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In this topic we will discuss about:
.Data Verification Sources
.Notice
.Essential Guidelines
.Discussions and cases about Merger and business valuations
Data Verification Sources
1 = Theories and problems in financial management by M.Y khan and P.K Jain third edition2 = Wikipedia the free encyclopedia (http://en.wikipedia.org/)3 = www.investopedia.com4 = Financial Management ACCA paper F9 by Kaplan5 = CA module F Paper F 19 Business Finance Decisions
The term merger refers to the combination of two or more firms. The analysis of financial aspects of merger covers three aspects
1. Determining the firm’s value2. Financing techniques for merger3. Merger as capital budgeting decision
Let us discuss each of them one by one
1. Determining the firm’s valueIt is first step in merger it is difficult as different factors are considered in conjunction with each other and book value itself is not an effective measure itself as it is useful in specific situations. The importance of appraisal value depends upon methods used to calculate it and nature of the business. The market value is key element in evaluating the firm’s worth particularly in large listed corporate firms. Another important criterion for merger decision is EPS. However worth of a firm should not be determined on basic of a single approach and a single figure but within a range after considering all the alternative approaches
The EPS basic of determining the value of firm is based on the effect of merger on the future EPS, that is, the EPS of the merged firm (EPSm) see this procedure and its effect
EPSm = EATA + EATT / NA + NT
WHERE:
EATA = Earning after tax of the acquiring firm
EATT = Earning after tax of the target firm
NA = Number of equity shares outstanding of the acquiring firm
NT = Number of equity shares of the target firm
Market value of the merged firm Vm= EPSm * P/EA
Total gain from merger:
Vm = (VA – VT)
WHERE:
VA = EPSA * P/EA
VT = EPST * P/ET
Gain for Acquiring (GA) and Target (GT) firm
GA = [Post-merger value of firm A less Pre-merger value of firm A]GA = [Post-merger value of firm T less Pre-merger value of firm T]
Approaches for valuations There are three main approaches for business valuations mentioned under
1. DVM based on the return paid to the share-holders
= P0 = [D0 (1+g)] / [(Ke – g)]
2. Income/earnings based - based on the returns earned by the firm
a. PE ratio method = value of the company = total earning (NP after tax) * P/E ratio
b. Earning yield = value
per sh
are = EPS * (1 / earning yield) OR
= value of share = total earnings * (1/earning yield)
While earning yield is simply inverse of P/E = EPS / price per share
c. Discounted cash flow basic
3. Asset-based – based on the tangible assets owned by the company4. ARR valuation method (value = (estimated annual profits / require return
on capital employed)5. Supper profit valuation method = super profit = [actual profit - ( net book
value of tangible assets * avg. industry return)] and the company willing to acquire mention that it will pay suppose for 3 years super profits in this case the results of the above formula is multiplied with 3.
6. Additional promised amounts based on achievement of a certain level of EAT
What is real worth of the company?
Valuation is described as an art not science; the real worth of the firm depends on the viewpoints of the various parties and qualitative factors:
The various methods of valuation will often give widely differing results It may be in interests of the investor to argue that either a high or low
value is appropriate The final figure will be a matter for negotiation between the interested
parties
2. Financing techniques for mergerSecond aspect of the merger is Mode of Financing. In case of a firm having a high P/E ratio, issue of equity shares is better, both to acquiring and target firms.
To meet the investment needs of investors, convertible securities can be issued yet another form of financing merger is the deferral payment plan
Tender offer is another alterative to acquiring a firm. The firm directly approaches the shareholders of the target firm; this approach may be cheaper provided the management of the target firm does not attempt to block it.
