CA.CS. Naveen. Rohatgi                               TYBMS: FINANCIAL MANAGEMNTMERGER AND ACQUISITION :ExpansionExpansion ...
CA.CS. Naveen. Rohatgi                              TYBMS: FINANCIAL MANAGEMNTJOINT VENTUREIn a Joint Venture two companie...
CA.CS. Naveen. Rohatgi                              TYBMS: FINANCIAL MANAGEMNTDemerger : The act of splitting off a part o...
CA.CS. Naveen. Rohatgi                              TYBMS: FINANCIAL MANAGEMNTDisinvestment/ Privitisation: Privatisation ...
CA.CS. Naveen. Rohatgi                              TYBMS: FINANCIAL MANAGEMNTVertical MergersA vertical merger involves m...
CA.CS. Naveen. Rohatgi                             TYBMS: FINANCIAL MANAGEMNTable to generate) and cost savings (to reduce...
CA.CS. Naveen. Rohatgi                               TYBMS: FINANCIAL MANAGEMNT           y   Sanction by the High Court:-...
CA.CS. Naveen. Rohatgi                            TYBMS: FINANCIAL MANAGEMNT                                              ...
CA.CS. Naveen. Rohatgi                              TYBMS: FINANCIAL MANAGEMNTPoor Business Fit: When the product or servi...
CA.CS. Naveen. Rohatgi                            TYBMS: FINANCIAL MANAGEMNTThere are only three approaches to value a bus...
CA.CS. Naveen. Rohatgi                            TYBMS: FINANCIAL MANAGEMNTmeaningful comparison. The difficulty lies in ...
CA.CS. Naveen. Rohatgi                              TYBMS: FINANCIAL MANAGEMNT    1. What is the present EPS of both the c...
CA.CS. Naveen. Rohatgi                              TYBMS: FINANCIAL MANAGEMNTCalculate:   a. EPS and P/E of both firms be...
CA.CS. Naveen. Rohatgi                               TYBMS: FINANCIAL MANAGEMNT                                XYZ LTD    ...
CA.CS. Naveen. Rohatgi                            TYBMS: FINANCIAL MANAGEMNT                              Large           ...
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48341855 merger-and-acquistion-3

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48341855 merger-and-acquistion-3

  1. 1. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNTMERGER AND ACQUISITION :ExpansionExpansion is a form of restructuring, which results in an increase in the size of the firm. It cantake place in the form of a merger, acquisition, tender offer; asset acquisition or a joint venture.MERGERMerger is defined as a combination of two or more companies into a single company. A mergercan take place either as an amalgamation or absorption.AmalgamationThis type of merger involves fusion of two or more companies. After the amalgamation, the twocompanies lose their individual identity and a new company comes into existence. A new firmthat is hitherto, not in existence comes into being. This form is generally applied to combinationsof firms of equal size.Example: The merger of Brooke Bond India Ltd., with Lipton India Ltd., resulted in theformation of a new company Brooke Bond Lipton India Ltd.AbsorptionThis type of merger involves fusion of a small company with a large company. After the mergerthe smaller company ceases to exist.Example: The merger of Bank of Rajasthan with ICICI Bank. After Merger the Bank ofRajasthan ceases to exist. The merger of Oriental Bank of Commerce with Global Trust Bank.After the merger, GTB ceased to exist while the Oriental Bank of Commerce expanded andcontinued.TENDER OFFERTender offer involves making a public offer for acquiring the shares of the target company with aview to acquire management control in that company.Example: (1) Flextronics International giving an open market offer at Rs.548 for 20% of paid-upcapital in Hughes Software Systems.(2) Astrazenca Pharmaceuticals AB, a Swedish firm, announced an open offer to acquire 8.4%stake in Astrazenca Pharma India at a floor price of Rs.825 per share.ASSET ACQUISITIONAsset acquisitions involve buying the assets of another company. These assets may be tangibleassets like a manufacturing unit or intangible assets like brands. In such acquisitions, the acquirercompany can limit its acquisitions to those parts of the firm that coincide with the acquirer¶sneeds.Example: The acquisition of the cement division of Tata Steel by Laffarge of France. Laffargeacquired only the 1.7 million tonne cement plant and its related assets from Tata Steel.The asset being purchased may also be intangible in nature. For example, Coca Cola paid Rs.170crore to Parle to acquire its soft drinks brands like Thums Up, Limca, Gold Spot, etc.Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  2. 2. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNTJOINT VENTUREIn a Joint Venture two companies enter into an agreement to provide certain resources towardsthe achievement of a particular common business goal. It involves intersection of only a smallfraction of the activities of the companies involved and usually for a limited duration. Theventure partners according to the pre-arranged formula, share the returns obtained from theventure. Usually the multinational companies use this strategy to enter into foreign market.Example: The proposed joint venture between Tata Global Beverages (TGB) and PepsiCo,announced this April to develop beverages in the health, is likely to begin with developingaffordable water. The possibility of pricing a one-litre bottle of water below Rs 10, perhaps evenaround Rs 5.Anil Ambani¶s