Amount in million NPR
Particulars Ntell. Nbell.
Sales Revenue 790.2 124.6
Earnings before Depreciation, Interest and Taxes (EBDIT) 244.4 37.4
Interest 13.8 4.3
Depreciation 72.4 10.1
Pre-tax Profit 158.2 23.0

Particulars Ntell. Nbell.

Non-Current Assets 723.9 98.2
Current Assets 142.6 46.5
7% Unsecured Bond - 40.0
Other non-current and current liabilities 212.4 20.2
Share Capital (Rs 100/share) 190.0 20.0
Reserves 464.1 64.5

Share of Profit and assets of Nbell’s three departments:

Department A Department B Department C
Current & noncurrent assets 40% 40% 20%
EBDIT and Pre-tax Profit 50% 40% 10%
Other information:
• It is estimated that for Department C, the realizable value of its non-current assets is 100% of
their book value, but its current assets realizable value is only 90% of their book value. The
costs related to closing Department C are estimated to be Rs. 3 million.
• The funds raised from the disposal of Department C will be used to pay off Nbell’s other non-
current and current liabilities.
• The 7% unsecured bond will be taken over by Nwell. It can be assumed that the current market
value of the bond is equal to its book value.
• At present, around 10% of Department B’s EBDIT comes from sale made to Department C.
• Nwell’s cost of capital is estimated to be 10%. It is estimated that in the first year of operation
Nwell’s free cash flows to firm will grow by 20%, and then by 5.2% annually thereafter.
• The tax rate applicable to all companies is 20%, and Nwell can claim 10% tax allowable
depreciation on its non-current assets. It can be assumed that the amount of tax allowable
depreciation is the same as the investment needed to maintain Nwell’s operations.
• Ntell’s current share price is Rs. 600 per share and it is estimated that Nbell’s PE ratio is 25%
higher than Ntell’s PE ratio. After the acquisition, when the Department A becomes part of
Ntell, it is estimated that Ntell’s PE ratio will increase by 15%.
• It is estimated that the combined company’s annual after-tax earnings will increase by Rs. 7
million due to the synergy benefits resulting from combining Ntell and Department A.
You are required to estimate the maximum premium Ntell could pay to acquire Nbell showing all
relevant calculations and explaining the approach taken and any assumption made.
Ans: 286 million

Demerger

Question 34
The following information is relating to Fortune India Ltd. having two division, viz. Pharma
Division and Fast Moving Consumer Goods Division (FMCG Division). Paid up share capital of
Fortune India Ltd. is consisting of 3,000 Lakhs equity shares of Re. 1 each. Fortune India Ltd.
decided to de-merge Pharma Division as Fortune Pharma Ltd. w.e.f. 1.4.2009. Details of Fortune
India Ltd. as on 31.3.2009 and of Fortune Pharma Ltd. as on 1.4.2009 are given below:
Particulars Fortune Pharma Ltd. Fortune India Ltd.
Outside Liabilities
Secured Loans 400 lakh 3,000 lakh
Unsecured Loans 2,400 lakh 800 lakh
Current Liabilities & Provisions 1,300 lakh 21,200 lakh
Assets
Fixed Assets 7,740 lakh 20,400 lakh
Investments 7,600 lakh 12,300 lakh
Current Assets 8,800 lakh 30,200 lakh
Loans & Advances 900 lakh 7,300 lakh
Deferred tax/Misc. Expenses 60 lakh (200) lakh
Board of Directors of the Company have decided to issue necessary equity shares of Fortune
Pharma Ltd. of Re. 1 each, without any consideration to the shareholders of Fortune India Ltd. For
that purpose, following points are to be considered:
• Transfer of Liabilities & Assets at Book value.
• Estimated Profit for the year 2009-10 is Rs.11,400 Lakh for Fortune India Ltd. & 1,470 lakhs
for Fortune Pharma Ltd.
• Estimated Market Price of Fortune Pharma Ltd. is Rs. 24.50 per share.
 • Average P/E Ratio of FMCG sector is 42 & Pharma sector is 25, which is to be expected for
both the companies.
Calculate:
1. The Ratio in which shares of Fortune Pharma are to be issued to the shareholders of Fortune
India Ltd.
2. Expected Market price of Fortune India (FMCG) Ltd.
3. Book Value per share of both the Companies immediately after Demerger.
Ans: (1) Exchange ratio = 0.50 (2) MPS = Rs. 159.60 (3) BVPS
(Pharma) =14; BVPS (FMCG) = 8