3. Merger as capital budgeting decision
If NPV of the decision is positive then go to merger, if NPV is 0 then it make no difference in this case observe quantitative factors and if NPV is negative then do not go for merger
NPV = P.V of all expected future cash inflows less P.V of cash paid
Cases:
Formulas to remember
P/E ratio = Price / EPSPrice = (P/E ratio) * EPS
Comprehensive Case (Cases and solutions may contain errors or omissions in such case please send feedback from home-page)
You have been provided the following financial data of the two companies
Firm A Firm T
Earning after taxes ($) 500 350Equity shares outstanding 200 100Earning par share ($) 2.50 3.50P/E ratio 14 10Market price per share ($) 35 35
Statement of financial position of the both companies is as under
Assets Firm A Firm T($) ($)
Non-current Assets;
Plant and machinery 500 100Furniture and fittings 50 50
Current Assets;
Cash 500 250Debtors 150 100
Total Assets 1200 500
Equity and Liabilities
Equity share capital ($1 each)
200 100
Retained Earnings 1000 125
Liabilities
Non Current Liabilities
14% Preference shares 0 2513% debt ($ 5each) 0 250
Total Equity and Liabilities 1200 500
Required: (Do not try to relate any requirement with other one until there is sure relationship as each case may be independent)
1. Determining the number of shares that will be issued for acquisition on market price basic
2. What will be the post merger EPS?3. What is the change is EPS for shareholders of both companies?4. Determine the market value of the post merger firm assuming P/E ratio
of A remains unchanged5. Ascertain the profit accruing to share-holders of both firms individually6. What is the equivalent EPS for share-holders of T ltd if exchange ratio
is 0.8 shares of firm A in exchange for 1 share of firm T?7. If firm A did not issue its shares but pay cash amounting 36.5 for each
share of T ltd then what will be the post-merger EPS?8. What must be the exchange ratio so that Post and Pre-merger EPS of
Firm A should be equal?9. If currently the firms defers the payment until three years after issuing
0.8 shares for one share of T ltd and post mergers earnings after tax for Firm T are 300, 450 and 250 respectively then determine the number of shares that should be issued each year for share-holders of T ltd assuming P/E ratio for T ltd remains unchanged
10.Suppose firm T has unused losses of $3000 resulting from several loss of incurred in the previous years and for tax purposes these losses can be carried forward for 6 years and tax rate is 35% for income of both companies and cost of capital for firm A is 20% then what is the net tax benefit to firm A by acquiring Firm T assuming same earnings each year
11.Assuming 5% growth in EPS of Firm A and T is expected and Firm A is contemplating to issue its shares in exchange of shares of Firm T based on market price then what will be the exchange ratio? And how much shares will be issued , and assuming no synergic gain, construct a schedule of MPS with and without acquisition and determine that
how long it take to eliminate the dilution in EPS for share-holders of T Ltd in the new firm?
12.What will be the capital structure after merger if A ltd issues shares based on market price? What percentage the debt will be in new firm’s capital, has the merged firm’s financial risk declined? And how much additional debt the merged firm can borrow to maintain 50% debt in capital structure?
13.If A ltd pays $2.50 for each share to share holders of firm T and also issue shares in (1:1) then what is the true cost of acquiring further if provided that the merger will result in cost savings of $1000 after 10 years and this saving will increase the market share price of merged firm suddenly after merger if cost of capital for the firm merged firm is 20% then what is true cost of acquiring after considering further information assuming P/E ratio of A ltd remains unchanged
14.Keeping in mind requirement 13th what is the Net benefit to the shareholders of T ltd if market price is determined based upon P/E ratio of A Ltd assuming unchanged?
