CHAPTER 13

Merger, Acquisition & Restructuring

BASIC CONCEPTS AND FORMULAE
1. Introduction
The terms ‘mergers’, ‘acquisitions’ and ‘takeovers’ are often used interchangeably in
common parlance. However, there are differences. While merger means unification of
two entities into one, acquisition involves one entity buying out another and absorbing the
same. In India, in legal sense merger is known as ‘Amalgamation’.
2. Reconstruction
Reconstruction involves the winding-up of an existing company and transfer of its asset
and liabilities to a new company formed to take the place of the existing company. In the
result, the same shareholders who agree to take equivalent shares in the new company
carry on the same enterprise through the medium of a new company.
3. Amalgamation or Merger
“Generally, where only one company is involved in a scheme and the rights of the
shareholders and creditors are varied, it amounts to reconstruction or reorganisation or
scheme of arrangement. In an amalgamation, two or more companies are fused into one by
merger or by one taking over the other. Amalgamation is a blending of two or more existing
undertakings into one undertaking, the shareholders of each blending company become
substantially the shareholder of the company which is to carry on the blended undertaking.
4. Types of Mergers
(a) Horizontal merger: The two companies which have merged are in the same
industry, normally the market share of the new consolidated company would be
larger and it is possible that it may move closer to being a monopoly or a near
monopoly.
(b) Vertical merger: It means the merger of two companies which are in different field
altogether, the coming together of two concerns may give rise to a situation similar
to a monopoly.
(c) Reverse merger- Where, in order to avail benefit of carry forward of losses which are
available according to tax law only to the company which had incurred them, the profit
making company is merged with companies having accumulated losses.
(d) Conglomerate Mergers- Such mergers involve firms engaged in unrelated type of
business operations. In other words, the business activities of acquirer and the
target are not related to each other horizontally (i.e. producing the same or

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competiting products) nor vertically (having relationship of buyer and supplier). In a

pure conglomerate merger, there are no important common factors between the
companies in production, marketing, research and development and technology.
(e) Congeneric Merger- In these mergers, the acquirer and the target companies are
related through basic technologies, production processes or markets. The acquired
company represents an extension of product-line, market participants or
technologies of the acquirer. These mergers represent an outward movement by the
acquirer from its current business scenario to other related business activities.
5. Reasons and Rationale for Mergers and Acquisitions
The most common reasons for Mergers and Acquisition (M&A) are:
• Synergistic operating economies;
• Diversification;
• Taxation;
• Growth; and
• Consolidation of production capacities and increasing market power.
6. Gains from Mergers or Synergy
The first step in merger analysis is to identify the economic gains from the merger. There
are gains, if the combined entity is more than the sum of its parts. That is, Combined
value > (Value of acquirer + Stand alone value of target).
The difference between the combined value and the sum of the values of individual
companies is usually attributed to synergy.
Value of acquirer + Stand alone value of target + Value of synergy = Combined value
7. Principal Steps in a Successful M & A Program
• Manage the pre-acquisition phase;
• Screen candidates;
• Eliminate those who do not meet the criteria and value the rest;
• Negotiate; and
• Post-merger integration.
8. Problems for M & A in India
• Indian corporates are largely promoter-controlled and managed.
• In some cases, the need for prior negotiations and concurrence of financial
institutions and banks is an added rider, besides SEBI’s rules and regulations.
• The reluctance of financial institutions and banks to fund acquisitions directly.

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• The BIFR route, although tedious, is preferred for obtaining financial concessions.
• Lack of exit policy for restructuring/downsizing.
• Absence of efficient capital market system makes the market capitalisation not fair in
some cases.
• Valuation is still evolving in India.
9. Mergers in Specific Sectors
The Companies Act, 1956 and the SEBI’s Takeover Code are the general source of
guidelines governing mergers. There are sector specific legislative provisions, which to a
limited extent empower the regulator to promote competition. Mergers in the banking
sector require approval from the RBI.
10. Acquisitions and Takeover
Acquisition refers to the purchase of controlling interest by one company in the share
capital of an existing company. When a company is acquired by another company, the
acquiring company has two choices either to merge both the companies into one and
function as a single entity and another is to operate the company as an independent
entity with changed management and policies. The first one is termed as ‘Merger’,
whereas the second one is known as ‘Takeover’.
11. The Evolution of Takeovers, Principles and Enforcement–The Indian Scenario
There are basically two major modes of takeover which are prevalent in India- Takeover
through direct negotiations with Financial Institutions and Takeover by acquisition of
adequate shareholding. Acquisition or Takeover may be by way of:
(i) Acquisition of company’s shares.
(ii) Acquisition of business assets (ABOs).
(iii) Acquisition of brand’s.
(iv) Acquisition of Companies by Friendly vs. Hostile takeover.
(v) Reverse acquisition.
12. Takeover Strategies
Other than tender offer, the acquiring company can also use the following techniques:
• Street Sweep: It refers to the technique where the acquiring company accumulates
large number of shares in a target company before making an open offer.
• Bear Hug: When the acquirer threatens the target company to make an open offer,
the board of the target company agrees to a settlement with the acquirer for change
of control.
• Strategic Alliance: This involves disarming the acquirer by offering a partnership
rather than a buyout. The acquirer asserts control from within and takes over the

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 Merger, Acquisition & Restructuring 13.4

target company.
• Brand Power: This refers to entering into an alliance with powerful brands to displace
the target’s brands and as a result, buyout the weakened company.
13. Takeover by Reverse Bid
In a 'reverse takeover', a smaller company gains control of a larger one. The concept of
takeover by reverse bid, or of reverse merger, is thus not the usual case of amalgamation
of a sick unit which is non-viable with a healthy or prosperous unit but is a case whereby
the entire undertaking of the healthy and prosperous company is to be merged and
vested in the sick company which is non-viable.
14. The Acquisition Process
The acquisition process involves the following five essential stages:
(i) Competitive analysis;
(ii) Search and screen;
(iii) Strategy development;
(iv) Financial evaluation; and
(v) Negotiation.
15. Defending a Company in a Takeover Bid
Due to the prevailing guidelines, the target company without the approval of the
shareholder cannot resort to any issuance of fresh capital or sale of assets etc., and also
due to the necessity of getting approvals from various authorities. Thus, the target
company cannot refuse transfer of shares without the consent of shareholders in a
general meeting.
A target company can adopt a number of tactics to defend itself from hostile takeover
through a tender offer.
• Divestiture;
• Crown jewels;
• Poison pill;
• Poison Put;
• Greenmail;
• White knight ;
• White squire;
• Golden parachutes ; and
• Pac-man defense.

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16. Legal Aspects of M & As

Merger control requirements in India are currently governed by the provisions of the
Companies Act, 1956 and the Securities and Exchange Board of India (Substantial
Acquisition of Shares and Takeovers) Regulations, 1997. (“the takeover code”). Other
statutes which govern merger proposals are the Industries (Development and Regulation)
Act, 1951; the Foreign Exchange Management Act, 2000, the Income Tax Act, 1961 and
the SEBI Act, 1992.
17. Due Diligence
Due diligence means research. Its purpose in M&A is to support the valuation process,
arm negotiators, test the accuracy of representations and warranties contained in the
merger agreement, fulfill disclosure requirements to investors, and inform the planners of
post-merger integration.
A due diligence process should focus at least on the following issues:
• Legal issues;
• Financial and tax issues;
• Marketing issues;
• Cross-border issues; and
• Cultural and ethical issues.
18. Target Valuation for M & A
The value of a business is a function of the business logic driving the M&A and is based
on bargaining powers of buyers and sellers. Thorough due diligence has to be exercised
in deciding the valuation parameters since these parameters would differ from sector to
sector and company to company. Some methods of valuation are:
(a) Earnings based valuation (discounted cash-flow being the most common
technique) takes into consideration the future earnings of the business and hence
the appropriate value depends on projected revenues and costs in future, expected
capital outflows, number of years of projection, discounting rate and terminal value
of business.
(b) In a cost to create approach, the cost for building up the business from scratch is
taken into consideration and the purchase price is typically the cost plus a margin.
(c) While using the market based valuation for unlisted companies, comparable listed
companies have to be identified and their market multiples (such as market
capitalizations to sales or stock price to earnings per share) are used as surrogates
to arrive at a value.
(d) The asset based value considers either the book value (assets net liabilities) or the
net adjusted value (revalued net assets). If the company has intangible assets like

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 Merger, Acquisition & Restructuring 13.6

brands, copyrights, intellectual property etc., these are valued independently and
added to the net asset value to arrive at the business value.
19. Corporate Restructuring
Restructuring of business is an integral part of modern business enterprises.
Restructuring usually involves major organizational changes such as shift in corporate
strategies. Restructuring can be internally in the form of new investments in plant and
machinery, Research and Development of products and processes, hiving off of non-core
businesses, divestment, sell-offs, de-merger etc. Restructuring can also take place
externally through mergers and acquisitions (M&A) and by forming joint-ventures and
having strategic alliances with other firms. The aspects relating to expansion or
contraction of a firm’s operations or changes in its assets or financial or ownership
structure are known as corporate re-structuring.
20. Reasons for Demerger/Divestment
There are various reasons for divestment or demerger viz.
(i) To pay attention on core areas of business;
(ii) The division’s/business may not be sufficiently contributing to the revenues;
(iii) The size of the firm may be too big to handle; and
(iv) The firm may be requiring cash urgently in view of other investment opportunities.
21. Different Ways of Divestment or Demerger
(a) Sell off: A sell off is the sale of an asset, factory, division, product line or subsidiary
by one entity to another for a purchase consideration payable either in cash or in
the form of securities.
(b) Spin-off: In this case, a part of the business is separated and created as a separate
firm.
(c) Split-up: This involves breaking up of the entire firm into a series of spin off (by
creating separate legal entities). The parent firm no longer legally exists and only
the newly created entities survive.
(d) Carve outs: This is like spin off however; some shares of the new company are
sold in the market by making a public offer, so this brings cash. In carve out, the
existing company may sell either majority stake or minority stake, depending upon
whether the existing management wants to continue to control it or not.
(e) Sale of a Division: In the case of sale of a division, the seller company is
demerging its business whereas the buyer company is acquiring a business.
22. Corporate Controls
(a) Going Private: This refers to the situation wherein a listed company is converted

