Topic: Valuation of acquisitions and mergers

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  • 14 Marks

AFM – Nov 2016 – L3 – Q4a – Valuation of acquisitions and mergers

Calculate the NPV of Mama Ltd's acquisition of Papa Ltd and determine the value of the combined entity and an appropriate share exchange ratio.

a) The Directors of Mama Ltd (Mama), a large listed company, are considering an opportunity to
acquire all the shares of Papa Ltd (Papa), a small listed company with a highly efficient
production technology.
Mama has 10 million shares of common stock in issue that are currently trading at GH¢6.00
each. Papa Ltd has 5 million shares of common stock in issue, each of which is trading at
GH¢4.50.
If Papa is acquired and integrated into the business of Mama, the production efficiency of the
combined entity would increase and save the combined business GH¢600,000 in operating
costs each year to perpetuity.
Though Mama operates in the same industry as Papa, its financial leverage is higher than that
of Papa. Mama’s total debt stock is valued at GH¢40 million, and its after-tax cost of debt is
22%. The beta of Mama’s common stock is 1.2. The return on the risk-free asset is 20% and
the market risk premium is 5%.
Required:
Suppose Mama offers a cash consideration of GH¢25 million from its existing funds to the
shareholders of Papa for all of their shares.
i) Calculate the NPV of the acquisition, and advise the directors of Mama on whether to
proceed with the acquisition or not. (8 marks)
ii) Calculate the value of the combined entity immediately after the acquisition. (3 marks)
iii) Suppose Mama would like to acquire all the shares in Papa by offering fresh shares of its
own common stock to the shareholders of Papa. Advise the directors on the appropriate
share exchange ratio based on market price.

(a) Mama Ltd – Acquisition

NPV and post-acquisition value

Computation of NPV:

The NPV of an acquisition is the gain from the acquisition less the cost of the
acquisition:
The gain from the acquisition is the PV of synergy from the acquisition:
𝐺𝑎𝑖𝑛 (𝑃𝑉 𝑜𝑓 𝑠𝑦𝑛𝑒𝑟𝑔𝑦) =

Cost saving = given as GHS600,000 every year perpetually
As the firm has both equity and debt in its capital structure, the appropriate
cost of capital to use as discount rate is the WACC.

Cost of equity, ke is estimated from the CAPM:

𝑘𝑒 = 𝑟𝑓 + 𝛽𝑖(𝐸(𝑟𝑚) − 𝑟𝑓)

𝑘𝑒 = 0.2 + 1.2(0.05) = 0.26

Cost of the acquisition is the excess of the purchase consideration over the
value of the target:

𝐶𝑜𝑠𝑡 = 𝐶𝑎𝑠ℎ 𝑜𝑓𝑓𝑒𝑟 − 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑃𝑎𝑝a

𝐶𝑜𝑠𝑡 = 𝐺𝐻𝑆25,000,000 − 𝐺𝐻𝑆22,500,000 = 𝐺𝐻𝑆2,500,000

The NPV is then computed as Gain less Cost:

𝑁𝑃𝑉 = 𝐺𝑎𝑖𝑛 − 𝐶𝑜𝑠𝑡 = 𝐺𝐻𝑆2,459,016 − 𝐺𝐻𝑆2,500,000 = (𝐺𝐻𝑆40,984)

Advice based on NPV:
The negative NPV suggests that if the acquisition happens, the value of
Mama would reduce by GHS40,984. Therefore, the directors of Mama
should discard the acquisition plan.

b. The value of combined entity:

𝑃𝑜𝑠𝑡 − 𝑎𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑣𝑎𝑙𝑢𝑒 = 𝑉𝑎𝑙𝑢𝑒𝑀𝑎𝑚𝑎 + 𝑉𝑎𝑙𝑢𝑒𝑃𝑎𝑝𝑎 + 𝑃𝑉 𝑜𝑓 𝑆𝑦𝑛𝑒𝑟𝑔𝑦 − 𝐶𝑎𝑠ℎ 𝑜𝑓𝑓𝑒𝑟
𝑃𝑜𝑠𝑡 − 𝑎𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑣𝑎𝑙𝑢𝑒
= 𝐺𝐻𝑆60,000,000 + 𝐺𝐻𝑆22,500,000 + 𝐺𝐻𝑆2,459,016 − 𝐺𝐻𝑆2,500,000
𝑃𝑜𝑠𝑡 − 𝑎𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑣𝑎𝑙𝑢𝑒 = 𝐺𝐻𝑆82,459,016m

ii) Share exchange ratio (ER)
The number of shares Mama should issue to shareholders of Papa can be
calculated based on market price as under:

The share exchange ratio between Mama and Papa may be expressed as 3:4
or 0.75:1. That is Mama should issue 3 shares of its ordinary stock for every
4 shares in Papa (or 75 shares of Mama for every 100 shares in Papa).