15.As the annual earnings of T ltd are 350 keeping in mind only capital structure of both companies and post merger weighted average cost of capital of A ltd as 15% determine the maximum price that A ltd will be willing to pay for one share of T ltd further assume that if the growth of earning of T ltd is 20% for 2 years after merger and after that will not grow further and each increase in cash flow will require $0.7 incremental investment in assets now based on the 12% pre-merger cost what maximum price A ltd will be willing to pay? (round off your answer to near decimal amount)
16.If firm A pays 50% dividend and firm T pays 60% dividend then determine growth rate in dividends of both firms
17.Based on the data given in the balance sheet determine if the merger is favorable or not while compiling after taking into considering that company A is expecting sales of T ltd @700 for 5 years and debentures will be settled by paying cash and cash amounting $1000 will be paid to shareholders of T ltd with issuing 0.5 share of AT ltd in exchange with one share in T ltd dissolution cost is $50 debtors are valued at $90 and cost of capital for the company is 20% and corporate tax is 30% for this case and salvage value of fixed assets is zero and P/E ratio for Firm A will remain unchanged
18.By using DVM valuation approach determine the value of the firm T if dividend this year is 50% of EPS and it was $1.496 before 4 years and firm beta (b) is 0.8 while current market required rate of return (Rm) is equal to 6% and risk free rate (Rf) is 5%
19.As in requirement 18th you are provided that current payout ratio is 50% and beta is 0.8, current market return (Rm) is 6% and risk free rate (Rf) is 5% if you were provided only these information along with
another information that rate of return on assets is10% then how will you calculate value of the firm? (round off answer to nearest cent)
20.If you are provided that a firm similar to that T has earning yield of 12.5% then what is market value of firm T?
21.Suppose firm A is willing to acquire firm T on the super profit of 3 years and avg. return in industry for such type of firms is 50% then what will be the amount payable? Further suppose that at this price share-holders of T ltd are not willing to sell the shares then firm is deciding to pay the extra amount if firm T be able to achieve a certain level of EAT more details are as under10% of average profit of 600 up to 80012% of average profit of 800 up to 100015% of average profit of 1000 up to 1200It is also estimated that probability of earnings are 30%, 15% and 5% respectivelyYou are required to calculate total minimum and maximum gross amount payable and expected amount payable based on probability estimations
Solution:
1. Number of shares to be issued = 100 (1:1 as MP is same)
2. Post merger EPS ($)
(500 + 350) / (100 + 200) = 850 / 300 = 2.83
3. Change is EPS for shareholders of both companies ($)
Firm Firm TFirm A
Pre-merger EPS 3.502.50
Post-merger EPS 2.83 2.83 Change [increase/ (Decrease)]
(0.67) 0.33
4. Market value of the post merger firm assuming P/E ratio of A remains unchanged ($)
Vm = EPS * P/E * S = 2.83*14*300 = 39.62 * 14 = 11886
WHERE:
S = Number of shares outstanding after issue [(100 + (200 *1)]
5. Profit accruing to share-holders of both firms individually (Gain from merger) ($)
Post merger value of the firm 11886Pre-merger value of the firm T (35*100) 3500Pre-merger value of the firm A (35*200) 7000Total 10500Total Gain from merger 1386
Apportionment of gainsFirm A
Firm B
New market value (MP * S) (39.62*200) (39.62*100) 79243962
Less: Old market value 7000 3500 Gain / (Loss) 924
462 = 1386
Alternatively:
(New Share market price of firm A less old share market price of form A)* Number of shares (each firm)