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into a private company by buying back all the outstanding shares from the markets.
(b) Equity buyback: This refers to the situation wherein a company buys back its own
shares from the market. This results in reduction in the equity capital of the
company. This strengthens the promoter’s position by increasing his stake in the
equity of the company.
(c) Restructuring of an existing business: It may involve, for instance, downsizing
and closing down of some unprofitable departments. May also include trimming the
number of personnel.
(d) Buy-outs: This is also known as Management buyouts (MBO). In this case, the
management of the company buys a particular part of the business from the firm
and then incorporates the same as a separate entity.
(e) Management buy-ins: They are a similar form of transaction but differ in the sense
that the entrepreneurs leading the transaction come from outside the company. The
Buy-ins is a hybrid form involving both existing and new managements.
23. Financial Restructuring
Financial restructuring refers to a kind of internal changes made by the management in
assets and liabilities of a company with the consent of its various stakeholders. This is a
suitable mode of restructuring for corporate entities who have suffered from sizeable
losses over a period of time. For such firms a plan of restructuring needs to be
formulated involving a number of legal formalities (which includes consent of court, and
other stake-holders viz., creditors, lenders and shareholders etc.).
24. Merger Failures or Potential Adverse Competitive Effects
The reasons for merger failures can be numerous. Some of the key reasons are:
• Acquirers generally overpay;
• The value of synergy is over-estimated;
• Poor post-merger integration; and
• Psychological barriers.
Most companies merge with the hope that the benefits of synergy will be realised.
Synergy will be there only if the merged entity is managed better after the acquisition
than it was managed before. Therefore, to make a merger successful, companies may
follow the steps listed as under:
• Decide what tasks need to be accomplished in the post-merger period;
• Choose managers from both the companies (and from outside);
• Establish performance yardstick and evaluate the managers on that yardstick; and
• Motivate them.

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25. Maximum Purchase Consideration

Maximum purchase consideration is value of vendor’s business from the viewpoint of the
purchaser. This is given by present value incremental cash flow accruing to the
purchaser on acquisition of vendor’s business. Some important points to be noted in this
regard are:
• The discounting rate represents the rate of return desired from the operating
activities.
• The operating cash flow of a business is the aggregate of cash flows generated by
the operating assets.
• The acquisition of business can give rise to certain additional liabilities.
• In theory, a business has infinite life. However, in reality it is very difficult to project
cash flows to eternity. It is, therefore, usual to assume that the business shall be
disposed off after the forecast period. The expected disposal value of the business,
called the terminal or horizon value is a cash flow in the terminal year. The present
value of terminal value is added with the present value of operating cash flows.
26. Acquiring for Shares
The acquirer can pay the target company in cash or exchange shares in consideration.
The analysis of acquisition for shares is slightly different. The steps involved in the
analysis are:
Estimate the value of acquirer’s (self) equity;
• Estimate the value of target company’s equity;
• Calculate the maximum number of shares that can be exchanged with the target
company’s shares; and
• Conduct the analysis for pessimistic and optimistic scenarios.
Exchange ratio is the number of acquiring firm’s shares exchanged for each share of the
selling firm’s stock. Suppose company A is trying to acquire company B’s 100,000 shares
at `230. So the cost of acquisition is ` 230,00,000. Company A has estimated its value
at `200 per share. To get one share of company B, A has to exchange (230/200) 1.15
share, or 115,000 shares for 100,000 shares of B. The relative merits of acquisition for
cash or shares should be analysed after giving due consideration to the impact on EPS,
capital structure, etc.
27. Impact of Price- Earnings Ratio
The reciprocal of cost of equity is price-earning (P/E) ratio. The cost of equity, and
consequently the P/E ratio reflects risk as perceived by the shareholders. The risk of
merging entities and the combined business can be different. In other words, the
combined P/E ratio can very well be different from those of the merging entities. Since

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market value of a business can be expressed as product of earning and P/E ratio (P/E x
E = P), the value of combined business is a function of combined earning and combined
P/E ratio. A lower combined P/E ratio can offset the gains of synergy or a higher P/E ratio
can lead to higher value of business, even if there is no synergy. In ascertaining the
exchange ratio of shares due care should be exercised to take the possible combined
P/E ratio into account.

Question 1
Explain the term “Demerger”.   
Answer
Demerger: The word ‘demerger’ is defined under the Income-tax Act, 1961. It refers to a situation
where pursuant to a scheme for reconstruction/restructuring, an ‘undertaking’ is transferred or sold
to another purchasing company or entity. The important point is that even after demerger; the
transferring company would continue to exist and may do business.
Demerger is used as a suitable scheme in the following cases:
• Restructuring of an existing business
• Division of family-managed business
• Management ‘buy-out’.
While under the Income tax Act there is recognition of demerger only for restructuring as provided
for under sections 391 – 394 of the Companies Act, in a larger context, demerger can happen in
other situations also.
Question 2
Explain the term 'Buy-Outs'.
Answer
A very important phenomenon witnessed in the Mergers and Acquisitions scene, in recent times is
one of buy - outs. A buy-out happens when a person or group of persons gain control of a
company by buying all or a majority of its shares. A buyout involves two entities, the acquirer and
the target company. The acquirer seeks to gain controlling interest in the company being acquired
normally through purchase of shares. There are two common types of buy-outs: Leveraged
Buyouts (LBO) and Management Buy-outs (MBO). LBO is the purchase of assets or the equity of a
company where the buyer uses a significant amount of debt and very little equity capital of his own
for payment of the consideration for acquisition. MBO is the purchase of a business by its
management, who when threatened with the sale of its business to third parties or frustrated by the
slow growth of the company, step-in and acquire the business from the owners, and run the
business for themselves. The majority of buy-outs is management buy-outs and involves the
acquisition by incumbent management of the business where they are employed. Typically, the

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purchase price is met by a small amount of their own funds and the rest from a mix of venture
capital and bank debt.
Internationally, the two most common sources of buy-out operations are divestment of parts of
larger groups and family companies facing succession problems. Corporate groups may seek to
sell subsidiaries as part of a planned strategic disposal programme or more forced reorganisation
in the face of parental financing problems. Public companies have, however, increasingly sought to
dispose of subsidiaries through an auction process partly to satisfy shareholder pressure for value
maximisation.
In recessionary periods, buy-outs play a big part in the restructuring of a failed or failing businesses
and in an environment of generally weakened corporate performance often represent the only
viable purchasers when parents wish to dispose of subsidiaries.
Buy-outs are one of the most common forms of privatisation, offering opportunities for enhancing
the performances of parts of the public sector, widening employee ownership and giving managers
and employees incentives to make best use of their expertise in particular sectors.
Question 3
What is take over by reverse bid?
Answer
Generally, a big company takes over a small company. When the smaller company
gains control of a larger one then it is called “Take-over by reverse bid”. In case of
reverse take-over, a small company takes over a big company. This concept has been
successfully followed for revival of sick industries.
The acquired company is said to be big if any one of the following conditions is
satisfied:
(i) The assets of the transferor company are greater than the transferee company;
(ii) Equity capital to be issued by the transferee company pursuant to the acquisition
exceeds its original issued capital, and
(iii) The change of control in the transferee company will be through the introduction
of minority holder or group of holders.
Reverse takeover takes place in the following cases:
(1) When the acquired company (big company) is a financially weak company
(2) When the acquirer (the small company) already holds a significant proportion of
shares of the acquired company (small company)
(3) When the people holding top management positions in the acquirer company want
to be relived off of their responsibilities.

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The concept of take-over by reverse bid, or of reverse merger, is thus not the usual case of
amalgamation of a sick unit which is non-viable with a healthy or prosperous unit but is a
case whereby the entire undertaking of the healthy and prosperous company is to be
merged and vested in the sick company which is non-viable.
Question 4
Write a short note on Financial restructuring
Answer
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. Can some of these Firms be revived? Financial
restructuring is one such a measure for the revival of only those firms that hold prom-
ise/prospects for better financial performance in the years to come. To achieve the desired
objective, 'such firms warrant / merit 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.
Question 5
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 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 ` 15. B Ltd. has 5,00,000 shares in
issue with a share price of ` 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 `12. Assume the price of B Ltd. shares remains constant.
Answer
Total market value of C Ltd is = 1,00,000 x ` 15 = ` 15,00,000
PE ratio (given) = 10
Therefore , earnings = ` 15,00,000 /10
= ` 1,50,000
Total market value of B Ltd. is = 5,00,000 x ` 12 = ` 60,00,000
PE ratio ( given) = 17

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Therefore, earnings = ` 60,00,000/17

= ` 3,52,941
The number of shares to be issued by B Ltd.
` 15,00,000 ÷ 12 = 1,25,000
Total number of shares of B Ltd = 5,00,000 + 1,25,000 = 6,25,000
The EPS of the new firm is = (` 3,52,941+`1,50,000)/6,25,000
= Re. 0.80
The present EPS of B Ltd is = ` 3,52,941 /5,00,000
= Re. 0.71
So the EPS affirm B will increase from Re. 0.71 to ` 0.80 as a result of merger.
Question 6
ABC Company is considering acquisition of XYZ Ltd. which has 1.5 crores shares outstanding
and issued. The market price per share is ` 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).
Answer
VALUATION BASED ON MARKET PRICE
Market Price per share ` 400
Thus value of total business is (` 400 x 1.5 Cr.) ` 600 Cr.
VALUATION BASED ON DISCOUNTED CASH FLOW
Present Value of cash flows
(` 250 cr x 0.893) + (` 300 cr. X 0.797) + ( ` 400 cr. X 0.712 ) = ` 747.15 Cr.
Value of per share (` 747.15 Cr. / 1.5 Cr) ` 498.10 per share

