MERGERS AND ACQUISITIONS – PROBLEM SET - SOLUTIONS
1. Unhygienix Fishmonger plans a diversification and is contemplating the acquisition of the
Fulliautomatix Foundry. The values of the two firms as separate entities are ₣102 million and ₣52
million, respectively. Unhygienix estimates that by combining the two companies, it will reduce
various expenses by ₣1.84 million per year in perpetuity. Unhygienix plans offer Fulliautomatix a
40% holding in Unhygienix. The opportunity cost of capital is 8%. What is the NPV of the
acquisition?
Merger gain = ₣1.84 million /8% = ₣23 million.
Merger cost = xPV(AB) − PV(B) = (40% × ₣177 million) − ₣52 million = ₣18.8 million.
NPV = Merger gain – merger cost = ₣23 million − ₣18.8 million = ₣4.2 million
2. Company L has an equity value of Rs. 100 crore, and Company M has an equity value of Rs. 50
crore. Merging the two would allow cost savings with a present value of Rs. 20 crore. Company L
purchases 100% of the equity of Company M for Rs. 55 crore.
(a) How much are Company L's shareholders’ net gains from this merger?
(b) If a consideration of Rs. 55 crore were to be offered by way of issue of stock of Company L,
what would be the percentage shareholding of the original shareholders of Company M in
Company L after the transaction is completed?
(a) Net gains to shareholders of L = Merger Gains – Merger Costs = Rs. 20 crores – (Rs. 55
crores – Rs. 50 crores) = Rs. 15 crores
(b) Percentage shareholding of shareholders of M in L = Price/ Expected Post-Merger Value =
Rs. 55 crores/ (Rs. 100 crores + Rs. 50 crores + Rs. 20 crores)= 32.35%
3. Alcazar Guerrillas Ltd (Alcazar) propose to acquire control of Tapioca Mercenaries Ltd (Tapioca)
and pay for it with stock of Alcazar. Tapioca’s management is willing to go ahead with the
transaction subject to the exchange ratio being acceptable to its shareholders. Since both companies
are unlisted, they have approached Loch Lomond Valuers (Loch Lomond) to recommend an
exchange ratio. Loch Lomond plans to rely on the following details and estimates regarding Alcazar
and Tapioca.
Alcazar Tapioca
Pre-tax cost of debt 8% 8%
Cost of equity 12% 12%
Tax rate 25% 25%
EBIT for the year just completed Rs. 20 crores Rs. 10 crores
Number of shares outstanding 5 crores 5 crores
Current level of debt Rs. 200 crores Rs. 100 crores
Both companies are mature firms and going forward, their respective EBITs are expected to grow
in perpetuity at 5% per year. Both companies agree that a constant debt-equity ratio of 1:1 in market
value terms would be an appropriate assumption for both of them. The costs of debt and equity
indicated above are based on this assumption.
What exchange ratio should Loch Lomond recommend? Assume that for both firms, capital
expenditure equals depreciation and that the level of working capital is constant.
If Alcazar anticipates the merger to result in synergies with a present value of Rs. 40 crores, what
is the best (from Tapioca’s perspective) exchange ratio it could offer to Tapioca’s shareholders.
If instead of a constant debt-equity ratio, Loch Lomond were to assume that Taipoca’s debt would
remain at the current level in perpetuity, what exchange ratio should they recommend? Disregard
the synergies.
All figures in Rs. crore unless otherwise indicated
Alcazar Tapioca
Pre-tax cost of debt 8.00% 8.00%
Cost of equity 12.00% 12.00%
Tax rate 25.00% 25.00%
EBIT for the year just completed 20 10
Number of shares outstanding (crore) 5 5
Current level of debt 200 100
Target DER 1.00 1.00
Target D/V 0.50 0.50
Target E/V 0.50 0.50
Growth rate to perpetuity (g) 5% 5%
EBIAT for next year (EBIT x (1-t) x (1 + g)) 15.75 7.88
WACC 9.00% 9.00%
Enterprise value 393.75 1 196.882
Less: Existing Debt -200.00 -100.00
Equity Value 193.75 96.88
Number of shares outstanding (crore) 5 5
Value per share (Equity Value/ Number of Shares)(Rs) 38.75 19.38
Exchange Ratio (shares of Alcazar per Tapioca share) 0.5
If Alcazar anticipates the merger to result in synergies with a present value of Rs. 40
crores, the combined entity would be worth Rs. 330.63 crores. The best offer Alcazar
could make is to pay Tapioca shareholders (96.88 + 40) = Rs. 136.88 crores, which
would value each Tapioca share at Rs. 27.38. This translates to an exchange ratio of 0.71
Alcazar shares per Tapioca share.