  • 4 Marks

AFM – May 2017 – L3 – Q3c – Valuation of acquisitions and mergers

Factors to be considered by the directors and shareholders in evaluating the worthiness of the takeover proposal.

Discuss briefly any other factors that the directors and shareholders of both companies might consider in assessing the worthwhileness of the proposed takeover. (4 marks)

The directors and shareholders of both Jacobs Ltd and Idowu Co Ltd should consider the following factors in assessing the worthiness of the proposed takeover:

  1. Price Premium:
    The shareholders of Idowu Co Ltd should evaluate whether the takeover price reflects a fair premium over their current market value. A premium is typically required to encourage the shareholders to sell, so they should aim for a price above the GH¢1.5 million market value.
  2. Operational Synergies:
    Jacobs Ltd expects cost savings and additional revenue post-acquisition. The directors should carefully reassess the feasibility of the projected synergies, such as the GH¢60,000 annual increase in sales and GH¢50,000 reduction in operating expenses. If these estimates are overly optimistic, the actual benefits may fall short of expectations.
  3. Impact on Employees and Company Culture:
    Any cost-saving measures, such as selling machinery or reducing expenses, might involve job cuts or operational changes. These decisions could affect employee morale and the long-term performance of the combined entity. The cultural alignment between the two companies should also be assessed to ensure smooth integration.
  4. Transaction Costs and Resistance:
    Both companies must account for the potential transaction costs associated with the takeover. Additionally, if the takeover is resisted by Idowu’s management or alternative bidders emerge, the overall cost of the acquisition might increase significantly, reducing its attractiveness.
  5. Regulatory and Competitive Environment:
    Both companies operate in the auto parts manufacturing industry. The combined entity’s potential market power might attract scrutiny from regulators. The directors should evaluate the likelihood of regulatory intervention and its impact on the business.
  6. Control and Ownership Dilution:
    For shareholders in both companies, the change in control should be a key consideration. Shareholders in Idowu Co Ltd will see their ownership reduced after the exchange of shares, while Jacobs Ltd’s shareholders may see their control diluted due to the issuance of new shares.

(Any 4 points for 4 marks)

  • 16 Marks

AFM – May 2017 – L3 – Q3a & b – Valuation of acquisitions and mergers

Calculating the maximum and minimum prices for Jacobs Ltd's acquisition of Idowu Co Ltd based on future revenue and cost synergies.

Jacobs Limited and Idowu Company Limited both manufacture and sell auto parts. The summarised profit and loss accounts of the two companies for 2014 are as follows:

Jacobs Ltd (GH¢’000) Idowu Co Ltd (GH¢’000)
Sale Revenue 1,500 800
Operating Expenses (800) (620)
Profit 700 180

Each company has earned a constant level of profit for a number of years, and both are expected to continue to do so. The policy of both companies is to distribute all profits as dividends to ordinary shareholders as they are earned. Neither company has any fixed interest capital. Details of the ordinary share capital of the two companies are as follows:

Jacobs Ltd (GH¢’000) Idowu Co Ltd (GH¢’000)
Authorised Ordinary Shares 2,500 2,000
Issued Ordinary Shares 2,000 1,000
Market Value per Share (Ex Div) 3.50 1.50

The directors of Jacobs Limited are considering submitting a bid for the entire share capital of Idowu Co Limited. They believe that, if the bid succeeds, the combined sales revenue of the two companies will increase by GH¢60,000 per annum, and savings in operating expenses, amounting to GH¢50,000 per annum, will be possible. Part of the machinery at present owned by Idowu Co Limited would no longer be required and could be sold for GH¢100,000. Furthermore, the directors of Jacobs Limited believe that the takeover would result in a reduction to 9% in the annual return required by the ordinary shareholders of Idowu Co Limited.

