Question Tag: Mergers

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  • 5 Marks

AFM – May 2019 – L3 – Q3b – Valuation of acquisitions and mergers

Evaluate whether Ape should proceed with the merger by assessing the financial impact and synergy benefits.

Ape has 2,500 shares outstanding at GH¢10 per share. Bee has 1,250 shares outstanding at GH¢5 per share. Ape estimates that the value of synergistic benefit from acquiring Bee is GH¢500. Bee has indicated that it would accept a cash purchase offer of GH¢6.50 per share.

Required:
Identify whether Ape should proceed with the merger

Since the net loss from the acquisition is GH¢1,375, Ape should not proceed with the merger as it results in a financial loss despite the synergy benefits.

  • 8 Marks

AFM – Nov 2018 – L3 – Q3a – Acquisitions and mergers versus other growth strategies

Discuss when takeovers make financial and economic sense and reasons why takeovers may fail to increase shareholder wealth.

Despite substantial evidence, drawn from different countries and different time periods, that suggests the wealth of shareholders in a bidding company is unlikely to be increased as a result of taking over another company, takeovers remain an important part of the business landscape.

Required:
i) Explain briefly when a takeover will make economic and financial sense.
(3 marks)

ii) Discuss briefly FIVE (5) reasons why a takeover may fail to deliver an expected increase in wealth for the bidding company’s shareholders.
(5 marks)

i) When a takeover makes economic and financial sense
A takeover makes economic and financial sense when it creates value through synergies. The value of the combined business must exceed the sum of the values of the individual businesses. This can be expressed as:

PV Combined business > PV Bidding business + PV Target business

This means that the takeover should generate benefits such as cost savings, revenue enhancement, or improved efficiency, which would not have been realized if the companies operated independently. The combined entity should deliver a higher net present value (NPV) or enhanced future cash flows, justifying the merger or acquisition.
(3 marks)

ii) Five reasons why a takeover may fail to deliver the expected increase in wealth for the bidding company’s shareholders

  1. Overpayment for the target company:
    Management of the bidding company may pay too much for the target company. Often, a premium is paid to convince shareholders of the target to sell their shares. This premium might not be justified by the future gains from the merger, leading to wealth transfer from the bidding company’s shareholders to the target’s shareholders.
  2. Hidden problems in the target company:
    Problems that were hidden or undiscovered during the due diligence process may emerge after the acquisition. These issues could be financial, operational, or legal, and they may erode the anticipated benefits from the takeover.
  3. Integration challenges:
    Integrating the operations, culture, and management of the two companies may prove difficult. Differences in organizational cultures, management styles, and systems can lead to inefficiencies and prevent the realization of expected synergies.
  4. Management complacency:
    After the takeover, management may become complacent, believing that the takeover itself guarantees success. Without continuous effort to integrate and improve operations, the anticipated benefits may not materialize, leading to underperformance.
  5. Errors in valuing the target company:
    Misjudgment in valuing the target company may lead to the bidding company overpaying for the acquisition. This often results from incorrect assumptions about future cash flows or failure to account for the risk associated with the acquisition.
  • 5 Marks

AFM – May 2016 – L3 – Q3b – Acquisitions and mergers versus other growth strategies, Regulatory framework and processes

Outline the actions a target company might take to prevent a hostile takeover bid.

b) As a Finance Manager in your company, you have been asked to produce an explanatory memo to Senior Management on the subject of Mergers and Acquisitions. Your memo should clearly outline what actions a target company might take to prevent a hostile takeover bid.

(5 marks)

Memo: Hostile Takeover Defense Strategies

To: Senior Management
From: Finance Manager
Subject: Actions to Prevent a Hostile Takeover Bid

In response to concerns regarding the possibility of a hostile takeover, there are several strategies that a target company can adopt to defend against such attempts. Below are five key actions:

  1. White Knight
    • This involves finding a friendly third-party company (a “white knight”) that offers a more favorable acquisition deal to outbid the hostile company. This strategy allows the target company to avoid falling into the hands of the hostile bidder.
      (1 mark)
  2. Shark Repellent
    • Amending the company’s charter or bylaws to make it difficult for the acquiring company to complete a takeover. This can include raising the threshold for shareholder approval or implementing supermajority voting requirements.
      (1 mark)
  3. Pac-Man Defense
    • In this defense, the target company turns the tables by attempting to acquire the hostile company that is attempting the takeover. This often deters the hostile bidder, as it becomes the target of the acquisition instead.
      (1 mark)
  4. Golden Parachutes
    • This strategy involves providing the company’s top executives with generous severance packages that are triggered in the event of a takeover. This increases the cost of the acquisition, making it less attractive for the hostile bidder.
      (1 mark)
  5. Poison Pill
    • A tactic where the target company issues new shares to existing shareholders at a discount, making it more difficult and expensive for the acquiring company to buy a controlling stake in the business. This dilutes the ownership of the hostile bidder.
      (1 mark)
  • 10 Marks

AFM – May 2016 – L3 – Q3a – Valuation of acquisitions and mergers, Acquisitions and mergers versus other growth strategies

Calculate pre-acquisition market values of two companies and determine the maximum price for an acquisition.

a) Plainview Farms Limited is considering acquiring Cottage Industries Limited. The extracts of the financial statements of the two companies are as follows:

Statement of Financial Position

Plainview Farms Ltd (GH¢’m) Cottage Industries Ltd (GH¢’m)
Net Assets 6,300 1,892
Equity Capital 2,000 1,000
Income Surplus 4,300 892

Income Statement

Plainview Farms Ltd (GH¢’m) Cottage Industries Ltd (GH¢’m)
Profit after tax 800 300
Dividend (600) (100)
Retained earnings 200 200

The two companies retain the same proportion of profits each year, and this is expected to continue in the future. Plainview Farms Limited’s return on investment is 16%, while Cottage Industries Limited’s is 21%. One year after the post-acquisition period, Plainview Farms will retain 60% of its earnings and expects to earn a return of 20% on new investment.

The dividends of both companies have been paid. The required rate of return for ordinary shareholders of Plainview Farms Limited is 12%, and for Cottage Industries Limited it is 18%. After the acquisition, the required rate of return will become 16%.

Required:
i) Calculate the pre-acquisition market values of both companies. (5 marks)
ii) Calculate the maximum price Plainview Farms Limited will pay for Cottage Industries Limited. (5 marks)

  • 4 Marks

AFM – May 2018 – L3 – Q3a – Acquisitions and mergers versus other growth strategies

Discussing strategic issues that arise from pursuing growth through mergers, acquisitions, and organic growth.

Expansion by organic growth or by acquisition should only be undertaken if it leads to an increase in the wealth of the shareholders.

Required:
i) Discuss TWO strategic issues that arise from pursuing growth through mergers and acquisitions. (4 marks)
ii) Discuss TWO strategic issues that arise from pursuing growth through organic growth. (4 marks)

i) Strategic Issues in Mergers and Acquisitions:

  1. Time: Mergers or acquisitions allow a firm to increase its market share or enter a new market more quickly than if the firm tried to expand organically. Since “time is money,” the ability to enter a market or increase market share fast through mergers or acquisitions can be the cheapest way to expand.
  2. Cost: While cost savings can be achieved due to synergies, mergers or acquisitions may also be the most expensive way to expand due to the “premium for control.” Acquisitions might be expensive if they face resistance from target companies or government regulations under competition laws.
  3. Regulation/Legislation/Culture: Mergers or acquisitions can ease entry into markets with regulatory restrictions, but they might lead to cultural issues or backlash from local customers or governments.
  4. Assimilation and Integration: Integrating new employees, systems, and processes can lead to strains on the management, and handling a larger number of products or markets can cause “corporate indigestion.”
  • 7 Marks

AT – May 2021 – L3 – Q2a – Mergers, Amalgamation and Reorganisation

Write a memo on the tax exposure after a merger involving three companies and asset revaluation gains.

There has been a merger among three companies: Ann Ltd, Bab Ltd, and Cee Ltd. The merger was geared towards creating a monopoly in the market. After careful revaluation of the assets and liabilities of the companies, the following is the outlook:

  • Ann Ltd: GH¢4,200,000
  • Bab Ltd: GH¢5,000,000
  • Cee Ltd: GH¢5,200,000

The following is the outlook of the new company after the merger:

  • Profit: GH¢5,000,000

Required:
As an intern of IKERN and Associates, write a memo to your partner on the company’s tax exposure after the merger.