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RANGE OF VALUATION
Per Share Total
` ` Cr.
Minimum 400.00 600.00
Maximum 498.10 747.15
Question 7
MK Ltd. is considering acquiring NN Ltd. The following information is available:
Company Earning after No. of Equity Shares Market Value
tax(`) Per Share(`)
MK Ltd. 60,00,000 12,00,000 200.00
NN Ltd. 18,00,000 3,00,000 160.00
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 MK Ltd. after merger, and
(ii) Find the exchange ratio so that shareholders of NN Ltd. would not be at a loss.
Answer
(i) Earning per share of company MK Ltd after merger:-
Exchange ratio 160 : 200 = 4 : 5.
that is 4 shares of MK Ltd. for every 5 shares of NN Ltd.
∴Total number of shares to be issued = 4/5 × 3,00,000 = 2,40,000 Shares.
∴Total number of shares of MK Ltd. and NN Ltd.=12,00,000 (MK Ltd.)+2,40,000 (NN Ltd.)
= 14,40,000 Shares
Total profit after tax = ` 60,00,000 MK Ltd.
= ` 18,00,000 NN Ltd.
= ` 78,00,000
∴ EPS. (Earning Per Share) of MK Ltd. after merger
` 78,00,000/14,40,000 = ` 5.42 per share
(ii) To find the exchange ratio so that shareholders of NN Ltd. would not be at a Loss:
Present earning per share for company MK Ltd.
= ` 60,00,000/12,00,000 = ` 5.00
Present earning per share for company NN Ltd.

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= ` 18,00,000/3,00,000 = ` 6.00
∴ Exchange ratio should be 6 shares of MK Ltd. for every 5 shares of NN Ltd.
∴ Shares to be issued to NN Ltd. = 3,00,000 × 6/5 = 3,60,000 shares
Now, total No. of shares of MK Ltd. and NN Ltd. =12,00,000 (MK Ltd.)+3,60,000 (NN Ltd.)
= 15,60,000 shares
∴ EPS after merger = ` 78,00,000/15,60,000 = ` 5.00 per share
Total earnings available to shareholders of NN Ltd. after merger = 3,60,000 shares × `
5.00 = ` 18,00,000.
This is equal to earnings prior merger for NN Ltd.
∴ Exchange ratio on the basis of earnings per share is recommended.
Question 8
A Ltd. wants to acquire T Ltd. and has offered a swap ratio of 1:2 (0.5 shares for every
one share of T Ltd.). Following information is provided:

A Ltd. T. Ltd.
Profit after tax ` 18,00,000 ` 3,60,000
Equity shares outstanding (Nos.) 6,00,000 1,80,000
EPS `3 `2
PE Ratio 10 times 7 times
Market price per share ` 30 ` 14

Required:
(i) The number of equity shares to be issued by A Ltd. for acquisition of T Ltd.
(ii) What is the EPS of A Ltd. after the acquisition?
(iii) Determine the equivalent earnings per share of T Ltd.
(iv) What is the expected market price per share of A Ltd. after the acquisition, assuming its
PE multiple remains unchanged?
(v) Determine the market value of the merged firm.
Answer
(a) (i) The number of shares to be issued by A Ltd.:
The Exchange ratio is 0.5
So, new Shares = 1,80,000 x 0.5 = 90,000 shares.

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(ii) EPS of A Ltd. After a acquisition:

Total Earnings (` 18,00,000 + ` 3,60,000) `21,60,000
No. of Shares (6,00,000 + 90,000) 6,90,000
EPS (` 21,60,000)/6,90,000) `3.13
(iii) Equivalent EPS of T Ltd.:
No. of new Shares 0.5
EPS `3.13
Equivalent EPS (` 3.13 x 0.5) `1.57
(iv) New Market Price of A Ltd. (P/E remaining unchanged):
Present P/E Ratio of A Ltd. 10 times
Expected EPS after merger `3.13
Expected Market Price (`3.13 x 10) `31.30
(v) Market Value of merged firm:
Total number of Shares 6,90,000
Expected Market Price `31.30
Total value (6,90,000 x 31.30) `2,15,97,000
Question 9
ABC Ltd. is intending to acquire XYZ Ltd. by merger and the following information is
available in respect of the companies:
ABC Ltd. XYZ Ltd.
Number of equity shares 10,00,000 6,00,000
Earnings after tax ( ` ) 50,00,000 18,00,000
Market value per share ( ` ) 42 28

Required:
(i) What is the present EPS of both the companies?
(ii) If the proposed merger takes place, what would be the new earning per share for ABC
Ltd.? Assume that the merger takes place by exchange of equity shares and the
exchange ratio is based on the current market price.
(iii) What should be exchange ratio, if XYZ Ltd. wants to ensure the earnings to members are
as before the merger takes place?
Answer
(i) Earnings per share = Earnings after tax /No. of equity shares

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ABC Ltd. = ` 50,00,000/10,00,000 = ` 5

XYZ Ltd. = ` 18,00,000 / 6,00,000 = ` 3
(ii) Number of Shares XYZ limited’s shareholders will get in ABC Ltd. based on market
value per share = ` 28/ 42 × 6,00,000 = 4,00,000 shares
Total number of equity shares of ABC Ltd. after merger = 10,00,000 + 4,00,000 =
14,00,000 shares
Earnings per share after merger = ` 50,00,000 + 18,00,000/14,00,000 = ` 4.86
(iii) Calculation of exchange ratio to ensure shareholders of XYZ Ltd. to earn the same
as was before merger:
Shares to be exchanged based on EPS = (` 3/` 5) × 6,00,000 = 3,60,000 shares
EPS after merger = (` 50,00,000 + 18,00,000)/13,60,000 = ` 5
Total earnings in ABC Ltd. available to shareholders of XYZ Ltd. = 3,60,000 × ` 5 =
` 18,00,000.
Thus, to ensure that Earning to members are same as before, the ratio of exchange should be 0.6
share for 1 share.
Question 10
XYZ Ltd., is considering merger with ABC Ltd. XYZ Ltd.’s shares are currently traded at ` 20.
It has 2,50,000 shares outstanding and its earnings after taxes (EAT) amount to ` 5,00,000.
ABC Ltd., has 1,25,000 shares outstanding; its current market price is ` 10 and its EAT are `
1,25,000. The merger will be effected 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?
Answer
(i) Pre-merger EPS and P/E ratios of XYZ Ltd. and ABC Ltd.
Particulars XYZ Ltd. ABC Ltd.
Earnings after taxes 5,00,000 1,25,000
Number of shares outstanding 2,50,000 1,25,000

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 13.17 Strategic Financial Management

EPS 2 1
Market Price per share 20 10
P/E Ratio (times) 10 10

(ii) Current Market Price of ABC Ltd. if P/E ratio is 6.4 = ` 1 × 6.4 = ` 6.40
` 20
Exchange ratio = = 3.125
` 6.40
Post merger EPS of XYZ Ltd.
` 5,00,000 + ` 1,25,000
=
2,50,000 + (1,25,000/ 3.125)
` 6,25,000
= = 2.16
2,90,000
(iii) Desired Exchange Ratio
Total number of shares in post-merged company
Post - merger earnings ` 6,25,000
= = = 3,12,500
Pre - merger EPS of XYZ Ltd 2

Number of shares required to be issued

= 3,12,500 – 2,50,000 = 62,500
Therefore, the exchange ratio is
62,500 : 1,25,000
62,500
= = 0.50
1,25,000
Question 11
Company X is contemplating the purchase of Company Y. Company X has 3,00,000 shares
having a market price of ` 30 per share, while Company Y has 2,00,000 shares selling at ` 20
per share. The EPS are ` 4.00 and ` 2.25 for Company X and Y respectively. Managements
of both companies are discussing two alternative proposals for exchange of shares as
indicated below:
(i) In proportion to the relative earnings per share of two companies.
(ii) 0.5 share of Company X for one share of Company Y (0.5 : 1).
You are required:
(i) To calculate the Earnings Per Share (EPS) after merger under two alternatives; and

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 Merger, Acquisition & Restructuring 13.18

(ii) To show the impact on EPS for the shareholders of two companies under both the
alternatives.
Answer
(i) Mergers effect on EPS
(Exchange ratio in proportion to relative EPS)
(in ` )
Company Existing No. of shares EPS Total earnings
X 3,00,000 4.00 12,00,000
Y 2,00,000 2.25 4,50,000
Total earnings 16,50,000

No. of shares after merger 3,00,000 + 1,12,500 = 4,12,500

⎛ 2.25 ⎞
Note: 1,12,500 may be calculated as = ⎜ 2,00,000 × ⎟
⎝ 4.00 ⎠
16,50,000
EPS for Co. X after merger = = ` 4.00
4,12,500
Equivalent EPS of Co. Y
Before merger ` 2.25
After merger (EPS before merger ÷ Share exchange ratio on EPS basis)
2.25 ÷ 0.5625 = ` 4.00
Merger effect on EPS with share exchange ratio of 0.5 : 1
Total earnings after merger ` 16,50,000
No. of shares post merger (3,00,000 + 1,00,000 (0.5 × 2,00,000) 4,00,000
EPS 16,50,000 ÷ 4,00,000 4.125
(ii) Impact on EPS
Co. X’ shareholders `
EPS before merger 4.00
EPS after merger i.e. (16,50,000 ÷ 4,00,000) 4.125
Increase in EPS 0.125

Co. Y' Shareholders

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 13.19 Strategic Financial Management

Equivalent EPS before merger 2.25 ÷ 0.5 4.5

EPS after the merger 4.125
Decrease in EPS 0.375
Question 12
K. Ltd. is considering acquiring N. Ltd., the following information is available :
Company Profit after Tax Number of Equity Market value per
shares 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 :
Find the earning per share for company K. Ltd. after merger.
Find the exchange ratio so that shareholders of N. Ltd. would not be at a loss.
Answer
(i) Earning per share for company K. Ltd. after Merger:
Exchange Ratio 160 : 200 = 4: 5
That is 4 shares of K. Ltd. for every 5 shares of N. Ltd.
4
∴ Total number of shares to be issued = × 2,50,000 = 2,00,000 shares
5
∴ Total number of shares of K. Ltd. and N .Ltd. = 10,00,000 K. Ltd.
+ 2,00,000 N. Ltd
12,00,000
Total profit after Tax = ` 50,00,000 K. Ltd.
` 15,00,000 N Ltd.
` 65,00,000
∴ E.P.S. (Earning per share) of K. Ltd. after Merger
` 65,00,000
= = ` 5.42 Per Share
12,00,000
(ii) To find the Exchange Ratio so that shareholders of N. Ltd. would not be at a Loss:
Present Earnings per share for company K. Ltd.