Question 35
At a recent board meeting of Huzzey it was decided that the company should divest itself of its
paint-manufacturing subsidiary, Supercover Ltd (Supercover). The board discussed the following
three proposed ways of carrying out the divestment:
Proposal 1 – Winding Down Operations - To reduce Supercover's operations over a period of three
years and then close it down.
Proposal 2 – Sell - To sell Supercover to another company.
Proposal 3 – Management Buy Out (MBO) - To sell Supercover to a team made up of its current
management.
It was decided at the board meeting that one of the criteria for choosing the best method of
divestment would be the present value of the cash flows associated with each proposal.
A suitable discount rate to assess the present value of the cash flows of all three proposals is 10%.
You should assume that corporation tax will be payable at the rate of 17% for the foreseeable
future and tax will be payable in the same year as the cash flows to which it relates.
Financial information for each proposal is as follows:
Proposal 1:
• Sales revenue for the year to 30 June 20X8 was £25 million. For the three years to 30 June
20Y1 sales volumes are expected to decrease by 10% p.a. compound. Selling prices will not
change and contribution is expected to be 60% of the selling price.
• The amount invested in working capital on 30 June 20X8 was £2 million. This amount will
reduce at the end of each year in line with the reduction in sales volumes. On 30 June 20Y1 all
remaining working capital will be recovered in full.
• On 30 June 20X8 Supercover's plant and equipment has a tax written down value of £3 million.
• On 30 June 20Y1 Supercover's plant and equipment will be sold for an estimated £9 million
(at 30 June 20Y1 prices).
• The plant and equipment attracts 18% (reducing balance) capital allowances in the year of
expenditure and in every subsequent year of ownership by the company, except the final year.
 In the final year, the difference between the plant and equipment's written down value for tax
purposes and its disposal proceeds will be treated by the company either as a:
– balancing allowance, if the disposal proceeds are less than the tax written down value; or
– balancing charge, if the disposal proceeds are more than the tax written down value.
• Redundancy payments on 30 June 20Y1 will amount to £0.50 million (at 30 June 20Y1 prices).
This amount is fully allowable for tax.
Proposal 2:
All the shares in Supercover will be sold for £38 million before taxation on 30 June 20X8. Assume
that this amount is fully taxable.
Proposal 3:
The management team will buy the shares of Supercover for £41 million. The £41 million will be
received in three installments as follows:
• On 30 June 20X8 £15 million
• On 30 June 20X9 £13 million
• On 30 June 20Y0 £13 million
Assume that all these installments are fully taxable in the year that they are received.

Required:
Advise the board of Huzzey as to which of the three divestment proposals should be chosen.
Assume that the current date is 30 June 20X8.
Ans: I – £ 32.59m; II - £31.54 m; III - £31.18 million