Memo

To: Partner
From: Tax Intern
Date: 16 February 2021
Subject: Tax Exposure After the Merger

Introduction:
Following our discussion on the above subject matter, I furnish the following for your consideration.

Issues:
The gains on the realisation of an asset accruing to or derived by a company arising out of a merger, amalgamation, or reorganisation of a company are exempt from tax when there is continuity of at least fifty percent of the underlying ownership in the asset.

Tax Implication:
The merger of the three companies and the gains arising from the revaluations shall be assessed based on the underlying ownership in the new entity. If the underlying ownership in the new entity is less than 50%, the gains will be subject to tax at the corporate rate of 25%. If ownership is maintained at or above 50%, the gains are exempt from tax.

  • Ann Ltd: GH¢4,200,000
  • Bab Ltd: GH¢5,000,000
  • Cee Ltd: GH¢5,200,000

From the above gains, if the underlying ownership in the new company post-merger is less than 50%, the gains shall be taxed at the marginal rate of 25%. If the ownership is maintained at 50% or more, the gains will be exempt from tax.

The profit being made by the new company indicates the success of the merger, and it shall be taxed at the corporate tax rate of 25%.

Conclusion:
I hope the above helps you in your further action on the matter.
Yours faithfully,
Handsome Padii.

  • 8 Marks

AT – May 2021 – L3 – Q1a – Mergers, Amalgamation and Reorganisation

Discuss the tax implications if Farmer Ltd acquires more than 50% of Bugum Ltd's underlying ownership.

Farmer Ltd is a non-resident company based in the USA. Farmer Ltd has succeeded over the years in acquiring and selling companies in distress alongside its primary objectives of buying and selling cosmetics. In the 2020 year of assessment, it decided to announce its presence in Ghana by acquiring Bugum Ltd, a resident company. Bugum Ltd has had financial setbacks in its fortunes over the last couple of years and became vulnerable to predators.

Required:
Advise the management of Farmer Ltd, what the tax implications are if Farmer Ltd acquires more than 50% of the underlying ownership of Bugum Ltd.

Mergers and acquisitions have blessings for the predator(s) and may equally bring losses to the predator. Therefore, under section 62 of Act 896 (Act 2015), the following shall not be benefitted by the new owners, that is, Farmer Ltd in this case:

  • The financial cost incurred under section 16 cannot be beneficial to the new owners.
  • Farmer Ltd shall not benefit from any loss incurred under section 17.
  • Farmer Ltd shall not claim any bad debts incurred by previous managers.
  • Farmer Ltd shall not carry back loss if it is in a long-term contract.
  • Farmer Ltd shall file two tax returns, one before and one after the change in underlying ownership.
  • Farmer Ltd will benefit from the new values of depreciable assets.
  • Farmer Ltd can rebrand to create a value-added image for the entity.
  • 5 Marks

AT – Nov 2019 – L3 – Q1b – Mergers, amalgamation, and reorganization

Analyze the tax implications of different ownership structures in a merger for Akolo Ltd and Abolo Ltd.

The management of Akolo Ltd (Akolo) has been running this business entity for some time now. At a seminar organized for some select businesses at the Trade Fair-Accra last year, the management of Abolo Ltd (Abolo) realized at the seminar that the two companies (Akolo and Abolo) have a lot in common with the same market share. Consequently, the two companies commenced processes to merge as one strong entity. The two agreed on a merger arrangement to benefit from the synergetic efforts.

The two companies intend to form a new entity called Akobolo Ltd (Akobolo).

Required:

i) What is the tax implication of the arrangement if, in the new company-(Akobolo), Akolo intends to hold 40% in the underlying ownership in the assets of the new company while Abolo holds 60%? (3 marks)

ii) What is the tax implication if both companies hold 50% each in the underlying ownership of the assets of the new company – Akobolo? (2 marks)

i) – Tax Implication of 40% and 60% Ownership:

Under section 47 of Act 2015 (Act 896), the gains on the realization of an asset accruing to or derived by a company arising out of a merger, amalgamation, or reorganization of a company is exempt from tax where there is a continuity of at least fifty percent of the underlying ownership in the asset.