Required:
i) On the basis of the above information, calculate the maximum price that Jacobs Ltd should be willing to pay for the entire share capital of Idowu Co Limited. (6 marks)
ii) Calculate the minimum price that the ordinary shareholders in Idowu Co Ltd should be willing to accept for their shares. (4 marks)

Assume that the takeover price is agreed at the figure calculated in part (ii) above, and that the purchase consideration will be settled by an exchange of ordinary shares in Idowu Co Ltd for the ordinary shares of Jacobs Ltd. Show how the entire benefit from the takeover will accrue to all the present shareholders of Jacobs Ltd. (6 marks)

The sale of the unused machinery would generate GH¢100,000, so the total value after the acquisition is:

TotalValue=GH¢9,900,000+GH¢100,000=GH¢10,000,000Total Value = GH¢9,900,000 + GH¢100,000 = GH¢10,000,000

Step 5: Calculate the maximum price
The maximum price Jacobs Ltd should pay is the difference between the value after the acquisition and its current value before the acquisition.

  • Current value of Jacobs Ltd: 2,000,000 shares × GH¢3.50 per share = GH¢7,000,000
  • Maximum price for Idowu Co Ltd: GH¢10,000,000 – GH¢7,000,000 = GH¢3,000,000

ii) Minimum price Idowu Co Ltd shareholders should accept

The minimum price that the ordinary shareholders in Idowu Co Ltd should accept is the current market value of their shares.

  • Market value of Idowu Co Ltd: 1,000,000 shares × GH¢1.50 per share = GH¢1,500,000

Thus, the minimum price the ordinary shareholders in Idowu Co Ltd should accept is GH¢1,500,000.

(Total: 10 marks)

b)

The agreed takeover price for Idowu Co Ltd was GH¢1,500,000, based on the minimum acceptable price for Idowu’s shareholders as calculated in part 3(a)(ii).

We need to determine how the entire benefit from the acquisition will accrue to the shareholders of Jacobs Ltd using a share exchange mechanism.

Step 1: Determine the number of shares to be issued in exchange

Let x represent the number of new shares to be issued to Idowu Co Ltd’s shareholders. The total number of shares in issue after the acquisition will be 2,000,000 shares (since Jacobs Ltd originally has 2,000,000 issued shares).

The total value of Jacobs Ltd after the acquisition is GH¢10,000,000 (as calculated in 3(a)(i)).

For the benefit of the acquisition to accrue fully to Jacobs Ltd’s shareholders, the value of the shares issued to Idowu Co Ltd’s shareholders should equal the agreed takeover price of GH¢1,500,000. This gives us the following equation:

 

The market value per share after the acquisition will be:

Before the acquisition, the market value of Jacobs Ltd’s shares was GH¢3.50 per share. After the acquisition, the value of each share increases to GH¢4.25, representing a gain of GH¢0.75 per share.

For Jacobs Ltd’s original 2,000,000 shares:

2,000,000×0.75=GH¢1,500,000 

Thus, the shareholders of Jacobs Ltd will receive the entire benefit from the acquisition, which is GH¢1,500,000, the same as the agreed takeover price.

  • 14 Marks

AFM – Nov 2016 – L3 – Q1b – Business reorganisation | Valuation of acquisitions and mergers

Calculate and analyze the effects of a proposed spin-off on shareholder wealth and discuss reasons and disadvantages of a spin-off.

Last Chance Limited operates various manufacturing and retail operations throughout Ghana and has 400 million GH¢0.25 ordinary shares in issue. For the year that has just ended, the directors reported total after-tax profits of GH¢300 million and the P/E ratio of the company is 11.4 times.

The company has developed sophisticated computer software over the years and now considers ‘spinning-off’ its subsidiary, Ananse Systems Limited. Ananse Systems Limited has contributed GH¢40 million of the total after-tax profits of Last Chance Limited. After the spin-off, Last Chance Limited’s P/E ratio is expected to reduce to 11.0 times, while Ananse Systems Limited is expected to attract a P/E ratio of either 17 or 18 times.