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 Merger, Acquisition & Restructuring 13.20

` 50,00,000
= =` 5.00
` 10,00,000
Present Earnings Per share for company N. Ltd.
` 15,00,000
= =` 6.00
` 2,50,000
∴ Exchange Ratio should be 6 shares of K. Ltd. for every 5 shares of N Ltd.
∴ Shares to be issued to N. Ltd.
2,50,000 × 6
= = 3,00,000 Shares
5
∴ Total No. of Shares of [Link]. and N. Ltd.
= 10,00,000 K. Ltd.
+ 3,00,000 N. Ltd
13,00,000
65,00,000
∴ E.P.S. After Merger = ` 5.00 Per Share
13,00,000
Total Earnings Available to Shareholders of N. Ltd. after Merger
= ` 3,00,000 × ` 5.00 = ` 15,00,000
This is equal to Earnings prior Merger for N. Ltd.
∴ Exchange Ratio on the Basis of Earnings per Share is recommended.
Question 13
M Co. Ltd., is studying the possible acquisition of N Co. Ltd., by way of merger. The
following data are available in respect of the companies:
Particulars M Co. Ltd. N Co. Ltd.
Earnings after tax ( ` ) 80,00,000 24,00,000
No. of equity shares 16,00,000 4,00,000
Market value per share ( ` ) 200 160
(i) If the merger goes through by exchange of equity and the exchange ratio is based on the
current market price, what is the new earning per share for M Co. Ltd.?
(ii) N Co. Ltd. wants to be sure that the earnings available to its shareholders will not be
diminished by the merger. What should be the exchange ratio in that case?

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 13.21 Strategic Financial Management

Answer
(i) Calculation of new EPS of M Co. Ltd.
No. of equity shares to be issued by M Co. Ltd. to N Co. Ltd.
= 4,00,000 shares × ` 160/` 200 = 3,20,000 shares
Total no. of shares in M Co. Ltd. after acquisition of N Co. Ltd.
= 16,00,000 + 3,20,000 = 19,20,000
Total earnings after tax [after acquisition]
= 80,00,000 + 24,00,000 = 1,04,00,000
` 1,04,00,000
EPS = = ` 5.42
19,20,000 equity shares
(ii) Calculation of exchange ratio which would not diminish the EPS of N Co. Ltd. after
its merger with M Co. Ltd.
Current EPS:
` 80,00,000
M Co. Ltd. = =`5
16,00,000 equity shares
` 24,00,000
N Co. Ltd. = =`6
4,00,000 equity shares
Exchange ratio = 6/5 = 1.20
No. of new shares to be issued by M Co. Ltd. to N Co. Ltd.
= 4,00,000 × 1.20 = 4,80,000 shares
Total number of shares of M Co. Ltd. after acquisition
= 16,00,000 + 4,80,000 = 20,80,000 shares
` 1,04,00,000
EPS [after merger] = =`5
20,80,000 shares
Total earnings in M Co. Ltd. available to new shareholders of N Co. Ltd.
= 4,80,000 × ` 5 = ` 24,00,000
Recommendation: The exchange ratio (6 for 5) based on market shares is beneficial to
shareholders of 'N' Co. Ltd.
Question 14
The following information is provided related to the acquiring Firm Mark Limited and the
target Firm Mask Limited:

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 Merger, Acquisition & Restructuring 13.22

Firm Firm
Mark Limited Mask Limited
Earning after tax ( ` ) 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.
Answer
Particulars Mark Ltd. Mask Ltd.
EPS ` 2,000 Lakhs/ 200 lakhs ` 400 lakhs / 100 lakhs
= ` 10 `4
Market Price ` 10 × 10 = ` 100 ` 4 × 5 = ` 20
(i) The Swap ratio based on current market price is
` 20 / ` 100 = 0.2 or 1 share of Mark Ltd. for 5 shares of Mask Ltd.
No. of shares to be issued = 100 lakh × 0.2 = 20 lakhs.
(ii) EPS after merger
` 2,000 lakhs + ` 400 lakhs
= = ` 10.91
200 lakhs + 20 lakhs
(iii) Expected market price after merger assuming P / E 10 times.
= ` 10.91 × 10 = ` 109.10
(iv) Market value of merged firm
= ` 109.10 market price × 220 lakhs shares = 240.02 crores
(v) Gain from the merger
Post merger market value of the merged firm ` 240.02 crores
Less: Pre-merger market value

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 13.23 Strategic Financial Management

Mark Ltd. 200 Lakhs × ` 100 = 200 crores

Mask Ltd. 100 Lakhs × ` 20 = 20 crores ` 220.00 crores
Gain from merger ` 20.02 crores
Appropriation of gains from the merger among shareholders:
Mark Ltd. Mask Ltd.
Post merger value 218.20 crores 21.82 crores
Less: Pre-merger market value 200.00 crores 20.00 crores
Gain to Shareholders 18.20 crores 1.82 crores
Question 15
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. ` Lacs Dimple 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 ` 65 lacs and of Simple Ltd. is ` 460 lacs.
Calculate the expected value of debt and equity separately for the merged entity.
Answer
Compute Value of Equity
Simple Ltd.
` in Lacs
High Growth Medium Growth Slow Growth
Debit + Equity 820 550 410
Less: Debt 460 460 460
Equity 360 90 -50
Since the Company has limited liability the value of equity cannot be negative therefore the value
of equity under slow growth will be taken as zero because of insolvency risk and the value of debt
is taken at 410 lacs. The expected value of debt and equity can then be calculated as:

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 Merger, Acquisition & Restructuring 13.24

Simple Ltd.
` in Lacs
High Growth Medium Growth Slow Growth Expected Value
Prob. Value Prob. Value Prob. Value
Debt 0.20 460 0.60 460 0.20 410 450
Equity 0.20 360 0.60 90 0.20 0 126
820 550 410 576
Dimple Ltd.
` in Lacs
High Growth Medium Growth Slow Growth Expected Value
Prob. Value Prob. Value Prob. Value
Equity 0.20 985 0.60 760 0.20 525 758
Debt 0.20 65 0.60 65 0.20 65 65
1050 825 590 823
Expected Values
` in Lacs
Equity Debt
Simple Ltd. 126 Simple Ltd. 450
Dimple Ltd. 758 Dimple Ltd. 65
884 515
Question 16
Following information is provided relating to the acquiring company Mani Ltd. and the target
company Ratnam Ltd:
Mani Ltd. Ratnam Ltd.
Earnings after tax (` lakhs) 2,000 4,000
No. of shares outstanding (lakhs) 200 1,000
P/E ratio ( No. of times) 10 5
Required:
(i) What is the swap ratio based on current market prices?
(ii) What is the EPS of Mani Ltd. after the acquisition?

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 13.25 Strategic Financial Management

(iii) What is the expected market price per share of Mani Ltd. after the acquisition, assuming
its P/E ratio is adversely affected by 10%?
(iv) Determine the market value of the merged Co.
(v) Calculate gain/loss for the shareholders of the two independent entities, due to the
merger.
Answer
(i) SWAP ratio based on current market prices:
EPS before acquisition:
Mani Ltd. : `2,000 lakhs / 200 lakhs: `10
Ratnam Ltd.: `4,000 lakhs / 1,000 lakhs: ` 4
Market price before acquisition:
Mani Ltd.: `10 × 10 `100
Ratnam Ltd.: `4 × 5 ` 20
SWAP ratio: 20/100 or 1/5 i.e. 0.20
(ii) EPS after acquisition:
` (2,000 + 4, 000) Lakhs
= `15.00
(200 + 200) Lakhs
(iii) Market Price after acquisition:
EPS after acquisition : `15.00
P/E ratio after acquisition 10 × 0.9 9
Market price of share (` 15 X 9) `135.00
(iv) Market value of the merged Co.:
`135 × 400 lakhs shares ` 540.00 Crores
or ` 54,000 Lakhs
(v) Gain/loss per share:
` Crore
Mani Ltd. Ratnam Ltd.
Total value before Acquisition 200 200
Value after acquisition 270 270
Gain (Total) 70 70

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 Merger, Acquisition & Restructuring 13.26

No. of shares (pre-merger) (lakhs) 200 1,000

Gain per share (`) 35 7

Question 17
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:
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.
Answer
P Ltd. R Ltd.
Profit before Tax (` in crore) 15 13.50
Tax 30% (` in crore) 4.50 4.05
Profit after Tax (` in crore) 10.50 9.45
Earning per Share (` ) 10.50 9.45
= ` 0.42 = ` 0.63
25 15
Price of Share before Merger 0.42 x ` 12 = ` 5.04 0.63 x ` 9 = ` 5.67
(EPS x P/E Ratio)
(i) ∴Market Value of company
P Ltd. = ` 5.04 x 25 Crore = ` 126 crore
R Ltd. = ` 5.67 x 15 Crore = ` 85.05 crore
Combined = ` 126 + ` 85.05 = ` 211.05 Crores