In this arrangement, Akolo has 40% in the underlying ownership in the asset of the new company, which suggests the realization of the assets and consequently, any gains made are subject to tax by adding it to business income and subjecting it to applicable tax rates.

In the case of Abolo, which intends to hold 60% in the underlying ownership in the assets of the new company, any gain from this merger is exempt from tax.

(3 marks)

ii) – Tax Implication of 50% and 50% Ownership:

If both companies hold 50% each in the underlying ownership of the assets of the new company, this constitutes a realization of assets, but the gains on this realization are exempt from tax in both Akolo Ltd and Abolo Ltd.

(2 marks)

  • 20 Marks

FM – Nov 2023 – L2 – Q2 – Business valuations | Mergers and acquisitions

Evaluate the potential acquisition of Akwaaba Films by Lekker Inc, including valuation, cost of equity, and reasons for potential merger failures.

Lekker Inc (Lekker) is a film company located in South Africa. The company is planning to expand into other African countries. The research department of Lekker recommends Ghana as a good location for establishing a subsidiary due to its abundant talent and political stability. However, the company is unsure whether to establish a completely new subsidiary or acquire an existing film company in Ghana. You have been engaged as a consultant to guide Lekker in taking this decision.

Your preliminary assessment revealed the following:

i) You have identified a Ghanaian filmmaker who owns a fast-growing film company called Akwaaba Films (Akwaaba). You observed that the Ghanaian filmmaker is likely to sell Akwaaba if Lekker could pay GH¢450,000 as purchase consideration. Akwaaba is entirely self-financed, with the owner receiving all profits as dividends. You forecast that Akwaaba’s profit after tax will grow at a rate of 6% per year for the first two years, 4% per year for the next two years, and thereafter, grow at a constant rate of 2% per year in perpetuity. The financial information extracted from Akwaaba shows the following:

Description GH¢
Revenue 250,000
Operating Cost (140,000)
Administrative cost (30,000)
Profit before tax 80,000
Tax @ 25% (20,000)
Profit after tax 60,000

ii) If Lekker decides to set up the subsidiary in Ghana by itself with the same GH¢450,000 purchase consideration for Akwaaba, its after-tax cash flows will be as follows:

Year Cash Flow (GH¢)
Year 1 15,000
Year 2 26,000
Year 3 35,000
Year 4 33,000

The overall Price/Earnings (P/E) ratio for the film industry in Ghana is 15 times. The average cash flow risk for unquoted companies in Ghana is 20%. Lekker does not intend to list on the Ghana Stock Exchange.

iii) Lekker’s cost of capital is 16%.

Required:
a) Enumerate THREE (3) advantages of expansion through acquisition over organic expansion to the owners of Lekker. (6 marks)
b) Compute the value of Akwaaba using the dividend valuation method and advise Lekker whether it should acquire Akwaaba at the purchase consideration of GH¢450,000. (8 marks)
c) Using the P/E ratio method, estimate the expected value of Lekker’s subsidiary in Ghana without the acquisition. (4 marks)
d) State TWO (2) reasons mergers and acquisitions may fail to achieve the expected outcomes. (2 marks)

a) Three Advantages of Expansion Through Acquisition Over Organic Expansion:

  1. Speed of Market Entry:
    Acquiring an existing company like Akwaaba allows Lekker to enter the Ghanaian market quickly, without the delays associated with setting up a new subsidiary from scratch.
  2. Established Market Presence:
    Through acquisition, Lekker would gain immediate access to Akwaaba’s existing customer base, established brand, and market relationships, which would take time to develop through organic growth.
  3. Lower Risk:
    Acquiring an existing, successful company like Akwaaba reduces the risk associated with entering a new market, as the business model, management team, and market strategy are already proven.

(6 marks)

b) Value of Akwaaba Using the Dividend Valuation Model:

The Dividend Valuation Model (DVM) can be used to value Akwaaba based on its expected future profits:

Note that the perpetuity is calculated from Year 4 onwards, therefor the discount
factor is the same as that of Year 4 and not Year 5
Conclusion: the purchase consideration of GH¢450,000 quoted by the Ghanaian
filmmaker is lower than the value of the firm, leading to a net gain of 33,524.92.
Based on this Lekker Inc. should purchase Akwaaba Inc

c) Expected Value of Lekker’s Subsidiary Using the P/E Ratio Method:

 

d) Two Reasons Mergers and Acquisitions May Fail to Achieve Expected Outcomes:

  1. Cultural Integration Issues:
    Differences in corporate cultures can lead to conflicts and inefficiencies post-merger, hampering the realization of expected synergies.
  2. Overvaluation of Target Company:
    If the acquiring company overestimates the value of the target company, the merger may not deliver the anticipated financial benefits, leading to losses.

