- 20 Marks
Question
a) Mergers and acquisitions are business strategies used to achieve various synergies. However, it is observed that there are instances where the desired results are not achieved after the mergers and acquisitions have taken place.
Required:
Explain THREE (3) reasons why mergers and acquisitions fail to achieve the desired results. (6 marks)
b) Mako Ghana Ltd is a company in Ghana operating in the Manufacturing industry and currently valued at GH¢200 million. Jini Ltd is also operating in the same industry but on a smaller scale and is currently valued at GH¢80 million. Due to growing challenging operating environment currently, the shareholders of both companies agreed to a 100% equity acquisition of Jini Ltd by Mako Ghana Ltd.
A detailed research and analysis by the Finance team of Mako Ghana Ltd shows the following:
- There will be incremental operation cost of GH¢40 million per annum in perpetuity due to the increased number of branches.
- The combined company’s market share will improve by 15% per annum on the average leading to incremental revenue of GH¢160 million per annum in perpetuity.
Based on the analysis above, both parties agreed to seal the deal under the following payment terms:
Option One:
Mako Ghana Ltd to pay GH¢170 million in cash for the 100% equity of Jini Ltd.
Option Two:
Mako Ghana Ltd to offer 25% of the combined company’s equity to shareholders of Jini Ltd as the payment for the 100% equity.
The cost of capital of Mako Ghana Ltd is 15% per annum.
Required:
i) Calculate the gains from the acquisition for Mako Ghana Ltd. (4 marks)
ii) Calculate the cost of the acquisition to Mako if cash is paid under Option one. (4 marks)
iii) Calculate the cost of the acquisition to Mako Ghana Ltd if the 25% of the combined equity is used for the payment under option two. (6 marks)
Answer
a) Reasons for failure in mergers and acquisitions:
- Agency problem: The management of target companies are often apprehensive of losing their jobs after the takeover and might frustrate the deal even if it eventually goes through, leading to failure.
- Unrealized economies of scale: Over optimistic or wrong assessment of economies of scale eventually does not materialize in practice after the takeover.
- Valuation problem: Errors in valuing or wrong assumptions in valuing the target can lead to wrong values.
- Integration problems: Poor integration of staff and management with different organizational cultures and attitudes can pose challenges to successful delivery of the desired outcome.
(Any 3 points @ 2 marks each = 6 marks)
b)
i) Gains from the acquisition:
Incremental Revenue = 160 million
Incremental cost = (40 million)
Net incremental revenue = 120 million
Cost of capital = 15%
Gains = 120 million / 0.15 = 800 million cedis
(4 marks)
ii) Cost of cash acquisition:
Cash cost = Cash – the value of Jini Ltd
= 170 million – 80 million = 90 million
(4 marks)
iii) Cost of Share acquisition:
Value of Mako Ltd = 200 million
Value of Jini Ltd = 80 million
Add gains = 800 million
Combined value = 1,080 million
Jini share of the combined value = 25%
25% x 1,080 million = 270 million
Cost = combined share of Jini– Value of Jini Ltd
= 270 Million – 80 million = GH¢190 million
(6 marks)
- Tags: Acquisitions, Cost Analysis, Gain Calculation, Mergers, Valuation
- Level: Level 2
- Topic: Mergers and acquisitions
- Series: AUG 2022
- Uploader: Joseph