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 13.27 Strategic Financial Management

After Merger
P Ltd. R Ltd.
No. of Shares 25 crores 4
15x = 12 crores
5
Combined 37 crores
% of Combined Equity Owned 25 12
x100 = 67.57% x100 = 32.43%
37 37
(ii) ∴ Value of Original Shareholders
P Ltd. R Ltd.
` 211.05 crore x 67.57% ` 211.05 crore x 32.43%
= ` 142.61 = ` 68.44
(iii) ∴ Price per Share after Merger
`19.95crore
EPS = = ` 0.539 per share
37crore
P/E Ratio = 12
Market Value Per Share = ` 0.539 X 12 = ` 6.47
Total Market Value = ` 6.47 x 37 crore = ` 239.39 crore
MarketValue 239.39 crore
Price of Share = = = ` 6.47
Number of Shares 37 crore

(iv) Effect on Share Price

P Ltd.
Gain/loss (-) per share = ` 6.47 – ` 5.04 = ` 1.43
6.47 − 5.04
i.e. × 100 = 0.284 or 28.4%
5.04
∴ Share price would rise by 28.4%
R Ltd.
4
6.47 x = ` 5.18
5
Gain/loss (-) per share = ` 5.18 – ` 5.67 = (-` 0.49)
5.18 − 5.67
i.e. × 100 (-) 0.0864 or (-) 8.64%
5.67
∴ Share Price would decrease by 8.64%.

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 Merger, Acquisition & Restructuring 13.28

Question 18
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. ` 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.
Answer
Swap Ratio Efficient Ltd. Healthy Ltd.
Market capitalisation 500 lakhs 750 lakhs
No. of shares 10 lakhs 7.5 lakhs
Market Price per share ` 50 ` 100
P/E ratio 10 5
EPS `5 ` 20
Profit ` 50 lakh ` 150 lakh
Share capital ` 100 lakh ` 75 lakh
Reserves and surplus ` 300 lakh ` 165 lakh
Total ` 400 lakh ` 240 lakh
Book Value per share ` 40 ` 32

(i) Calculation of Swap Ratio

EPS 1 : 4 i.e. 4.0 × 40% 1.6

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 13.29 Strategic Financial Management

Book value 1 : 0.8 i.e. 0.8 × 25% 0.2

Market price 1 : 2 i.e. 2.0 × 35% 0.7
Total 2.5
Swap ratio is for every one share of Healthy Ltd., to issue 2.5 shares of Efficient Ltd. Hence,
total no. of shares to be issued 7.5 lakh × 2.5 = 18.75 lakh shares
Promoter’s holding = 4.75 lakh shares + (5 × 2.5 = 12.5 lakh shares) = 17.25 lakh i.e.
Promoter’s holding % is (17.25 lakh/28.75 lakh) × 100 = 60%.
Calculation of EPS, Market price, Market capitalization and free float market capitalization.
(ii) Total No. of shares 10 lakh + 18.75 lakh = 28.75 lakh
Total capital 100 lakh + 187.5 lakh = ` 287.5 lakh
EPS Total profit 50 lakh + 150 lakh 200
= =
No. of shares 28.75 lakh 28.75
= ` 6.956
(iii) Expected market price EPS 6.956 × P/E 10 = ` 69.56
Market capitalization = ` 69.56 per share × 28.75 lakh shares
= ` 1,999.85 lakh
(iv) Free float of market capitalization = ` 69.56 per share × (28.75 lakh × 40%)
= ` 799.94 lakh
Question 19
Abhiman Ltd. is a subsidiary of Janam Ltd. and is acquiring Swabhiman Ltd. which is also a
subsidiary of Janam Ltd.
The following information is given :
Abhiman Ltd. Swabhiman Ltd.
% Shareholding of promoter 50% 60%
Share capital ` 200 lacs 100 lacs
Free Reserves and surplus ` 900 lacs 600 lacs
Paid up value per share ` 100 10
Free float market capitalization ` 500 lacs 156 lacs
P/E Ratio (times) 10 4
Janam Ltd., is interested in doing justice to both companies. The following parameters have been
assigned by the Board of Janam Ltd., for determining the swap ratio:
Book value 25%

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 Merger, Acquisition & Restructuring 13.30

Earning per share 50%

Market price 25%
You are required to compute
(i) The swap ratio.
(ii) The Book Value, Earning Per Share and Expected Market Price of Swabhiman Ltd.,
(assuming P/E Ratio of Abhiman ratio remains the same and all assets and liabilities of
Swabhiman Ltd. are taken over at book value.)
Answer
SWAP RATIO
Abhiman Ltd. Swabhiman Ltd.
(`) (`)
Share capital 200 lacs 100 lacs
Free reserves & surplus 900 lacs 600 lacs
Total 1100 lacs 700 lacs
No. of shares 2 lacs 10 lacs
Book value for share ` 550 ` 70
Promoters Holding 50% 60%
Non promoters holding 50% 40%
Free float market capitalization (Public) 500 lacs ` 156 lacs
Total Market Cap 1000 lacs 390 lacs
No. of shares 2 lacs 10 lacs
Market Price ` 500 ` 39
P/E ratio 10 4
EPS ` 50.00 ` 9.75
Calculation of SWAP Ratio
Book Value 1:0.1273 0.1273 × 25% 0.031825
EPS 1:0.195 0.195 × 50% 0.097500
Market Price 1:0.078 0.078 × 25% 0.019500
Total 0.148825
(i) SWAP Ratio is 0.148825 shares of Abhiman Ltd. for every share of Swabhiman Ltd.
Total No. of shares to be issued = 10 lakh × 0.148825 = 148825 shares
(ii) Book value, EPS & Market Price.
Total No. shares = 200000 +148825=348825

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 13.31 Strategic Financial Management

Total capital = `200 lakh + `148.825 lac = ` 348.825 lac

Reserves = ` 900 lac + ` 551.175 lac = ` 1451.175 lac
` 348.825 lac + ` 1451.175 lac
Book value = = ` 516.02
3.48825 lac
Total Pr ofit ` 100 lac + ` 97.50 lac
EPS = = = ` 56.62
No. of shares 3.48825 lac
Expected market price = ` 56.62 × PE Ratio= ` 56.62 × 10 = ` 566.20
Question 20
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 (`) 200 lakh 100 lakh
Free Reserve and Surplus (`) 800 lakh 500 lakh
Paid up Value per share (`) 100 10
Free float Market Capitalisation (`) 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, Earning 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 ` 5 each fully paid.

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 Merger, Acquisition & Restructuring 13.32

Answer
(a) Swap Ratio
Abhiman Ltd. Abhishek Ltd.
Share Capital 200 Lakh 100 Lakh
Free Reserves 800 Lakh 500 Lakh
Total 1000 Lakh 600 Lakh
No. of Shares 2 Lakh 10 Lakh
Book Value per share ` 500 ` 60
Promoter’s holding 50% 60%
Non promoter’s holding 50% 40%
Free Float Market Cap. i.e. 400 Lakh 128 Lakh
relating to Public’s holding
Hence Total market Cap. 800 Lakh 320 Lakh
No. of Shares 2 Lakh 10 Lakh
Market Price ` 400 ` 32
P/E Ratio 10 4
EPS 40 8
Profits (` 2 X 40) 80 -
(` 8 X 10) - 80
 
Calculation of Swap Ratio
Book Value 1 : 0.12 i.e. 0.12 x 25% 0.03
EPS 1 : 0.2 0.20 x 50% 0.10
Market Price 1 : 0.08 0.08 x 25% 0.02
Total 0.15
Swap ratio is for every one share of Abhishek Ltd., to issue 0.15 shares of Abhiman Ltd.
Hence total no. of shares to be issued
10 Lakh x 0.15 = 1.50 lakh shares
(b) Book Value , EPS & Market Price
Total No of Shares 2 Lakh + 1.5 Lakh = 3.5 Lakh
Total Capital ` 200 Lakh + ` 100 Lakh = ` 300 Lakh
Reserves ` 800 Lakh + ` 500 Lakh = ` 1,300 Lakh
Book Value ` 350 Lakh + ` 1,250 Lakh = ` 457.14 per share
3.5 Lakh

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 13.33 Strategic Financial Management

Total Profit ` 80 Lakh + ` 80 Lakh ` 160 Lakh

EPS = =
No. of Share 3.5 Lakh 3.5
= ` 45.71
Expected Market Price EPS (` 45.71) x P/E Ratio (10) = ` 457.10
(c) (1) Promoter’s holding
Promoter’s Revised Abhiman 50% i.e. 1.00 Lakh shares
Holding Abhishek 60% i.e. 0.90 Lakh shares
Total 1.90 Lakh shares
Promoter’s % = 1.90/3.50 x 100 = 54.29%
(2) Free Float Market Capitalisation
Free Float Market = (3.5 Lakh – 1.9 Lakh) x ` 457.10
Capitalisation = ` 731.36 Lakh
(3) (i) & (ii)
Revised Capital ` 350 Lakh + ` 175 Lakh = ` 525 Lakh
No. of shares before Split (F.V ` 100) 5.25 Lakh
No. of Shares after Split (F.V. Rs 5 ) 5.25 x 20 = 105 Lakh
EPS 160 Lakh / 105 Lakh = 1.523
Book Value Cap. ` 525 Lakh + ` 1125 Lakh
No. of Shares =105 Lakh
= ` 15.714 per share
Question 21
You have been provided the following Financial data of two companies:
Krishna Rama
Ltd. Ltd.
Earnings after taxes ` 7,00,000 ` 10,00,000
Equity shares (outstanding) ` 2,00,000 ` 4,00,000
EPS 3.5 2.5
P/E ratio 10 times 14 times
Market price per share ` 35 ` 35

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 Merger, Acquisition & Restructuring 13.34