(2 marks)

 

  • 20 Marks

FM – July 2023 – L2 – Q2 – Mergers and acquisitions

Calculate the value of a combined business after a merger, determine the maximum and minimum acceptable prices for the merger, and evaluate the type of merger.

Amanfi Ltd manufactures cooking oil for the local markets in Ghana. The management of Amanfi Ltd believes that by merging with one of their input suppliers, Aseebu Ltd, the company will be able to control supply, thus giving the Amanfi Group a low-price advantage in the market. Aseebu Ltd is a key supplier of inputs to companies in the cooking oil industry. The financial statements of the two companies are shown below:

Income Statement for the past Five Years (Amanfi Ltd)

Year (Million GH¢) 2018 2019 2020 2021 2022 (current year)
Sales 3,720 4,092 4,500 4,950 5,442
Cost of Sales (1,674) (1,841) (2,025) (2,228) (2,449)
Operating Profit 2,046 2,251 2,475 2,722 2,993
Finance Cost (252) (278) (305) (336) (369)
Earnings Before Tax 1,794 1,973 2,170 2,386 2,624
Tax @ 30% (538) (592) (651) (716) (787)
Earnings After Tax 1,256 1,381 1,519 1,670 1,837

Income Statement for the past Five Years (Aseebu Ltd)

Year (Million GH¢) 2018 2019 2020 2021 2022 (current year)
Sales 1,860 2,046 2,250 2,475 2,496
Cost of Sales (837) (921) (1,013) (1,114) (1,123)
Operating Profit 1,023 1,125 1,237 1,361 1,373
Finance Cost (126) (139) (153) (168) (169)
Earnings Before Tax 897 986 1,084 1,193 1,204
Tax @ 30% (269) (296) (325) (358) (361)
Earnings After Tax 628 690 759 835 843

Additional Information:
Amanfi Ltd and Aseebu Ltd have beta of 1.6 and 1.1 respectively. The government treasury bill rate pays a yield of 8% and risk premium on the market is 17%. If the merger goes through, the combined company’s earnings after tax will grow at the same rate as Amanfi Ltd. The merger will lead to annual cost savings of GH¢850 million in perpetuity.

Required:
a) As a Finance Manager, calculate the value of the combined business based on the present value of expected earnings. (8 marks)
b) What is the maximum amount that Amanfi Ltd should pay for Aseebu Ltd? (4 marks)
c) What is the minimum bid that Aseebu Ltd shareholders should be prepared to accept? (4 marks)
d) Calculate the gain/loss from the merger. (2 marks)
e) Identify and explain the type of merger between Amanfi Ltd and Aseebu Ltd. (2 marks)

a) Calculation of the Value of the Combined Business Based on the Present Value of Expected Earnings
Value of Combined Business (GH¢’million):
(1 mark for each line up to 5, 1 mark each for the growth rate and 2 marks for cost of equity = 8 marks)

b) Maximum Amount that Amanfi Ltd Should Pay for Aseebu Ltd
Value of Amanfi = = GH¢8,081 million
(2 marks each for the maximum price and the value of Amanfi = 4 marks)

c) Minimum Bid that Aseebu Ltd Shareholders Should Be Prepared to Accept

(2 marks for the minimum price and 1 mark each for the growth rate and the cost of equity = 4 marks)

d) Gain/Loss from the Merger
Gain:
Value of Combined business − (Value of Amanfi + Value of Aseebu)
=14,216 − (8,081 + 4,672) = GH¢1,463 million

e) Type of Merger Between Amanfi Ltd and Aseebu Ltd
Backward Vertical Merger/Acquisition:
A merger between firms that operate at different stages of the same production chain, or between firms that produce complementary goods. This type of vertical merger between a supplier and a firm is known as a backward merger. (2 marks)

 

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