Miscellaneous

Type 1 – Capital Budgeting like NPV Sum

Question 36
M/s Tiger Ltd. wants to acquire M/s. Leopard Ltd. The balance sheet of Leopard Ltd. as on 31st
March, 2012 is as follows:
Liabilities Rs. Assets Rs.
Equity Capital (70,000 shares) 700,000 Cash 50,000
Retained earnings 3,00,000 Debtors 70,000
12% Debentures 3,00,000 Inventories 2,00,000
Creditors and other liabilities 3,20,000 Plants & Eqpt. 13,00,000
16,20,000 16,20,000
Additional Information:
(i) Shareholders of Leopard Ltd. will get one share in Tiger Ltd. for every two shares. External
liabilities are expected to be settled at Rs. 5,00,000. Shares of Tiger Ltd. would be issued at its
current price of Rs. 15 per share. Debenture holders will get 13% convertible debentures in the
 purchasing company for the same amount. Debtors and inventories are expected to realize
Rs. 2,00,000.
(ii) Tiger Ltd. has decided to operate the business of Leopard Ltd. as a separate division. The
division is likely to give cash flows (after tax) to the extent of Rs. 5,00,000
per year for 6 years. Tiger Ltd. has planned that, after 6 years, this division would be demerged
and disposed of for Rs. 2,00,000.
(iii)The company’s cost of capital is 16%.
Make a report to the Board of the company advising them about the financial feasibility of this
acquisition.
Net present values for 16% for Rs. 1 are as follows:
Years 1 2 3 4 5 6
PV .862 .743 .641 .552 .476 .410
Ans: NPV= 849,000

Question 37
The following is the Balance Sheet of Poor Ltd. as on 31st Ashadh 2069.
Rs. in million
Capital & Liabilities Amount Assets Amount
Equity Share Capital 200 Fixed assets 190
(2 m. shares of 100 each) Investment 10
10% Preference Share 10 Current Assets
Reserve and Surplus 40 Stock 50
12% Debentures 30 Debtors 40
Current Liabilities 20 Cash/Bank Balance 10

300 300
Strong Ltd. has negotiated to acquire the Poor Ltd. with the payment of following purchase
consideration:
(i) 13% Debentures of Strong Ltd. to repay the 12% Debentures of Poor Ltd.
(ii) 11% Preference shares of Strong Ltd. to repay the 10% Preference shares of Poor Ltd.
(iii) 2 million equity shares in Strong Ltd. to be issued at the current market price of Rs. 150 per
share.
(iv) Acquisition cost of Rs. 3 million is paid by Strong Ltd.
Projected incremental free cash flows expected from the acquisition for 6 years are as follows:
Year-end 1 2 3 4 5 6
Incremental cash flows (Rs. million) 45 60 78 90 65 35
The incremental free cash flows after 6 years are expected to decline at 10% per annum.
Immediately after the acquisition, Strong Ltd. will sell the investment made by Poor Ltd. at Rs. 12
million. This proceed can be used for payment of purchase consideration to Poor Ltd. Strong Ltd.
do have sufficient working capital to manage post acquisition operating activities. Current
liabilities are expected to be settled at Rs. 19 million. Cost of capital of Strong Ltd. after acquisition
is expected to decline at 14%.
Required:
Is the acquisition proposal financially feasible to Strong Ltd.? Give your advice with detailed
computation.
Ans: NPV = (38.92 million)

Type 2 – Bank Merger

Question 38
Bank 'R' was established in 2005 and doing banking in India. The bank is facing DO OR DIE
situation. There are problems of Gross NPA (Non-Performing Assets) at 40% & CAR/CRAR
(Capital Adequacy Ratio/ Capital Risk Weight Asset Ratio) at 4%. The net worth of the bank is
not good. Shares are not traded regularly. Last week, it was traded @ Rs. 8 per share.
RBI Audit suggested that bank has either to liquidate or to merge with other banks.
Bank 'P' is professionally managed bank with low gross NPA of 5%. It has Net NPA at 0% and
CAR at 16%. Its share is quoted in the market @ Rs.128 per share. The board of directors of bank
'P' has submitted a proposal to RBI for takeover of bank 'R' on the basis of share exchange ratio.
The Balance Sheet details of both the banks are as follows:
Bank ‘R’ Bank ‘P’ Amt. In
Amt. in ` lacs ` lacs
Paid up share capital 140 500
Reserves & Surplus 70 5,500
Deposits 4,000 40,000
Other liabilities 890 2,500
Total Liabilities 5,100 48,500
Cash in hand & with RBI 400 2,500
Balance with other banks - 2,000
Investments 1,100 15,000
Advances 3,500 27,000
Other Assets 100 2,000
Total Assets 5,100 48,500
It was decided to issue shares at Book Value of Bank 'P' to the shareholders of Bank 'R'. All assets
and liabilities are to be taken over at Book Value.