Firm A = (39.62 less 35) * 200 = 924Firm B = (39.62 less 35) * 100 = 462
THIS IS CALLED NPV OF MERGER
6. Equivalent EPS for share-holders of T ltd if exchange ratio is (0.8:1)
Equivalent EPS = (Post-merger EPS * exchange ratio) = 3.04 * 0.8 = 2.43
WHERE:Post merger EPS = [(500 + 350)] / [(200) + (100*0.8) = 850 / 280 = 3.04
7. Post-merger EPS if cash amounting 36.5 is paid for each share of T Ltd.
Post merger EPS = [(500 + 350)] / [(100)] = 850 / 100 = 8.50
8. Exchange ratio so that Post and Pre-merger EPS of Firm T should be equal
Suppose X represents the total number of ordinary shares issued to acquire Firm T
(350 / 100) = [(350+500)/100+X)]3.5 = 850 / 100+X(100 + X)*3.50 = 8503.50X = 850 less 350X = 142.86
So total shares that should be issued are 142.86 for 200 shares and thus exchange ratio is 0.71 shares (142.86/200) of Firm A for 1 share of firm T
9. Number of shares that should be issued for share-holders of T ltd if earnings are 300, 450 and 250
Number of shares = EAT * P/ET / MVA
As: P/E = EPS/P and P = EPS*P/E and EPS = EAT/S Now P = (EAT/S)*P/E and V = SP = (S*EAT/S)*P/E and V = EAT*P/EWHERE: P = Market Price per share, S = no. of ordinary shares and V = value of the firm
Where P/ET is Price earning of target firm and MVA = share market value of acquiring firm In contrast total value of the target firm in each year divided by market price par share of acquiring firm in each year
Yearno. of shares to be issued
1 (300*10) / 3585.71
2 (450*10) / 35128.57
3 (250*10) / 3571.43
10. Net tax benefit to firm A by acquiring Firm T when tax rate is 35%
Year EBIT (865/0.65) Accumulated Loss Taxable Income Tax Tax on normal income Gross Savings1307 3000 0 0 457.45 457.451307 1693 0 0 457.45 457.451307 386 921 322.35 457.45 135.11307
Year Savings PV IF @20% P.V457.45 0.833333333 381.2083333457.45 0.694444444 317.6736111135.1 0.578703704 78.18287037
777.0648148
11. Exchange ratio based upon market price per share
Market price per share of T / market price per share of A = 35/35 = 1 total number of shares to me issued = 100*1 = 100Total number of shares outstanding after issue = 200+100 = 300New EPS = (350+500)/ (200+100) = 2.83
12. Schedule of EPS with and without Merger
Firm A Firm T Firm ATYear EAT
($)EPS ($)
EAT ($)
EPS ($)
EAT ($) EPS ($)
0 350.00
3.50
500.00
2.50
850.00 2.83
1 367.50
3.68
525.00
2.63
892.50 2.98
2 385.88
3.86
551.25
2.76
937.13 3.12
3 405.17
4.05
578.81
2.89
983.98 3.28
4 425.43
4.25
607.75
3.04
1,033.18
3.44
5 446.70
4.47
638.14
3.19
1,084.84
3.62
13. How long it take to eliminate the dilution in EPS?
Current EPS of Firm A is 3.5 and after merger it will took approximately 5 years to eliminate dilution in EPS as in 4th year EPS will be 3.44 that is less than current EPS (Before Merger) but in 5th year it becomes 3.62 that is greater than current EPS (Before Merger) so it will be happen in 5th year
14. Capital structure after merger if A ltd issues shares based on market price? Percentage the debt will be in new firm’s capital, has the merged firm’s financial risk declined? And Additional debt the merged firm can borrow to maintain 50% debt in capital structure?
Total shares to be issued = 100 and total shares in the new firm = 300
New capital structure after issue
Assets
Non-current Assets;
Plant and machinery 600Furniture and fittings 100
Current Assets;
Cash 750
Debtors 250Good will 3275
Total Assets 4975
Equity and Liabilities
Equity share capital ($1 each) 300
14% Preference shares 25Share Premium 3400
Retained Earnings 1000
Liabilities
Non Current Liabilities
13% debt ($ 5each) 250
Total Equity and Liabilities 4975
In the new firm financial risk as referred to A ltd increased and as referred to T ltd decreases as to maintain 50% debt equity ratio company can increase debt to 2362.50 (50% of equity) but currently company has 250 of debt which means that company can issue $2112.50