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.
Answer
(i) Exchange Ratio 1:1
New Shares to be issued 2,00,000
Total shares of Rama Ltd. (4,00,000+2,00,000) 6,00,000
Total earnings (` 10,00,000 + ` 7,00,000) ` 17,00,000
New EPS (` 17,00,000/6,00,000) ` 2.83
(ii) Existing EPS of Rama Ltd. ` 2.50
Increase in EPS of Rama Ltd (` 2.83 – ` 2.50) ` 0.33
Existing EPS of Krishna Ltd. ` 3.50
Decrease in EPS of Krishna Ltd. (` 3.50 – ` 2.83) ` 0.67
(iii) P/E ratio of new firm (expected to remain same) 14 times
New market price (14 × ` 2.83) ` 39.62
Total No. of Shares 6,00,000
Total market Capitalization (6,00,000 × ` 39.62) ` 2,37,72,000
Existing market capitalization (` 70,00,000 + ` 1,40,00,000) ` 2,10,00,000
Total gain ` 27,72,000
(iv)
Rama Ltd. Krishna Ltd Total
No. of shares after merger 4,00,000 2,00,000 6,00,000
Market price ` 39.62 ` 39.62 ` 39.62
Total Mkt. Values ` 1,58,48,000 ` 79,24,000 ` 2,37,72,000
Existing Mkt. values ` 1,40,00,000 ` 70,00,000 ` 2,10,00,000
Gain to share holders ` 18,48,000 ` 9,24,000 ` 27,72,000
or ` 27,72,000 ÷ 3 = ` 9,24,000 to Krishna Ltd. and ` 18,48,000 to Rama Ltd. (in 2: 1
ratio)

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 13.35 Strategic Financial Management

Question 22
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.
` 10 Equity shares outstanding 12 Lakhs 6 Lakhs
Debt:
10% Debentures (` Lakhs) 580 --
12.5% Institutional Loan (` Lakhs) -- 240
Earning before interest, depreciation and tax (EBIDAT) (` Lakhs) 400.86 115.71
Market Price/share (` ) 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.
Answer
As per T Ltd.’s Offer
` in lakhs
(i) Net Consideration Payable
7 times EBIDAT, i.e. 7 x ` 115.71 lakh 809.97
Less: Debt 240.00
569.97
(ii) No. of shares to be issued by T Ltd
` 569.97 lakh/` 220 (rounded off) (Nos.) 2,59,000
(iii) EPS of T Ltd after acquisition
Total EBIDT (` 400.86 lakh + ` 115.71 lakh) 516.57
Less: Interest (` 58 lakh + ` 30 lakh) 88.00
428.57

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 Merger, Acquisition & Restructuring 13.36

Less: 30% Tax 128.57

Total earnings (NPAT) 300.00

Total no. of shares outstanding 14.59 lakh

(12 lakh + 2.59 lakh)
EPS (` 300 lakh/ 14.59 lakh) ` 20.56
(iv) Expected Market Price:
` in lakhs
Pre-acquisition P/E multiple:
EBIDAT 400.86
10
Less: Interest ( 580 X ) 58.00
100
342.86
Less: 30% Tax 102.86
240.00
No. of shares (lakhs) 12.00
EPS ` 20.00
220
Hence, PE multiple 11
20
Expected market price after acquisition (` 20.56 x 11) ` 226.16

As per E Ltd’s Plan

` in lakhs
(i) Net consideration payable
6 lakhs shares x ` 110 660
(ii) No. of shares to be issued by T Ltd
` 660 lakhs ÷ ` 220 3 lakh
(iii) EPS of T Ltd after Acquisition
NPAT (as per earlier calculations ) 300.00
Total no. of shares outstanding (12 lakhs + 3 lakhs) 15 lakh
Earning Per Share (EPS) ` 300 lakh/15 lakh ` 20.00
(iv) Expected Market Price (` 20 x 11) 220.00

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 13.37 Strategic Financial Management

(v) Advantages of Acquisition to T Ltd

Since the two companies are in the same industry, the following advantages could
accrue:
- Synergy, cost reduction and operating efficiency.
- Better market share.
- Avoidance of competition.
Question 23
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:
1. Transfer of Liabilities & Assets at Book value.
2. Estimated Profit for the year 2009-10 is ` 11,400 Lakh for Fortune India Ltd. & ` 1,470
lakhs for Fortune Pharma Ltd.
3. Estimated Market Price of Fortune Pharma Ltd. is ` 24.50 per share.
4. Average P/E Ratio of FMCG sector is 42 & Pharma sector is 25, which is to be
expected for both the companies.

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 Merger, Acquisition & Restructuring 13.38

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 Ltd.
3. Book Value per share of both the Companies immediately after Demerger.
Answer
Share holders’ funds (` Lakhs)
Particulars Fortune India Fortune Pharma Fortune India
Ltd. Ltd. (FMCG) Ltd.
Assets 70,000 25,100 44,900
Outside liabilities 25,000 4,100 20,900
Net worth 45,000 21,000 24,000
1. Calculation of Shares of Fortune Pharma Ltd. to be issued to shareholders of
Fortune India Ltd.
Fortune Pharma Ltd.
Estimated Profit ( ` in lakhs) 1,470
Estimated market price ( ` ) 24.5
Estimated P/E 25
Estimated EPS ( ` ) 0.98
No. of shares lakhs 1,500

Hence, Ratio is 1 share of Fortune Pharma Ltd. for 2 shares of Fortune India Ltd.
2. Expected market price of Fortune India Ltd.
Fortune India (FMCG) Ltd.
Estimated Profit ( ` in lakhs) 11,400
No. of equity shares ( ` in lakhs) 3,000
Estimated EPS ( ` ) 3.8
Estimated P/E 42
Estimated market price ( ` ) 159.60

© The Institute of Chartered Accountants of India

 13.39 Strategic Financial Management

3. Book value per share

Fortune Pharma Fortune India
Ltd. (FMCG) Ltd.
Net worth ( ` in lakhs) 21,000 24,000
No. of shares ( ` in lakhs) 1,500 3,000
Book value of shares ` 14 `8
Question 24
Reliable Industries Ltd. (RIL) is considering a takeover of Sunflower Industries Ltd. (SIL).
The particulars of 2 companies are given below:
Particulars Reliable Industries Sunflower Industries
Ltd Ltd.
Earnings After Tax (EAT) ` 20,00,000 ` 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?
Answer
(i) Market value of Companies before Merger
Particulars RIL SIL
EPS `2 Re.1
P/E Ratio 10 5
Market Price Per Share ` 20 `5
Equity Shares 10,00,000 10,00,000
Total Market Value 2,00,00,000 50,00,000

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 Merger, Acquisition & Restructuring 13.40

(ii) Post Merger Effects on RIL

`
Post merger earnings 30,00,000
Exchange Ratio (1:4)
No. of equity shares o/s (10,00,000 + 2,50,000) 12,50,000
EPS: 30,00,000/12,50,000 2.4
PE Ratio 10
Market Value 10 x 2.4 24
Total Value (12,50,000 x 24) 3,00,00,000
Gains From Merger: `
Post-Merger Market Value of the Firm 3,00,00,000
Less: Pre-Merger Market Value
RIL 2,00,00,000
SIL 50,00,000 2,50,00,000
Total gains from Merger 50,00,000
Apportionment of Gains between the Shareholders:
Particulars RIL( `) SIL( `)
Post Merger Market Value:
10,00,000 x 24 2,40,00,000 --
2,50,000 x 24 - 60,00,000
Less : Pre-Merger Market Value 2,00,00,000 50,00,000
Gains from Merger: 40,00,000 10,00,000

Thus, the shareholders of both the companies (RIL + SIL) are better off than before
(iii) Post-Merger Earnings:
Increase in Earnings by 20%
New Earnings: ` 30,00,000 x (1+0.20) ` 36,00,000
No. of equity shares outstanding: 12,50,000
EPS ( ` 36,00,000/12,50,000) ` 2.88
PE Ratio 10
Market Price Per Share:
= ` 2.88 x 10 = ` 28.80
∴ Shareholders will be better-off than before the merger situation.

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 13.41 Strategic Financial Management

Question 25
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 Ltd., (without any 8%
additional capital investment and without any change in risk of
operations)
Current Market price per share of AFC Ltd. ` 100
Current Market price per share of BCD Ltd. ` 20
Current Dividend per share of BCD Ltd. Re. 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 ` 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 ` 8 and that of BCD is ` 2.50. It is assumed
that AFC Ltd. invests its cash to earn 10%.
Answer
(i) For BCD Ltd., before acquisition
The cost of capital of BCD Ltd. may be calculated by using the following formula:
Dividend
+ Growth %
Pr ice
Cost of Capital i.e., Ke = (0.60/20) + 0.07 = 0.10
After acquisition g (i.e. growth) becomes 0.08
Therefore, price per share after acquisition = 0.60/(0.10-0.08) = ` 30
The increase in value therefore is = ` (30-20) x 5,00,000 = ` 50,00,000/-
(ii) To share holders of BCD Ltd. the immediate gain is ` 100 – ` 20x4 = ` 20 per share
The gain can be higher if price of shares of AFC Ltd. rise following merger which
they should undertake.