For the swap ratio, weights assigned to different parameters are as follows:
 Gross NPA 30%
CAR 20%
Market price 40%
Book value 10%

a) What is the swap ratio based on above weights?

b) How many shares are to be issued?
c) Prepare Balance Sheet after merger.
d) Calculate CAR & Gross NPA % of Bank 'P' after merger.
Ans: Swap Ratio = 0.125; (b) 1.75 Lakh Shares; (d) CAR = 14.53%;
Gross NPA %= 9.02%

Type 3 – Use of Normal Probability Distribution Table

Question 39
XYZ Limited wishes to acquire ABC Limited. Following information is available:
Particulars XYZ ABC
No. of Shares 10 Lakhs 2 Lakhs
EPS Rs. 30 Rs. 50
MPS Rs. 450 Rs. 300
P/E ratio 15 times 6 times
Additional Information:
• Agreed swap ratio is 0.5 shares in XYZ for each share in ABC.
• Increase in annual earnings by NPR 40 Lakhs is expected due to synergy.
• XYZ is not sure about the P/E ratio that can be maintained after acquisition. It finds that
average expected P/E ratio is 12 with a standard deviation of 3.
• XYZ will accept the merger only if probability of merger being beneficial is more than
70%.
State whether merger is acceptable to XYZ?
Ans: Not Acceptable

Type 4 – Residuals
Question 40
Simple Ltd. and Dimple Ltd. are planning to merge. The total value of the companies are dependent
on the fluctuating business conditions. The following information is given for the total value (debt
+ equity) structure of each of the two companies.
Business Condition Probability Simple Ltd. Dimple
(Lacs ) Ltd. (Lacs)
High Growth 0.20 820 1050
Medium Growth 0.60 550 825
Slow Growth 0.20 410 590
The current debt of Dimple Ltd. is Rs. 65 lacs and of Simple Ltd. is Rs. 460 lacs. Calculate the
expected value of debt and equity separately for the merged entity.
Ans: 884 Lakhs , 515 Lakhs
SOLUTIONS TO SELF PRACTICE QUESTIONS

Answer 1

𝑀𝑃𝑆−𝑇𝑎𝑟𝑔𝑒𝑡 𝑐𝑜𝑜𝑚𝑝𝑎𝑛𝑦 250

1. Swap ratio (Based on MPS) = 𝑀𝑃𝑆−𝐴𝑐𝑞𝑢𝑖𝑟𝑖𝑛𝑔 𝑐𝑜𝑚𝑝𝑎𝑛𝑦 = = 5:6
300
𝐸𝑃𝑆−𝑇𝑎𝑟𝑔𝑒𝑡 𝑐𝑜𝑜𝑚𝑝𝑎𝑛𝑦 30
2. Swap ratio (Based on EPS) = 𝐸𝑃𝑆−𝐴𝑐𝑞𝑢𝑖𝑟𝑖𝑛𝑔 𝑐𝑜𝑚𝑝𝑎𝑛𝑦 = = 3:4
40
𝐵𝑉𝑆−𝑇𝑎𝑟𝑔𝑒𝑡 𝑐𝑜𝑜𝑚𝑝𝑎𝑛𝑦 150
3. Swap ratio (Based on B.V.) = 𝐵𝑉𝑆−𝐴𝑐𝑞𝑢𝑖𝑟𝑖𝑛𝑔 𝑐𝑜𝑚𝑝𝑎𝑛𝑦 = = 6:5
125

Verification:

1. No dilution of Market price [when swap ratio based on MPS]

5
No. of shares offered to shareholders of Target Ltd. = 1,50,000 * 6 = 125,000

Total market value of merged firm = value of Vendor company + value of target company

= 300/share * 2,00,000 + 250/share *1,50,000

= 9,75,00,0000
975 𝑙𝑎𝑘ℎ
Value of share (Merged firm) = 2 𝑙𝑎𝑘ℎ+1.25 𝑙𝑎𝑘ℎ = 300

Effect on shareholder wealth

1. MPS (before) = 300

MPS (after) = 300

2. Target company
MPS (before) = 250
MPS (after) = 300
Proportionate MPS (after) = 300 * 5/6 = 250

No effect on wealth.

2. No dilution of Earnings [when swap ratio based on EPS]

3
No. of shares offered to shareholders of Target Ltd. = 1,50,000 * 4 = 1,12,500
 40 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒∗2,00,000+30 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒∗1,50,000 1250 𝑙𝑎𝑘ℎ
Earnings per share of merged firm = = = 40
2+1.125 𝑙𝑎𝑘ℎ 3.125

Effect on EPS

Vendor company

EPS (before) = 40

EPS (after) = 40

No effect in earnings.

Target company

EPS (before) = 30

EPS (after) = 40

Proportionate EPS (after) = 40 * 3/4 = 30

No effect in EPS.

3. No dilution of B.V. per share [when swap ratio based on BVPS]

1.2
No. of shares offered to shareholders of Target Ltd. = 1,50,000 * 1 = 1,80,000

125𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒∗2,00,000+150 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒∗1,50,000 475 𝐿𝑎𝑘ℎ

B.V. per share of merged firm = = = 125
2+1.8 𝑙𝑎𝑘ℎ 3.8 𝑙𝑎𝑘ℎ

Effect on B.V. Per Share

Vendor company

B.V. Per Share (before) = 125

B.V. per share (after) = 125

No effect in B.V. per share.

Target company

B.V. Per Share (before) = 150

B.V. per share (after) = 125

Adjusted EPS (after) = 125 * 1.2/1 = 150

No effect in B.V. per share

Conclusion: The firm may base swap ratio on that variable in which it does not want changes.

Answer 13

1. Calculation of EPS after Merger [= Total earnings/no of shares]

Earnings of Krishna ltd- Given 7,00,000

Earnings of Rama Ltd – Given 10,00,000

Total earnings 17,00,000

÷ no of equity shares 6,00,000

[ 2,00,000 + 4,00,000 * 1/1]
EPS 2.83

2. Calculation of ∆in EPS

a. For shareholder of Krishna Ltd.
EPS before merger = 3.5
EPS, after merger = 2.83
Equivalent EPS = 2.83 * 1/ 1 = 2.83
∆ in EPS = 0.67, decrease

b. For shareholder of Rama ltd

EPS before merger = 2.5
EPS, after merger = 2.83
∆ in EPS = 0.33 increase

3. Market value of post-merger firm

MPS = EPS * PE ratio
= 2.83 * 14 [same as that of Rama ltd]
= 39.62
 ∴ Market value = 39.62 * 6,00,000 = 237,72,000

4. Profit accruing to shareholder

a. Profit of Krishna ltd’s shareholder
= VAT * % holding - VT
2𝑙
= 237,72,000 * 6𝑙 - [35 * 2,00,000]
= 9,24,000
b. Profit of Rama Ltd’s shareholder
= VAT * % of holding – VA
4𝑙
= 237,72,000 * 6𝑙 - [35 * 4,00,000]
= 18,48,000
 Standard Normal Distribution Table