If Tapioca is assumed to have a constant debt of Rs. 100 crores in perpetuity, Loch Lomond should
use the APV method to value Tapioca shares.
rA for Tapioca would be rE(E/V) + rD(D/V) = 12% x 0.5 + 8% x 0.5 = 10%
The base case NPV (all equity NPV) of Tapioca would be EBIAT1/(rA – g) = 7.88/ (10% - 5%) =
Rs. 157.6 crores
The present value of Tapioca’s tax shield would be Rs. 100 crores x 25% = Rs. 25 crores
Therefore, the APV of Tapioca would be Rs. 182.6 crores.
Therefore, the equity value of Tapioca would be Rs. 82.6 crores i.e. Rs. 16.52 per share.
This translates to an exchange ratio of 0.43 Alcazar shares per Tapioca share.
1
Next year’s EBIAT1/ (WACC – g). Note that (Depreciation – Capex) is zero and ΔWC is zero.
2
Next year’s EBIAT1/ (WACC – g). Note that (Depreciation – Capex) is zero and ΔWC is zero.
4. Details relating to two companies for the financial year ended March 31, 2019 are given below,
Mealey Limited Bryers Limited
Sales (Rs. crores) 3,000 1,500
Operating Expenses1 as a %age of 87% 88%
Revenues
Depreciation (Rs. crores) 200 75
Tax Rate 35% 35%
Working Capital 10% of Sales 10% of Sales
Outstanding Debt (Rs. crores) 160 250
Credit Rating AAA AA
Interest rate 8% 9%
1
- Excludes depreciation
Sales and EBIT of both companies are projected to grow at 5% p.a. to perpetuity. Capital
expenditure can be assumed to be equal to depreciation. The beta of the equity of both companies
is 1. The yield on long term government securities is 7%, while the market risk premium is 7%.
Mealey and Bryers have targeted debt-equity ratios of 0.13 and 0.35 respectively. (Note: These are
targeted debt-equity ratios and not the current debt-equity ratios.)
The merger is expected to result in reduction in the operating expenses of the combined entity
(Mealey Bryers Limited) to 86% of total revenues. The merged entity is also expected to have an
equity beta of 1 and a target debt-equity ratio of 0.17. Also, the merged entity would have a credit
rating of AA.
Estimate the following as on 1 April, 2019. (Hint: Compute free cash flows to firm and discount
at a suitable rate)
a) Enterprise Value of Mealey (Rs. crores)
b) Enterprise Value of Bryers (Rs. crores)
c) Enterprise Value of Mealey Bryers (post merger) (Rs. crores)
Rs. crore
Mealey - 2020 Bryers - 2020 Mealey-Bryers
-2020
Sales & EBIT growth % 5.0% 5.0% 5.0%
Sales 3,150.0 1,575.0 4,725.0
Opex%Sales 87.0% 88.0% 86.0%
Operating Expenses 2,740.5 1,386.0 4,063.5
EBITDA 409.5 189.0 661.5
Depreciation 210.0 78.8 288.8
EBIT 199.5 110.3 372.8
Tax rate 35.0% 35.0% 35.0%
EBIAT 129.7 71.7 242.3
Add: Depreciation 210 78.8 288.8
Less: Capital expenditure 210 78.8 288.8
NWC%Sales 10.0% 10.0% 10.0%
Change in WC (15.0) (7.5) (22.5)
FCFF for YE 31 Mar 2020 114.7 64.2 219.8
re 14.0% 14.0% 14.0%
rd 8.0% 9.0% 9.0%
DER 0.13 0.35 0.17
WACC 12.99% 11.89% 12.82%
Enterprise Value as on 1 Apr 2019 1,435.7 931.6 2,812.1
5. Company R is in the business of manufacturing doodads while Company S is in the business of
manufacturing thingamajigs. The two companies plan to merge in an all-stock transaction. Details
of the two companies are given below.
Company R Company S
EBITDA (TTM) Rs. 18 crores Rs. 24 crores
Debt Rs. 30 crores Rs. 80 crores
Number of equity shares 5 crore 10 crore
outstanding
In addition to its operating assets, Company R holds real estate which is estimated to have a market
value of Rs. 20 crores. Company S holds surplus cash and cash equivalents of Rs. 40 crores.
The industry average EV/ EBITDA (TTM) ratio for doodad manufacturing companies is 5 while
that for thingamajig manufacturers is 10.
Using the EV/ EBITDA ratios and other details provided, estimate a suitable share exchange ratio
for the merger. Assume there are no merger gains or merger costs.
Equity Value of Company R
= Average EV/EBITDA of doodad manufacturers x EBITDA of R + Value of real estate – Value
of Debt
= 5 x 18 + 20 – 30 = Rs. 80 crores i.e. 80/5 = Rs. 16 per share
Equity Value of Company S
= Average EV/EBITDA of thingamajig manufacturers x EBITDA of S + Value of surplus cash –
Value of Debt
= 10 x 24 + 40 – 80 = Rs. 200 crores i.e. 200/10 = Rs. 20 per share
Therefore, the exchange ratio would be 20/16 i.e. 1.25 equity shares of R for every equity share
of S or 5 equity shares of R for every 4 equity shares of S.