Required:
i) Suggest THREE reasons why Last Chance Limited may wish to ‘spin-off’ part of its operations. (3 marks)
ii) Discuss THREE possible disadvantages of a ‘spin-off’ for the shareholders of Last Chance Limited. (3 marks)
iii) Calculate the likely effect of the proposed ‘spin-off’ on the wealth of a shareholder holding 10,000 ordinary shares in Last Chance, assuming that Ananse Systems Limited trades at a P/E ratio of 17 times and 18 times. (8 marks)
(Ignore taxation)

i) Three reasons for ‘spin-off’:

  • Market sentiment: Investors may feel more confident in separate, specialized companies rather than a conglomerate, increasing shareholder value.
  • Market valuations: The market may undervalue a particular operation. A spin-off can help unlock the value of that operation.
  • Strategic objectives: Directors may wish to focus on the core business, spinning off non-core operations for better strategic alignment.
    (3 marks)

ii) Three disadvantages of ‘spin-off’:

  • Increased vulnerability to takeover: After the spin-off, Last Chance may become a smaller, more attractive acquisition target.
  • Reduced ability to raise finance: A smaller company post-spin-off may struggle to raise finance through debt or equity.
  • Loss of economies of scale: With reduced size, Last Chance may lose advantages like bulk purchasing and shared administrative costs.
    (3 marks)

iii) Effect of spin-off on shareholder wealth:

  • Before spin-off:
    Value of one share in Last Chance Ltd = GH¢300 million × 11.4 / 400 million = GH¢8.55
    Value of 10,000 shares = 10,000 × GH¢8.55 = GH¢85,500
  • After spin-off:
    Earnings available to Last Chance Ltd after spin-off = GH¢300 million – GH¢40 million = GH¢260 million
    Value of one share in Last Chance Ltd after spin-off = GH¢260 million × 11.0 / 400 million = GH¢7.15
    Value of 10,000 shares = 10,000 × GH¢7.15 = GH¢71,500

Ananse Systems Ltd (P/E ratio of 17 times):
Value of one share in Ananse Systems = GH¢40 million × 17 / 64 million = GH¢10.625
Value of 10,000 shares = (1/8 × 10,000) × GH¢10.625 = GH¢13,281
Total wealth of the shareholder = GH¢71,500 + GH¢13,281 = GH¢84,781

Ananse Systems Ltd (P/E ratio of 18 times):
Value of one share in Ananse Systems = GH¢40 million × 18 / 64 million = GH¢11.25
Value of 10,000 shares = (1/8 × 10,000) × GH¢11.25 = GH¢14,062
Total wealth of the shareholder = GH¢71,500 + GH¢14,062 = GH¢85,562

Comment on findings:
The shareholder’s wealth after the spin-off is nearly equal to or slightly higher than before the spin-off, indicating a marginal benefit at best. There is a risk that shareholder wealth could be reduced, depending on the P/E ratio achieved by Ananse Systems.

 

  • 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.

  • 15 Marks

AFM – May 2019 – L3 – Q3a – Valuation of acquisitions and mergers

Use comparative analysis to value Alpha Ltd based on data from Beta Ltd and Gamma Ltd, and discuss factors for private company valuation.

At a meeting of the Directors of the Alpha Company Limited – a privately owned company – in May 1975, the recurrent question is raised as to how the company is going to finance its future growth and at the same time enable the founders of the company to withdraw a substantial part of their investment. A public quotation was discussed in 1974 but because of the depressed nature of the stock market at that time, consideration was deferred. Although the matter is not of immediate urgency, the Chairman of the company – one of the founders – produces the following information which he has recently obtained from a firm of financial analysts in respect of two publicly quoted companies, Beta Limited and Gamma Limited, which are similar to Alpha Limited in respect to size, asset composition, financial structure, and product mix.

The only information you have available at the meeting in respect of Alpha Limited is the final accounts for 1974, which disclose the following:
Alpha Limited
Share Capital (no variation for 8 years) 100,000 Ordinary GH¢1 Share
Post-Tax Earnings GH¢400,000
Gross Dividends GH¢100,000
Book Value GH¢3,500,000

From memory, you are of the view that the post-tax earnings and gross dividends for 1974 were at least one-third higher than the average of the previous five years.

Required:

i) Use the information provided to answer the Chairman’s question on what Alpha Ltd was worth in 1974.
ii) Discuss FOUR (4) factors to be taken into account in trying to assess the potential market value of shares in a private company when they are first offered for public subscription.

i) Valuation of Alpha Ltd

ii) Factors to Consider in Valuing a Private Company for Public Offering

  1. Opportunity Cost:
    Investors will compare the expected returns from the company’s shares with the returns from alternative investments. If the potential return on investment is not competitive, investors may not subscribe to the shares.
  2. Risk Perception:
    The perceived risk of investing in a private company will affect its valuation. Private companies generally carry higher risk, and this may result in a lower valuation due to risk premiums.
  3. Marketability:
    The ease with which shares can be traded once they are publicly listed will influence valuation. Less liquid shares may be valued lower due to the risk of being unable to quickly sell them when needed.
  4. Information Asymmetry:
    Investors may have limited information about the private company’s operations and finances, which increases uncertainty and can lead to lower valuation. Public companies generally provide more transparency, reducing this gap.
  • 20 Marks

AFM – Nov 2017 – L3 – Q3 – Valuation of acquisitions and mergers

Calculating the valuation per share for minority and complete takeover of Fasco and Boscan, and discussing limitations of the approach.