0 z

z .00 .01 .02 .03 .04 .05 .06 .07 .08 .09
0.0 .0000 .0040 .0080 .0120 .0160 .0199 .0239 .0279 .0319 .0359
0.1 .0398 .0438 .0478 .0517 .0557 .0596 .0636 .0675 .0714 .0753
0.2 .0793 .0832 .0871 .0910 .0948 .0987 .1026 .1064 .1103 .1141
0.3 .1179 .1217 .1255 .1293 .1331 .1368 .1406 .1443 .1480 .1517
0.4 .1554 .1591 .1628 .1664 .1700 .1736 .1772 .1808 .1844 .1879
0.5 .1915 .1950 .1985 .2019 .2054 .2088 .2123 .2157 .2190 .2224
0.6 .2257 .2291 .2324 .2357 .2389 .2422 .2454 .2486 .2517 .2549
0.7 .2580 .2611 .2642 .2673 .2704 .2734 .2764 .2794 .2823 .2852
0.8 .2881 .2910 .2939 .2967 .2995 .3023 .3051 .3078 .3106 .3133
0.9 .3159 .3186 .3212 .3238 .3264 .3289 .3315 .3340 .3365 .3389
1.0 .3413 .3438 .3461 .3485 .3508 .3531 .3554 .3577 .3599 .3621
1.1 .3643 .3665 .3686 .3708 .3729 .3749 .3770 .3790 .3810 .3830
1.2 .3849 .3869 .3888 .3907 .3925 .3944 .3962 .3980 .3997 .4015
1.3 .4032 .4049 .4066 .4082 .4099 .4115 .4131 .4147 .4162 .4177
1.4 .4192 .4207 .4222 .4236 .4251 .4265 .4279 .4292 .4306 .4319
1.5 .4332 .4345 .4357 .4370 .4382 .4394 .4406 .4418 .4429 .4441
1.6 .4452 .4463 .4474 .4484 .4495 .4505 .4515 .4525 .4535 .4545
1.7 .4554 .4564 .4573 .4582 .4591 .4599 .4608 .4616 .4625 .4633
1.8 .4641 .4649 .4656 .4664 .4671 .4678 .4686 .4693 .4699 .4706
1.9 .4713 .4719 .4726 .4732 .4738 .4744 .4750 .4756 .4761 .4767
2.0 .4772 .4778 .4783 .4788 .4793 .4798 .4803 .4808 .4812 .4817
2.1 .4821 .4826 .4830 .4834 .4838 .4842 .4846 .4850 .4854 .4857
2.2 .4861 .4864 .4868 .4871 .4875 .4878 .4881 .4884 .4887 .4890
2.3 .4893 .4896 .4898 .4901 .4904 .4906 .4909 .4911 .4913 .4916
2.4 .4918 .4920 .4922 .4925 .4927 .4929 .4931 .4932 .4934 .4936
2.5 .4938 .4940 .4941 .4943 .4945 .4946 .4948 .4949 .4951 .4952
2.6 .4953 .4955 .4956 .4957 .4959 .4960 .4961 .4962 .4963 .4964
2.7 .4965 .4966 .4967 .4968 .4969 .4970 .4971 .4972 .4973 .4974
2.8 .4974 .4975 .4976 .4977 .4977 .4978 .4979 .4979 .4980 .4981
2.9 .4981 .4982 .4982 .4983 .4984 .4984 .4985 .4985 .4986 .4986
3.0 .4987 .4987 .4987 .4988 .4988 .4989 .4989 .4989 .4990 .4990
3.1 .4990 .4991 .4991 .4991 .4992 .4992 .4992 .4992 .4993 .4993
3.2 .4993 .4993 .4994 .4994 .4994 .4994 .4994 .4995 .4995 .4995
3.3 .4995 .4995 .4995 .4996 .4996 .4996 .4996 .4996 .4996 .4997
3.4 .4997 .4997 .4997 .4997 .4997 .4997 .4997 .4997 .4997 .4998
3.5 .4998 .4998 .4998 .4998 .4998 .4998 .4998 .4998 .4998 .4998

Gilles Cazelais. Typeset with LATEX on April 20, 2006.