15. True cost of acquiring
True cost of acquiring = (Cash paid + Market value of shares issued) less market value of shares acquired (M.V of T firm)True cost of acquiring = ((2.5*100) + (100*35)) less (100*35)True cost of acquiring = $250
16. True cost of acquiring after considering further information
While calculating new share price the present value of the savings will be
considered so 1000(1.2) ^-10 = 161.51 so the new share price will be(Current earnings of firm A + current earnings of firm T + present value of savings) / number of shares after merger(350+500+162) /300 = 3.37
True cost of acquiring = (Cash paid + Market value of shares issued) less market value of shares acquired (M.V of T firm)True cost of acquiring = ((2.5*100) + (100*3.37*14)) less (100*35)True cost of acquiring = $1472.67
Note: as the benefit is related to merger so its credit should be allocated to merged firm
17. Maximum price that A ltd will be willing to pay for one share of T ltd
Increase in CFAT from T ltd = 350 /0.15 = 2333Total net value per share 2333/100 = 23.33
18. Maximum price that A ltd will be willing to pay for one share of T ltd at 20% growth and incremental investment
Year CFAT Incremental Investment Net CFAT
P.V.I.F @12% P.V ($)
1 350 0 350 0.892857143 3132 420 49 371 0.797193878 2963 504 58.8 445.2 0.711780248 3173 504 0 504 8.333333333 4200
Maximum Value of the Firm 5125
20. Growth rate in dividend
Growth (G) = B*R (Retention ratio * ROI)
Firm A = (0.5 * 0.10) = 0.050 or 5% Firm B = (0.4 * 0.07) = 0.028 or 2.8%
ROE of both firms
ROE = (EAT / Value of Equity funds)ROE for firm A = (350 / 3500) = 0.10 ROE for Firm T = (500 / 7000) = 0.07
In some books ROI is calculated as (EAT / Net Tangible Assets)
21. Evaluation of merger considering balance sheet
Cost of merger; ($)
Cash payment 1000Payment to debentures 250Cost of dissolution 50Market value of the shares issued 2800 (see attached notes)Total 4100
Financial Benefits from merger; ($)
Present value of cash flow after tax 1496 (see attached notes)Cash realized from T firm 250Debtors value 90Total 1836
Net benefitTotal benefits 1836Less: total cost (4100)Net 2264
No merger is not feasible, As present value is negative
Attached Notes:
Market value of the shares issued:Post merger combined earnings / total number of shares outstanding
(500+500) / (50+200) = 4*14 = 56Number of shares issued (100*0.5) = 50Total value of the shares issued = 50*56 = 2800
Present value of net cash inflowsSales 700Less depreciation (100+50) /5 (30)
670Less tax (30%) 201Net profit after tax 469Add back depreciation 30CFAT 499 or approximately 500
Present value of CFAT = CFAT * PVIF@2% for 5 years = 500 * 2.991 = 1496
22. DVM valuation approach when two dividends are provided
Formula for current value of the share is
P0 = [D0 (1+g)] / [(Ke – g)]
P0 = [1.75 (1+0.04)] / [(0.058 – 0.04)]
P0 = 101.11
Value of the firm = number of shares * value of shareValue of the firm = 100 * 101.11 = 10111.11
We haveD0 = (EPS*50%) = (3.5*0.5) =1.75
Will have to calculate Ke and growth rate (g)By CAPMKe = Rf + b(Rm – Rf)Ke = 0.05 + 0.8 (0.06 – 0.05)Ke = 5.8%
And
Growth (g) = [(current dividend / last mentioned dividend)] ^ 1/n – 1
Growth (g) = [(1.75 / 1.496)] ^ 1/4 – 1 = 4%
22. DVM valuation approach when payout ratio is provided
If payout ratio is provided then we can calculate growth by the formula BR (retention * return on assets) soGrowth (g) = 0.5*0.1 = 0.05 And we know thatFormula for current value of the share is
P0 = [D0 (1+g)] / [(Ke – g)]
P0 = [1.75 (1+0.05)] / [(0.058 – 0.05)]
P0 = 230
Value of the firm = number of shares * value of shareValue of the firm = 100 * 230 = 23000
23. Value of firm based on earning yield
Value of firm = Total net earning * (1/earning yield)Value of firm = 350 * (1/0.125) = 2800
24. Value firm based on earnings and flotation cost
Cost of merger; ($)