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 Merger, Acquisition & Restructuring 13.42

To AFC Ltd. shareholders ( ` (In lakhs)

Value of Company now 1,000
Value of BCD Ltd. __150
1,150
No. of shares 11.25
∴ Value per share 1150/11.25= ` 102.22

Gain to shareholders of BCD Ltd. = ` 102.22 – ` (4 x 20) = ` 22.22

Gain to shareholders of AFC Ltd. = ` 102.22 – ` 100.00 = ` 2.22
(iii) Gain to shareholders of AFC Ltd:-
Earnings of BCD Ltd. (5,00,000 x 2.50) ` 12,50,000/-
Less: Loss of earning in cash (5,00,000 x ` 22 x 0.10) ` 11,00,000/-
Net Earning ` 1,50,000/-
Number of shares 10,00,000
Net increase in earning per share 0.15
P/E ratio of AFC Ltd. = 100/8 = 12.50
Therefore, Gain per share of shareholders of AFC Ltd.
= 0.15x12.50 = ` 1.88
Gain to the shareholders of BCD Ltd. ` (22-20) = ` 2/- per share
Question 26
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 ` 10 each. The highest and the lowest
market quotation during the last 6 months were ` 570 and ` 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 summarised below:
` lakhs
Sources
Share Capital
20 lakhs equity shares of ` 10 each fully paid 200
10 lakhs equity shares of ` 10 each, ` 5 paid 50
Loans 100
Total 350

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 13.43 Strategic Financial Management

Uses
Fixed Assets (Net) 150
Net Current Assets 200
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 ` 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 (i) Aggregate of discounted cash flows at 8% and (ii)
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.
Answer
Price/share of AB Ltd. for determination of number of shares to be issued:
( ` 570 + ` 430)/2 ` 500
Value of XY Ltd based on future cash flow capitalization
(105 x 0.93)+(120 x 0.86)+(125 x 0.79)+(120 x 0.74) x (300 x 0.68) ` lakhs 592.40
Value of XY Ltd based on net assets ` lakhs 250.00
Average value (592.40+250)/2 421.20
No. of shares in AB Ltd to be issued ` 4,21,20,000/500 Nos. 84240
Basis of allocation of shares
Fully paid equivalent shares in XY Ltd. (20+5) lakhs 2500000

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 Merger, Acquisition & Restructuring 13.44

Distribution to fully paid shareholders 84240 x 20/25 67392

Distribution to partly paid shareholders 84240-67392 16848
Question 27
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 ( ` ) 24,00,000 15,00,000
Equity capital ( ` 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 ( ` ) 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 ` 40 ` 15

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 13.45 Strategic Financial Management

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 ` 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.
Answer
Market price per share (MPS) = EPS X P/E ratio or P/E ratio = MPS/EPS
(i) Determination of EPS, P/E ratio, ROE and BVPS of BA Ltd. and DA Ltd.
BA Ltd. DA Ltd.
Earnings After Tax (EAT) ` 2,10,000 ` 99,000
No. of Shares (N) 100000 80000
EPS (EAT/N) ` 2.10 ` 1.2375
Market price per share (MPS) 40 15
P/E Ratio (MPS/EPS) 19.05 12.12
Equity Funds (EF) ` 12,00,000 ` 8,00,000
BVPS (EF/N) 12 10
ROE (EAT/EF) × 100 17.50% 12.37%
(ii) Estimation of growth rates in EPS for BA Ltd. and DA Ltd.
Retention Ratio (1-D/P ratio) 0.6 0.4
Growth Rate (ROE × Retention Ratio) 10.50% 4.95%

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 Merger, Acquisition & Restructuring 13.46

(iii) Justifiable equity shares exchange ratio

(a) Intrinsic value = ` 20 / ` 40 = 0.5:1 (upper limit)
based
(b) Market price based = MPSDA /MPS BA = ` 15 / ` 40 = 0.375:1 (lower
limit)
Since, BA Ltd. has a higher EPS, ROE, P/E ratio and even higher EPS growth
expectations, the negotiable terms would be expected to be closer to the lower limit,
based on the existing share prices.
(iv) Calculation of post merger EPS and its effects
Particulars BA Ltd. DA Ltd. Combined
EAT (`) (i) 2,10,000 99,000 3,09,000
Share outstanding (ii) 100000 80000 132000*
EPS (`) (i) / (ii) 2.1 1.2375 2.341
EPS Accretion (Dilution) (Re.) 0.241 (0.301***)
(v) Estimation of Post merger Market price and other effects
Particulars BA Ltd. DA Ltd. Combined
EPS (`) (i) 2.1 1.2375 2.341
P/E Ratio (ii) 19.05 12.12 19.05
MPS (`) (i) / (ii) 40 15 44.6
MPS Accretion (`) 4.6 2.84***

* Shares outstanding (combined) = 100000 shares + (.40 × 80000)= 132000 shares

** EPS claim per old share = ` 2.34 × 0.4 ` 0.936
EPS dilution = ` 1.2375 – ` 0.936 ` 0.3015
***S claim per old share ( ` 44.60 × 0.4) ` 17.84
Less : MPS per old share ` 15.00
` 2.84
Question 28
A valuation done of an established company by a well-known analyst has estimated a value of
` 500 lakhs, based on the expected free cash flow for next year of ` 20 lakhs and an
expected growth rate of 5%.

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 13.47 Strategic Financial Management

While going through the valuation procedure, you found that the analyst has made the mistake
of using the book values of debt and equity in his calculation. While you do not know the book
value weights he used, you have been provided with the following information:
(i) Company has a cost of equity of 12%,
(ii) After tax cost of debt is 6%,
(iii) The market value of equity is three times the book value of equity, while the market
value of debt is equal to the book value of debt.
You are required to estimate the correct value of the company.
Answer

Cost of capital by applying Free Cash Flow to Firm (FCFF) Model is as follows:-
FCFF1
Value of Firm = V0 =
K c − gn
Where –
FCFF1 = Expected FCFF in the year 1
Kc = Cost of capital
gn = Growth rate forever
Thus, ` 500 lakhs = ` 20 lakhs /(Kc-g)
Since g = 5%, then Kc = 9%
Now, let X be the weight of debt and given cost of equity = 12% and cost of debt = 6%,
then 12% (1 – X) + 6% X = 9%
Hence, X = 0.50, so book value weight for debt was 50%
∴ Correct weight should be 75% of equity and 25% of debt.
∴ Cost of capital = Kc = 12% (0.75) + 6% (0.25) = 10.50%
and correct firm’s value = ` 20 lakhs/(0.105 – 0.05) = ` 363.64 lakhs.
Question 29
Following informations are available in respect of XYZ Ltd. which is expected to grow at a
higher rate for 4 years after which growth rate will stabilize at a lower level:
Base year information:
Revenue - ` 2,000 crores
EBIT - ` 300 crores
Capital expenditure - ` 280 crores
Depreciation - `200 crores

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 Merger, Acquisition & Restructuring 13.48

Information for high growth and stable growth period are as follows:
High Growth Stable Growth
Growth in Revenue & EBIT 20% 10%
Growth in capital expenditure and 20% Capital expenditure are
depreciation offset by depreciation
Risk free rate 10% 9%
Equity beta 1.15 1
Market risk premium 6% 5%
Pre tax cost of debt 13% 12.86%
Debt equity ratio 1:1 2:3
For all time, working capital is 25% of revenue and corporate tax rate is 30%.
What is the value of the firm?
Answer
High growth phase :
ke = 0.10 + 1.15 x 0.06 = 0.169 or 16.9%.
kd = 0.13 x (1-0.3) = 0.091 or 9.1%.
Cost of capital = 0.5 x 0.169 + 0.5 x 0.091 = 0.13 or 13%.
Stable growth phase :
ke = 0.09 + 1.0 x 0.05 = 0.14 or 14%.
kd = 0.1286 x (1 - 0.3) = 0.09 or 9%.
Cost of capital = 0.6 x 0.14 + 0.4 x 0.09 = 0.12 or 12%.
Determination of forecasted Free Cash Flow of the Firm (FCFF)
(` in crores)
Yr. 1 Yr. 2 Yr 3 Yr. 4 Terminal Year
Revenue 2,400 2,880 3,456 4,147.20 4,561.92
EBIT 360 432 518.40 622.08 684.29
EAT 252 302.40 362.88 435.46 479.00
Capital Expenditure 96 115.20 138.24 165.89 -
Less Depreciation
∆ Working Capital 100.00 120.00 144.00 172.80 103.68
Free Cash Flow (FCF) 56.00 67.20 80.64 96.77 375.32

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 13.49 Strategic Financial Management

Alternatively it can also be computed as follows:

(` in crores)
Yr. 1 Yr. 2 Yr 3 Yr. 4 Terminal Year
Revenue 2,400 2,880 3,456 4,147.20 4,561.92
EBIT 360 432 518.40 622.08 684.29
EAT 252 302.40 362.88 435.46 479.00
Add: Depreciation 240 288 345.60 414.72 456.19
492 590.40 708.48 850.18 935.19
Less: Capital Exp. 336 403.20 483.84 580.61 456.19
Δ WC 100.00 120.00 144.00 172.80 103.68
56.00 67.20 80.64 96.77 375.32
Present Value (PV) of FCFF during the explicit forecast period is:
FCFF PVF @ 13% PV
(` in crores) (` in crores)
56.00 0.885 49.56
67.20 0.783 52.62
80.64 0.693 55.88
96.77 0.613 59.32
` 217.38
Terminal Value of Cash Flow
375.32
= ` 12,510.67 CroresrRREes
0.12 - 0.09
PV of the terminal, value is:
1
` 12,510.67 Crores x = ` 12,510.67 Crores x 0.613318 = ` 7,673.02 Crores
(1.13) 4
The value of the firm is :
` 217.38 Crores + ` 7,673.02 Crores = ` 7,890.40 Crores
Question 30
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%.