Zed Ltd is considering the immediate purchase of some, or all, of the share capital of one of two firms—Fasco Ltd and Boscan Ltd. Both Fasco Ltd and Boscan Ltd have one million ordinary shares issued, and neither company has any debt capital outstanding.

Both firms are expected to pay a dividend in one year’s time—Fasco’s expected dividend amounting to 30p per share, and Boscan’s being 27p per share. Dividends will be paid annually and are expected to increase over time. Fasco’s dividends are expected to display perpetual growth at a compound rate of 6% per annum. Boscan’s dividend will grow at the high annual compound rate of 33⅓% until a dividend of 64p per share is reached in year 4. Thereafter, Boscan’s dividend will remain constant.

If Zed is able to purchase all the equity capital of either firm, then the reduced competition would enable Zed to save some advertising and administrative costs, which would amount to GH¢225,000 per annum indefinitely, and, in year 2, to sell some office space for GH¢800,000. These benefits and savings will only occur if a complete takeover is carried out. Zed would change some operations of any company completely taken over, the details are:

  • Fasco – No dividend would be paid until year 3. Year 3 dividend would be 25p per share, and dividends would then grow at 10% per annum indefinitely.
  • Boscan – No change in total dividends in years 1 to 4, but after year 4, dividend growth would be 25% per annum compound until year 7. Thereafter, annual dividends would remain constant at the year 7 amount per share.

An appropriate discount rate for the risk inherent in all the cash flows mentioned is 15%.

Required:
a) Calculate the valuation per share for a minority investment in each of the firms, Fasco and Boscan, which would provide the investor with a 15% rate of return. (6 marks)

b) Calculate the maximum amount per share which Zed should consider paying for each company in the event of a complete takeover. (8 marks)

c) Comment on any limitation of the approach used in part (a), and specify the other major factors which would be important to consider if the proposed valuations were being undertaken as a practical exercise. (6 marks)

Valuation per share for a minority investment

Using the dividend valuation model (DVM), the value of ordinary shares is given by:

 

c) Limitations of the Approach

  • Dividend Growth Assumptions: The dividend valuation model assumes that dividends grow at a constant rate indefinitely, which may not hold in real-life scenarios. Boscan’s variable dividend growth complicates the model.
  • Market Conditions: The model does not account for the short-term market factors or price-earnings ratio that may affect stock prices.
  • Synergies: The assumed synergies and cost savings may not materialize in practice, affecting the overall valuation.

Other factors to consider include:

  • Management changes after acquisition.
  • Competitive responses in the market.
  • Financing options and capital structure post-acquisition.
  • 20 Marks

AFM – Nov 2015 – L3 – Q5 – Valuation of acquisitions and mergers

Evaluate the acquisition of Anas-Expo Clothing Ltd by Two-Pack Fashion Ltd, analyzing its effect on EPS, shareholders' wealth, and sources of conflict.

You are the Finance Manager of a growing clothing company, Two-Pack Fashion Ltd (Two-Pack). Two-Pack has enjoyed significant growth in recent years using an internal growth strategy. Two-Pack is now seeking to acquire other companies to speed up its growth drive. It has identified Anas-Expo Clothing Ltd (Anas-Expo) as a suitable candidate for takeover. Both companies have the same level of risk.

Anas-Expo produces high-quality handmade clothes, with which it has earned several awards. The company has recorded considerable profits in the past, but its output has dwindled over the past two years due to increasing labour costs. Labour unions have pressured policymakers into amending labour regulations, particularly those relating to pensions and minimum wages, to provide more benefits and protection for workers. Directors of Two-Pack believe that production and profitability of Anas-Expo will be enhanced if its production process is mechanized.