Cash payment 1000Payment to debentures 250Cost of dissolution 50Market value of the shares issued 56 (see attached notes)Total 1356
Financial Benefits from merger; ($)
Present value of cash flow after tax 2028 (see attached notes)Cash realized from T firm 250Debtors value 90Total 2368
Net benefitTotal benefits 2368Less: total cost 1356Net 1012
Yes merger is feasible as present value is positive
Attached Notes:
Market value of the shares issued:Post merger combined earnings / total number of shares outstanding(290+500) / (50+200) = 1.129Number of shares issued (100*0.5) = 50Total cost = 50*1.129 = 56
Present value of net cash inflowsSales 400Less depreciation (100+50) /5 (30)
370Less tax (30%) 111Net profit after tax 259Add back depreciation 30CFAT 289 or approximately 290
Effective Ke (EKe) = = [(1+Ke) / (1+flotation rate)] - 1Effective Ke (EKe) = = [(1+0.2) / (1+0.05)] - 1Effective Ke (EKe) = = 14.29%
Present value of CFAT = CFAT / EKe = 290 / 0.143 = 2028
25. Supper profit valuation method
Super profit = [actual profit - (net book value of tangible assets * avg. industry return)]Super profit = [350 - (500 * 0.50)] = 100
Total payable amount = super profit * number of years for multipleTotal payable amount = 100 * 3 = 300
26. Total minimum and maximum gross amount payable
There are two probabilities 1st that firm will not achieve the target level on future 2nd that firm will be able to achieve the level weight of each probability is 50% so minimum total payable amount is 300 when no extra gross amount to be paid the maximum amount is that when firm succeed to achieve the maximum earning level i.e. of 1200 then amount of 180(1200*0.15) plus initial 300 total (480) will be payable
Expected amount payable based on probability estimations
First compute average expected amount with its probability and percentage of payment
Lower Range
Upper Range
Average Probability Expected Earning
Payment Percentage
Total Estimated Payment
600 800 700 0.3 210 10% 21800 1000 900 0.15 135 12% 16.2
1000 1200 1100 0.05 55 15% 8.25Total 45.45
Valuation of debt and preference shares and other cases
Case 1:
A firm has issued $100 12% shares and required rate of return by invertors is 14% what is market value of debt?
Case 2:
A company has issued irredeemable loan notes with a coupon rate of 7% and par value of 100. If the required rate of return of investor is 4% what is the current market value of the debt?
Case 3:
A company issues 9% redeemable debt with 10 years to redemption. Redemption will be at par. The investors require a return of 16% what is the market value of the debt?
Case 4:
ABC company issue convertible loan notes with a coupon rate of 12%. Each $100 loan note may be converted into 20 ordinary shares at any time until the date of expiry and any remaining loan notes will be redeemed at $100 (Par value)
The loan notes have five years left to run. Investors would normally require a rate of return of 8% p.a. on a five-year debt security should investor convert if current market price is
1. $4.002. $5.003. $6.00
Case 5:
Suppose ABC Company is planning to obtain listing on stock-exchange by offering 40% its existing shares to the public. No new share will be issued. Last statement of comprehensive income is as under
Description AmountTurn-over 120,000 Earnings 1,500
Number of shares 3,000
The company has 30% debt and 70% equity and it pays regularly pays 50% dividends and with reinvested earnings is expected to achieve 5% dividend growth each year summarized balance sheet of a company in the similar industry and same business as also as under
Description AmountCapital 50%Debt 50%
Equity beta 1.5
The current treasury bills yield is 7% a year. The average market return is estimated to be 12%. The new shares will be issued at discount of 15% to the estimated post issue price
What will be the issue share price if company has in 30% tax bracket?
