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- 10 Marks
Question
Global companies continuously explore ways to be more efficient and effective to survive the challenging global competition. Some resort to mergers and acquisitions to survive. In the light of this, Carsley Ltd and Powell Ltd are planning to merge to form Stimac Ltd. It has been agreed that Powell’s shareholders will accept three shares in Carsley for every share in Powell they hold. Other details are as follows:
| Carsley Ltd | Powell Ltd | |
|---|---|---|
| Number of shares | 40m | 10m |
| Annual earnings | GH¢10m | GH¢5.8m |
| P/E ratio | 8 | 10 |
Post-merger annual earnings of the enlarged company are expected to be eight percent higher than the sum of the earnings of each of the companies before the merger, due to economies of scale and other benefits. The market is expected to apply a P/E ratio of 9 to Stimac Plc.
Required:
Determine the extent to which the shareholders of Powell will benefit from the proposed merger. (10 marks)
Answer
Market Value of Powell Ltd:
Powell’s market value, using its P/E ratio and earnings, is calculated as:
Market Value = Earnings× P/E Ratio
Market Value = GH¢5.8m × 10 = GH¢58m
(2 marks)
Post-Merger Annual Earnings of Stimac Ltd:
The earnings of Stimac Ltd will be:
Post-Merger Earnings = (Carsley Earnings + Powell Earnings) × 1.08
Post-Merger Earnings = (GH¢10m+GH¢5.8m) × 1.08 = GH¢17.06m
(2 marks)
Market Value of Stimac Ltd:
Using a P/E ratio of 9, the value of Stimac Ltd is calculated as:
Market Value of Stimac Ltd = GH¢17.06m × 9 = GH¢153.54m
(2 marks)
Wealth of Powell’s Shareholders Post-Merger:
The 10 million shares of Powell will be swapped for 30 million Carsley shares, making 70 million shares in the new company in total. Therefore, the wealth of Powell’s shareholders will now be:
(2 marks)
(2 marks)
- Tags: Merger Benefits, Post-Merger Analysis, Shareholder Value
- Level: Level 2
- Topic: Mergers and acquisitions
- Series: NOV 2019
- Uploader: Kwame Aikins