Reliance Media World will form an equal joint venture with iconic Americanmedia company CBS Corporation to launch a potentially disruptive network of televisionchannels under the Brand BIG CBS.Take over : A take over generally involves acquisition of certain equity capital which enablesthe acquirer to exercise control over the affairs of the company. Example United breweriesacquired majority stake in Deccan aviation Ltd. Mahindra Telecom takeover of Satyam. Otherexample are Indal by Hindalco, IPCL by Reliance industries, VSNL by Tatas, Balco by Sterlite.In theory the acquirer must buy more than 50% of the paid up capital of the acquired company toenjoy complete control. In practice however effective control can exercised by holding between20% to 40%. Since the remaining shareholders are small and scattered. Take over can behostile takeover or friendly takeover.Hostile Takeover of a company against the wishes of current management and the board ofdirectors. This takeover may be attempted by another company or by HNI. If the price offered ishigh enough, shareholders may vote to accept the offer even if management resists and claimsthat the company is actually worth even more. If the acquirer raises the price high enough,management may change its attitude, converting the hostile takeover into a friendly one.Example The recently consummated Arcelor Mittal deal is an example of hostile takeover,where the LN Mittal group acquired management control of Arcelor against the wishes of theArcelor management. India Cements takes over Rassi Cements in 1998.ITC Ltd takes over EastIndia Hotels Ltd in 2000Friendly takeover: It is a takeover effected with the consent of the taken over company. In thiscase there is an agreement between the managements of the two companies through negotiationsand the takeover bid may be with the consent of majority shareholders of the target company. Itis also known as negotiated takeover. Merger of Brooke Bond and Lipton has formed a newentity Broke bond lipton with permission of its Board, it is termed as Friendly takeoverContractionContraction is a form of restructuring, which results in a reduction in the size of the firm. It cantake place in the form of a Demerger, Partial sell off or equity carve-out.Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  3. 3. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNTDemerger : The act of splitting off a part of an existing company to become a new company,which operates completely separate from the original company. Shareholders of the originalcompany are usually given an equivalent stake of ownership in the new company. A demerger isoften done to help each of the segments operate more smoothly, as they can now focus on a morespecific task. opposite of merger. For eg In this case, Bajaj limited has been demerged into (a)Bajaj auto limited to focus on the auto business, (b) Bajaj Finserv Ltd (BFSL) to focus on windenergy generation, insurance, consumer finance etc, and (c) Bajaj Holdings & Investment Ltd(BHIL) to focus on investments and new business opportunities. For example Dabur Indiademerged in july, 2003, Demerger of L & T cement division to a new entity CEMCO, Demergerof Reliance industries in August 2005. In most of these cases, investors have gained in case ofdemerer in case of RIL, shareholders got shares in four other ventures including telecom, powerand finance. All of these have done quite well post the separation. For 100 shares in RIL, theyreceived the same number of shares in Reliance Communication Ventures and RNRL, and asmaller number in Capital and Energy holding companies.Partial selloff :A partial sell off involves the sale of the business division or plant of onecompany to another . It is the miiror image of a purchase of a business.SPLIT-UPS:In a split-up the entire firm is broken up in series of spin-offs, so that the parent company nolonger exists and only the new offsprings survive. A split-up involves the creation of a new classof stock for each of the parent¶s operating subsidiaries, paying current shareholders a dividend ofeach new class of stock, and then dissolving the parent company. Stockholders in the newcompanies may be different as shareholders in the parent company may exchange their stock forstock in one or more of the spin-offs.Example: The Andhra Pradesh State Electricity Board (APSEB) was split-up in 1999 as part ofthe Power Sector reforms. The power generation business and the transmission and distributionbusiness was transferred to two separate companies called APGENCO and APTRANSCOrespectively. APSEB ceased to exist as a result of the split-up.EQUITY CARVE-OUTA Equity carve out, a parent company sells a portion of its equity in a wholly ownedsubsidary.The sale may be a general public or strategic investor.Other forms of restructingLEVERAGE BUYOUTLeveraged buyout is a financing technique where debt is used in the acquisition of a company.The term is often applied to a firm-borrowing fund to buy-back its stock to convert from apublicly owned to a privately owned company. A management buyout is a LBO. in whichmanagers of the firm to be taken private are also equity investors. Tata Steels acquisition ofCorus is a classic example of leveraged buyout. Typically, in such a buyout as much as 90 percent of the funds required for the takeover are mobilised through borrowings principally throughjunk bonds carrying high interest.Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  4. 4. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNTDisinvestment/ Privitisation: Privatisation involves transfer of ownership (represnted by equityshares)partial or total of public enterprises from the government to individual and non-govtinstitutions. the government will look into the possibility of disinvestment in Oil and Natural GasCorporation and Indian Oil Corporation in the current fiscal itself. However, disinvestmentsecretary Sumit Bose said right now there is nothing on the cards.Aiming to raise Rs 40,000 crore (Rs 400 billion) through disinvestment this fiscal, so far, thegovernment could mobilise only Rs 1,000 crore (Rs 10 billion) in Satluj Jal Vidyut Nigam.Besides, the government expects to mop up Rs 977 crore (Rs 9.77 billion) from the 10 per centdisinvestment in the state-run Engineers India . "We are hopeful to meet the Rs 40,000 croredisinvestment target," Bose said. Further said divestment in PowerGrid, Coal India, Hindustan Copper , SAIL , Manganese Ore,is likely in the current fiscal. But this would not add up to Rs 40,000 crore so there could bemore in the list selloff list for the current fiscal. "As and when we will get the Cabinet approvalfor other companies, it would be communicated," Bose added.Finance Minister Pranab Mukherjee had set a target of mobilising Rs 40,000 crore this fiscalfrom the divestment process to part fund the social sector investment and bridge the wideningfiscal deficit.Last fiscal the government had raised Rs 25,000 crore (Rs 250 billion) from divestment in OilIndia, NHPC, NTPC, NMDC and REC.TYPES OF MERGERS(i) Horizontal mergers, (ii) Vertical mergers, and (iii) Conglomerate mergers.Horizontal MergerA horizontal merger involves a merger between two firms operating and competing in the samekind of business activity. The main purpose of such mergers is to obtain economies of scale ofproduction. The economies of scale is obtained by the elimination of duplication of facilities andoperations and broadening the product line, reduction in investment in working capital,elimination of competition in a product, reduction in advertising costs, increase in market share,exercise of better control on market, etc.Horizontal mergers result in decrease in the number of firms in an industry and hence such typeof mergers make it easier for the industry members to join together for monopoly profits.The merger of Centurion Bank and Bank of Punjab, Oriental Bank of Commerce and GTB inBanking Sector, Tata Industrial Finance Ltd., with Tata Finance Ltd., in Finance Sector. A bigmerger between Holicim and Gujarat Ambuja Cement Ltd., with Associated Cement companiesis also a merger in the manufacturing industry. Essar-Hutch and BPL¶s mobile merger, VSNL¶sacquisition of Chennai based Dishnet DSL¶s Internet Service Provider (ISP) are some otherhorizontal mergers that took place recently.Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  5. 5. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNTVertical MergersA vertical merger involves merger between firms that are in different stages of production orvalue chain. They are combination of companies that usually have buyer-seller relationships. Acompany involved in a vertical merger usually seeks to merge with another company or wouldlike to take over another company mainly to expand its operations by backward or forwardintegration. In vertical combination, the merging company would be either a supplier or a buyerusing its product as an intermediary material for final production.Firms integrate vertically between various stages due to reasons like technological economies,elimination of transaction costs, improved planning for inventory and production, reconciliationof divergent interests of parties to a transaction, etc. Anti-competitive effects have also beenobserved as both the motivation and the result of these mergers.Examples: Nirma¶s bid for Gujarat Heavy Chemical (backward integration) or HindalcoBidding for Pennar Aluminium (forward integration). Videocon Group¶s acquisition ofThomson¶s Colour Picture Tube Business in China.Conglomerate MergersConglomerate mergers involve merger between firms engaged in unrelated types of businessactivity. The basic purpose of such combination is utilization of financial resources. Such type ofmerger enhances the overall stability of the acquirer company and creates balance in thecompany¶s total portfolio of diverse products and production processes and thereby reduces therisk of instability in the firm¶s cash flows. For example BankCorp of America- HughesElectronics.Advantages of Mergers & Acquisitions.# Economies of Scale: This generally refers to a method in which the average cost per unit isdecreased through increased production, since fixed costs are shared over an increased number ofgoods. In a layman¶s language, more the products, more is the bargaining power. This is possibleonly when the companies merge/ combine/ acquired, as the same can often obliterate duplicatedepartments or operation, thereby lowering the cost of the company relative to theoretically thesame revenue stream, thus increasing profit. It also provides varied pool of resources of both the0combining companies along with a larger share in the market, wherein the resources can beexercised.