Below are summarized financial data for the two companies immediately before acquisition:

Two-Pack (GHS’m) Anas-Expo (GHS’m)
Sales revenue 285.8
Net operating income 85.8
Interest charges 14.2
Net income before tax 71.6
Corporate tax 15.8
Net income after tax 55.8
Dividends 22.3
Addition to retained earnings 33.5

Two-Pack has 40 million shares and a P/E ratio of 18, while Anas-Expo has 25 million shares and a P/E ratio of 12. Directors of Two-Pack have decided that Two-Pack takes up all the equity shares in Anas-Expo by offering to its shareholders one new share for every share they hold. They have also decided that Two-Pack mechanizes Anas-Expo’s production process immediately at the cost of GHS18 million, replacing work currently done by hand. It is estimated that operational efficiency arising from the acquisition and integration of the two companies would yield after-tax benefits of GHS25 million per year to perpetuity. The cost of capital of Two-Pack is 25%.

Required:

(a) Evaluate the acquisition proposal, and recommend whether the acquisition should go ahead.
(b) Analyze the effect of the acquisition on the earnings per share (EPS) of Two-Pack following the successful acquisition of Anas-Expo.
(c) Analyze the effect of the acquisition on the wealth of the shareholders of each company.
(d) Advise the directors of Two-Pack on three likely sources of conflict in relation to the acquisition of Anas-Expo and the mechanization of its production process, and suggest ways through which the conflict could be avoided or resolved.

a) Evaluation of the Acquisition Proposal
The net present value (NPV) of the acquisition can be computed by evaluating the synergy benefits and acquisition costs. The present value of the synergy is:

The cost of the acquisition is calculated as the market value of the shares issued by Two-Pack to acquire Anas-Expo. Anas-Expo has 25 million shares, and the share price after acquisition will be:

Post-acquisition share price=

Post-acquisition share price==22.94 GHS

The cost of acquisition is then:

Cost of acquisition=22.94 GHS×25 million shares=573.5 million 

Therefore, the NPV of the acquisition is:

NPV=100 million GHS−(573.5 million GHS−404.4 million GHS=−87.1 million GHS

Recommendation: Since the NPV is negative, the acquisition should not proceed unless the acquisition price or synergy benefits can be improved.

(b) Effect on Earnings per Share (EPS)
The post-acquisition EPS is computed by summing the earnings of both companies and dividing by the new number of shares.

  • Total earnings after acquisition = GHS55.8m + GHS33.7m + GHS25m = GHS114.5m
  • Number of shares = 40m (Two-Pack) + 25m (Anas-Expo) = 65m shares
  • Post-acquisition EPS = GHS114.5m / 65m = GHS1.76

The EPS will increase from GHS1.395 to GHS1.76, an increase of GHS0.365.

(c) Effect on Shareholders’ Wealth
For Two-Pack shareholders, the value of their shares will drop from:

  • Pre-acquisition price = GHS25.11
  • Post-acquisition price = GHS22.94

This results in a loss of GHS86.8 million in market value for Two-Pack shareholders.

For Anas-Expo shareholders, the value of their shares will increase from GHS16.176 to GHS22.94, a gain of GHS169.1 million.

(d) Likely Sources of Conflict

  1. Impact on Employees: The mechanization will likely lead to job losses, creating resistance from employees and unions. This can be mitigated by offering adequate compensation and retraining opportunities.
  2. Cultural Clash: The integration of the two companies may lead to conflicts between management teams due to differences in corporate cultures. A smooth integration process with clear communication and shared goals can help manage this.
  3. Quality Concerns: Anas-Expo’s handmade products are well-known for their quality, and mechanization may reduce product quality, leading to dissatisfaction among customers. A phased approach to mechanization, along with efforts to maintain product quality, can help resolve this issue.
  • 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)

  • 12 Marks

AFM – May 2018 – L3 – Q3b – Valuation of acquisitions and mergers

Evaluating the favourability of a takeover and its impact on EPS and share price.

Okumkom Ltd has a current price of GH¢2.20 per share and a price/earnings ratio of 15. At present, it has 10 million, GH¢1.00 ordinary shares issued. Okumkom Ltd is considering the takeover of Dasco Ltd. The current price of each of Dasco’s 4 million issued shares is 330 pesewas. Dasco’s price/earnings ratio is 10. Okumkom Ltd expects to be able to purchase the shares at their current price and will pay for them with an issue of its own shares valued at their current price.

Okumkom Ltd wishes to know how many shares to offer for each of Dasco Ltd’s shares, and the effect of the takeover on Okumkom Ltd’s reported earnings per share and share price.

Required:
Evaluate the favourability of this takeover and comment on your computations. (12 marks)

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