Case 6:
You have been provided the following statement of financial position about ABC Company that can earn $27.5 after tax at constant rate which you want to acquire and your undiscounted required rate of return is 20%
Assets Amount Liabilities Amount
Sundry net Assets 160 Capital ($10) 507% Preference shares 40
Reserves 258% Debentures 45
Total 160 Total 160
Debentures and preference shares are to be valued at par. Ignore Taxation
Case 7:
ABC Ltd is contemplating to acquire XYZ Ltd the following information are provided to you
Description ABC XYZEarnings 100 50
Anticipated growth 4% 2%Cost of capital 15% 18%
If total earnings of the merged firm will be the sum of current individual earnings and growth rate will be 5% then what minimum price share holders of ABC
company will accept and what Maximum price share-holders of ABC will willing to pay? (round off figures to nearest cent)
Solutions
Case 1:
Using P0 = D / Ke = 12 / 0.14 = $85.71
Case 2:
M.V = 7 / 0.04 = $175
Case 3:
Time Cash flow ($) PVIF @16% PV($)1 to 10 9 4.833 43.50
10 100 0.227 22.70Present value (Current Market value) 66.20
Case 4:
If the security is not converted there will be following benefits to the share-holder
Description Amount ($) PVIF @8% PV ($)Interest Payment form (1-5) years 12 3.993 47.92Redemption at 5th year 100 0.681 68.10Total Present value 116.02
Value of equity if security is converted
Number of shares
Market Value of Share Total value
20 4 80.0020 5 100.0020 6 120.00
It is concluded that if the market value of the debt raise to 6 then security should be sold as present value of cash that will be received will be 120 that is $3.980 more than keeping security and break even share market price is 116.02 / 20 = 5.80 per share
Case 5:
As we know that
P0 = [(D0) (1+g) / (Ke-g)]
And for this formula Ke is required which is not provided in the question and for this first we will convert the beta provided for another company that is geared and also in the same industry but with different debt/ equity ratio into the beta of un-geared company the formula is as under
bu = [(bg) / (D/E (1-t))]bu = [(1.5) / (0.5/0.5 (1-0.3))]bu = 2.14 Now convert this beta to our current firms capital structure and as we know thatbu = [(bg) / (D/E (1-t))]2.14 = [(bg) / (0.3/0.7 (1-0.3))]bg = 2.4*0.3 = 0.642
According to CAPM model
Ke = rf + b (rm - rf)
Ke = 0.07 + 0.642(0.12-0.07)Ke = 10.21%
And P0 = [(D0) (1+g) / (Ke-g)]P0 = [(0.25) (1+0.05) / (0.1021-0.05)]D0 = EPS * 0.5 = (1500/3000) = 0.25P0 = 5.04And as it is mentioned that shares will be issued at 15% discount so new issue
price will be 5.04(1-0.15) = 4.28
Case 6:
Income before interest 27.50 + (45*0.08) = 31.10
Market value of the firm 31.10 / (0.2) = 155.50
Value of the equity 155.50 – 40 – 45 = 70.50
Value per share 70.50 / 5 = 1.41
Case 7:
Minimum price share holders of XYZ Company will accept
P0 = [(D0) (1+g) / (Ke - g)]P0 = [(50) (1+0.2) / (0.18 – 0.02)]P0 = 319
Maximum price share-holders of ABC will willing to pay
As ABC Company will absorb XYZ Company share price of merged firm will change so share holders ABC Company will calculate the value of the company before merger and after merger and they will be willing to pay the difference if there is any gain but after merger cost of capital will also change so first we will have to calculate that figure. As we know that in the new firm 67% (1000/1500) shares will be of ABC and remaining 33% (500/1500) will be of XYZ ltd. So new weighted average cost of capital for merged firm will be
(0.15*0.67) + (0.18*0.33) = 16%
Thus value of new firm
P0 = [(D0) (1+g) / (Ke - g)]P0 = [(150) (1+0.05) / (0.16 – 0.05)] = 1432
Value of current firm
P0 = [(100) (1+0.04) / (0.15 – 0.04)]P0 = 946
Total Gain = 1432 – 946 = 486
So the share-holders of ABC will be willing to pay maximum $486 as then there will be loss on merger
Note: All the Data and Cases are Uploaded for the public best interest in case of any error or omission please send feedback form home page as soon as possible to avoid further misconception