# Increased revenue /Increased Market Share: This motive assumes that the company will beabsorbing the major competitor and thus increase its power (by capturing increased marketshare) to set prices.# Cross selling: For example, a bank buying a stock broker could then sell its banking productsto the stock brokers customers, while the broker can sign up the bank¶ customers for brokerageaccount. Or, a manufacturer can acquire and sell complimentary products.# Corporate Synergy: Better use of complimentary resources. It may take the form of revenueenhancement (to generate more revenue than its two predecessor standalone companies would beYesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  6. 6. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNTable to generate) and cost savings (to reduce or eliminate expenses associated with running abusiness).# Taxes : A profitable can buy a loss maker to use the target¶s tax right off i.e. wherein a sickcompany is bought by giants.# Geographical or other diversification: this is designed to smooth the earning results of acompany, which over the long term smoothens the stock price of the company givingconservative investors more confidence in investing in the company. However, this does notalways deliver value to shareholders.# Resource transfer: Resources are unevenly distributed across firms and interaction of target andacquiring firm resources can create value through either overcoming information asymmetry orby combining scarce resources. Eg: Laying of employees, reducing taxes etc.# Improved market reach and industry visibility - Companies buy companies to reach newmarkets and grow revenues and earnings. A merge may expand two companies marketing anddistribution, giving them new sales opportunities. A merger can also improve a companysstanding in the investment community: bigger firms often have an easier time raising capital thansmaller ones.P6ROCEDURE OF MERGER AND ACQUISITION:The Act lays down the legal procedures for mergers or acquisitions :- y Permission for merger:- Two or more companies can amalgamate only when the amalgamation is permitted under their memorandum of association. Also, the acquiring company should have the permission in its object clause to carry on the business of the acquired company. In the absence of these provisions in the memorandum of association, it is necessary to seek the permission of the shareholders, board of directors and the Company Law Board before affecting the merger. y Information to the stock exchange:- The acquiring and the acquired companies should inform the stock exchanges (where they are listed) about the merger. y Approval of board of directors:- The board of directors of the individual companies should approve the draft proposal for amalgamation and authorize the managements of the companies to further pursue the proposal. y Application in the High Court:- An application for approving the draft amalgamation proposal duly approved by the board of directors of the individual companies should be made to the High Court. y Shareholders and creators meetings:- The individual companies should hold separate meetings of their shareholders and creditors for approving the amalgamation scheme. At least, 75 percent of shareholders and creditors in separate meeting, voting in person or by proxy, must accord their approval to the scheme.Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  7. 7. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNT y Sanction by the High Court:- After the approval of the shareholders and creditors, on the petitions of the companies, the High Court will pass an order, sanctioning the amalgamation scheme after it is satisfied that the scheme is fair and reasonable. The date of the courts hearing will be published in two newspapers, and also, the regional director of the Company Law Board will be intimated. y Filing of the Court order:- After the Court order, its certified true copies will be filed with the Registrar of Companies. y Transfer of assets and liabilities:- The assets and liabilities of the acquired company will be transferred to the acquiring company in accordance with the approved scheme, with effect from the specified date. y Payment by cash or securities:- As per the proposal, the acquiring company will exchange shares and debentures and/or cash for the shares and debentures of the acquired company. These securities will be listed on the stock exchange.Due DiligenceThe basic function of due diligence is to assess the benefits and the costs of a proposedacquisition by inquiring into all relevant aspects of the past, present and the predictable future ofa business to be purchased. Due diligence is of vital importance to prevent ³unpleasant surprises´after completing the acquisition. The due diligence should be thorough and extensive. Both theparties to the transaction should conduct their own due diligence to get the accurate assessmentof potential risks and rewards. Generally, it is a process of enquiry and investigation aboutproposed merger deal. It is a judgment process of the deal. The due diligence consists of fivestrands, viz.,y The verification of assets and liabilities.y The identification and quantification of risks.y The protection needed against such risks which will in turn feed into the negotiations.y The identification of synergy benefits.y Post-acquisition