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 Merger, Acquisition & Restructuring 13.50

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 ` 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 ` 287 ` 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.
Answer
a. β equity ungreared for the proxy company = 1.1 X 4 / [ 4 + (1 – 0.3) ] = 0.9362
0.9362 = β equity greared X 3/ [ 3 + (1 - 0.3)]
β equity geared = 1.1546
Cost of equity = 0.04 + 1.1546 X (0.1 – 0.04) = 10.93%
b. P/E valuation
(Based on earning of ` 10 Crore)
Using proxy Using XYZ’s
Entity’s P/E P/E

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 13.51 Strategic Financial Management

Pre synergistic value 12 X ` 10 Crore 10 X ` 10 Crore

= ` 120 Crore = ` 100 Crore
Post synergistic value 12 X ` 10 Crore X 1.1 10 X ` 10 Crore X 1.1
= ` 132 Crore = ` 110 Crore
Dividend valuation model
Based on 50% payout Based on 40% payout
Pre synergistic value 0.5 X 10 X 1.07 0.4 X10X1.07
0.1093 - 0.07 0.1093 - 0.07
= ` 136.13 Crore =` 108.91 Crore
Post synergistic value 0.5 X 10 X 1.1 X 1.07 0.4 X 10 X 1.1 X 1.07
0.1093 - 0.07 0.1093 - 0.07
= ` 149.75 Crore = ` 119.79 Crore
Market Price
Although no information is available about the value of KLM, it may be possible to
calculate a market value based on proportion of earnings of ABC that is generated by
KLM.
Market value of ABC = 80 Lakh Shares X ` 375 = ` 300 Crore
Post Tax earnings of ABC = ` 300/13 = ` 23.08 Crore
If market value of ABC is allocated to KLM in the proportion of relative earning of KLM to
that of ABC, KLM would have a market value of ` 300 crore X [ 10/23.08] = ` 130 Crore.
KLM’s Post Tax earning = ` 10 Crore.
If ABC’s P/E ratio is applied to it, the market value of KLM becomes ` 10 Crore X 13 = `
130 Crore.
Therefore, it assumes that KLM has the same P/E ratio as that of ABC.
Range of valuation
Pre synergistic ` 100 Crore ` 136.13 Crore
Post synergistic ` 110 Crore ` 149.75 Crore

Question 31
 
Using the chop-shop approach (or Break-up value approach), assign a value for Cranberry
Ltd. whose stock is currently trading at a total market price of €4 million. For Cranberry Ltd,
the accounting data set forth three business segments: consumer wholesale, retail and
general centers. Data for the firm’s three segments are as follows:

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 Merger, Acquisition & Restructuring 13.52

 
Business Segment Segment Segment Segment Operating
Sales Assets Income
Wholesale €225,000 €600,000 €75,000
Retail €720,000 €500,000 €150,000
General € 2,500,000 €4,000,000 €700,000
Industry data for “pure-play” firms have been compiled and are summarized as follows:
Business Capitalization/Sales Capitalization/Assets Capitalization/Operating
Segment Income
Wholesale 0.85 0.7 9
Retail 1.2 0.7 8
General 0.8 0.7 4
Answer
Business Segment Capital-to-Sales Segment Sales Theoretical Values
Wholesale 0.85 €225000 €191250
Retail 1.2 €720000 €864000
General 0.8 €2500000 €2000000
Total value €3055250

Business Segment Capital-to-Assets Segment Assets Theoretical Values

Wholesale 0.7 €600000 €420000
Retail 0.7 €500000 €350000
General 0.7 €4000000 €2800000
Total value €3570000

Business Segment Capital-to- Operating Income Theoretical Values

Operating Income
Wholesale 9 €75000 €675000
Retail 8 €150000 €1200000
General 4 €700000 €2800000
Total value €4675000
3055250 + 3570000 + 4675000
Average theoretical value = = 3766750
3
Average theoretical value of Cranberry Ltd. = €3766750

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 13.53 Strategic Financial Management

Question 32
 The following is the Balance-sheet of Grape Fruit Company Ltd as at March 31st ,2011.
Liabilities (` in lakhs) Assets (` in lakhs)
Equity shares of ` 100 each 600 Land and Building 200
14% preference shares of ` 200 Plant and Machinery 300
100/- each
13% Debentures 200 Furniture and Fixtures 50
Debenture interest accrued and 26 Inventory 150
payable
Loan from bank 74 Sundry debtors 70
Trade creditors 340 Cash at bank 130
Preliminary expenses 10
Cost of issue of 5
debentures
Profit and Loss account 525
1440 1440
The Company did not perform well and has suffered sizable losses during the last few years.
However, it is felt that the company could be nursed back to health by proper financial
restructuring. Consequently the following scheme of reconstruction has been drawn up :
(i) Equity shares are to be reduced to ` 25/- per share, fully paid up;
(ii) Preference shares are to be reduced (with coupon rate of 10%) to equal number of
shares of ` 50 each, fully paid up.
(iii) Debenture holders have agreed to forgo the accrued interest due to them. In the future,
the rate of interest on debentures is to be reduced to 9 percent.
(iv) Trade creditors will forego 25 percent of the amount due to them.
(v) The company issues 6 lakh of equity shares at ` 25 each and the entire sum was to be
paid on application. The entire amount was fully subscribed by promoters.
(vi) Land and Building was to be revalued at ` 450 lakhs, Plant and Machinery was to be
written down by ` 120 lakhs and a provision of `15 lakhs had to be made for bad and
doubtful debts.
Required:
(i) Show the impact of financial restructuring on the company’s activities.
(ii) Prepare the fresh balance sheet after the reconstructions is completed on the basis of
the above proposals.

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 Merger, Acquisition & Restructuring 13.54

Answer
Impact
  of Financial Restructuring
(i) Benefits to Grape Fruit Ltd.
(a) Reduction of liabilities payable
` in lakhs
Reduction in equity share capital (6 lakh shares x `75 per share) 450
Reduction in preference share capital (2 lakh shares x `50 per share) 100
Waiver of outstanding debenture Interest 26
Waiver from trade creditors (`340 lakhs x 0.25) 85
661
(b) Revaluation of Assets
Appreciation of Land and Building (`450 lakhs - `200 lakhs) 250
Total (A) 911
(ii) Amount of `911 lakhs utilized to write off losses, fictious assets and over- valued assets.
Writing off profit and loss account 525
Cost of issue of debentures 5
Preliminary expenses 10
Provision for bad and doubtful debts 15
Revaluation of Plant and Machinery 120
(`300 lakhs – `104 lakhs)
Total (B) 675
Capital Reserve (A) – (B) 236
(ii) Balance sheet of Grape Fruit Ltd as at 31st March 2011 (after re-construction)
(` in lakhs)
Liabilities Amount Assets Amount
12 lakhs equity shares of 300 Land & Building 450
`25/- each
10% Preference shares of 100 Plant & Machinery 180
`50/- each
Capital Reserve 236 Furnitures & Fixtures 50
9% debentures 200 Inventory 150
Loan from Bank 74 Sundry debtors 70
Trade Creditors 255 -15 55
Cash-at-Bank 280
(Balancing figure)*
1165 1165
*Opening Balance of `130/- lakhs + Sale proceeds from issue of new equity shares
`150/- lakhs.

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 13.55 Strategic Financial Management

EXERCISES
Question 1
Fuller Plc. is intending to acquire Felicy Plc. by merger and the following information is
available in respect of the companies:
Fuller Plc. Felicy Plc.
Number of equity shares 1,00,000 60,000
Earnings after tax (£) 5,00,000 1,80,000
Market value per share (£) 42 28
Required:
(i) What is the present EPS of both the companies?
(ii) If the proposed merger takes place, what would be the new earning per share for Fuller
Plc.? Assume that the merger takes place by exchange of equity shares and the
exchange ratio is based on the current market price.
(Answer: (i) Fuller Plc. = £ 5 and Felicy Plc.= £ 3 (ii) £ 4.86 )
Question 2
Cool-cool Ltd. makes thermal clothing for winter sports and outdoor work, and is considering
acquiring Sking Shell Ltd. which manufactures and sells ski clothing. Sking Shell is about one
quarter of Frozen's size and manufactures its entire product line in a small rented factory on a
mountaintop in Manali. It costs about Rs.10,00,000 a year in overhead to operate in the
factory. Cool-cool Ltd. produces its output in a less popular in North but more popular north-
east locations. Its factory has at least 50% excess capacity. Cool-cool's plan is to acquire
Sking Shell, and combine production operations in its north-eastern factory, but otherwise run
the companies separately.
Sking Shell's beta is 2.0, Treasury bills currently yield 5% and the Nifty Index is yielding 9%.
The corpoarte income tax rate for both firms is 40%. Because Sking Shell will no longer be
maintaining its own production facilities, it can be assumed that only a minimal amount of cash
will have to be reinvested to keep its equipment current and for future growth. This amount is
estimated at ` 1,00,000 per year. Selected financial information for Sking Shell is as follows:
Revenue ` 1,25,00,000
EAT ` 13,00,000
Depreciation ` 6,00,000
(a) Calculate the appropriate discount rate for evaluating the Sking Shell acquisition.
(b) Determine the annual cash flow expected by Cool-cool Ltd. from Sking Shell if the
acquisition is made (don't forget to include the synergy).

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 Merger, Acquisition & Restructuring 13.56

(c) Calculate the value of the acquisition to Cool-cool Ltd. assuming the benefits last for (1)
five years, (2) 10 years, and (3) 15 years.
(d) Sking Shell has 2,50,000 shares of stock outstanding. Calculate the maximum price
Cool-cool Ltd. should be willing to pay per share to acquire the firm under the three
assumptions in part c.
(e) If Cool-cool Ltd. is willing to assume the benefits of the Sking Shell acquisition will last
indefinitely but not grow, what should it be willing to pay per share?
(Answer: (a) 13% (b) ` 2,400,000 (c) (1) ` 8,441,000 (2) ` 13,023,000 (3) ` 15,510,000
(d) (1) ` 33.76 (2) ` 52.09 (3) ` 62.04 (e) ` 73.85)
Question 3
In above question , assume that the cash flow from the Sking Shell acquisition grows at 10% from
its initial value for one year and then grows at 5% indefinitely (starting in the third year). Calculate
the value of the firm and the implied stock price under these conditions. Use a terminal value at the
beginning of the period of 5% growth. What price premium is implied in dollars and as a percent of
market price if Sking Shell's stock is currently selling at ` 62?
(Answer: 102.10% of market price)

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