planning.Due Diligence Topics and-their Focus on Enquiry Due Diligence Focus of Enquiries Expected Results Topics Financial Historical records, review of Confirms underlying profits. management and systems. Provides basis for valuation. Legal Various contractual Acts in the Warranties and indemnities, country. validation of all existing contracts, sale and purchase agreement. Commercial Market conditions, competitive Sustainability of future profits, position and target¶s commercial planning, decision on strategy to be prospects. adopted for the combined business. Tax Existing tax levels, liabilities and Avoid any unforeseen tax arrangements. liabilities, opportunities to optimize position of combined business. Management Management quality, Identification of key integration organizational structure issues, outline of new structure forYesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  8. 8. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNT the combined business.REASONS FOR FAILURE OF MERGE AND ACQUISITIONSThere are various reasons why mergers and acquisitions fail. The most common of these reasonsare:Payment of High Price: In a competitive bidding situation, a company may tend to pay more.Often highest bidder is one who overestimates value out of ignorance. Though he emergesas the winner, he happens to be in a way the unfortunate winner. This is called winnerscurse hypothesis. When the acquirer fails to achieve the synergies required compensatingthe price, the M&As fails. More you pay for a company, the harder you will have to work tomake it worthwhile for your shareholders. When the price paid is too much, how well thedeal may be executed, the deal may not create value.Culture Clash: Lack of proper communication, differing expectations, and conflictingmanagement styles due to differences in the corporate culture contribute to failure ofimplementation plan and hence failure of the merger.One of the reasons for the dismal performance of the Warner Hindustan Parke Da is merger wasthe absence of a well defined strategy to merge the two cultures Both were well-establishedcompanies with strong but different cultures While Parke Davis was a people driven companywith a participative culture Warner Hindustan was a more task-focused and formal organizationEven though the merger focused on rationalizing the facilities, restructuring and allocation ofdesignations, the cultural and procedural issues were left unattended. The differences in thecultural orientations and operating rules created many operational bottlenecks and resulted inlowering of performance.Size Issues A mismatch in the size between acquirer and target has been found to lead topoor acquisition performance. Many acquisitions fail either because of acquisitionindigestion through buying too big targets or failed to give the smaller acquisitions the timeand attention it required.Lack of researchAcquisition requires gathering a lot of data and information and analyzing it. It requiresextensive research. A carelessly carried out research about the acquisition causes thedestruction of acquirers wealth.Overstated Synergies: Acquisition can create opportunities of synergy by increasing revenues,reducing costs, producing net working capital and improving the investment intensity.Overestimation of such synergies may lead to a failure of the mergers.Inconsistent Strategy: For mergers and acquisitions to succeed they must be driven by a soundbusiness strategy. Inaccurate assessment of the strategic benefits of the merger may lead to itsfailure.Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  9. 9. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNTPoor Business Fit: When the product or service does not naturally fit into the acquirer¶smarketing, sales, distribution systems or geographic requirement, it no longer remains an idealfit. Such a firm delays efficient integration and may also lead to the failure of the mergers.Inadequate Due Diligence: The process of due diligence helps in detecting any financial andbusiness risks that the buyer might inherit from the seller. Inadequate due diligence results in thefailure of the merger.Over Leverage: Cash acquisitions frequently result in the acquirer assuming too much debt.Future interest costs consume a great portion of the acquired company¶s earnings. An even moreserious problem results when the acquirer resorts to cheaper short-term financing and then hasdifficulty refunding on a long-term basis. A well-planned capital structure is critical for asuccessful merger.Boardroom Split: When mergers are structured with 50/50 board representation or substantialrepresentation from the target, care must be taken to determine the compatibility of the directorsfollowing the merger. A failure to focus on this aspect of the merger can create or worsen aculture clash and slow down or prevent integration.Regulatory Delay: The announcement of a merger is a dislocating event for the employees andother constituents of one or both companies. It is customary to have detailed plans to deal withpotential problems immediately following an announcement. However, when there is thepossibility of regulatory delay, the risk of substantial deterioration of the business increases astime goes on, with valuable employees and customer and supplier relationships being lost. Thisloss is a key consideration in evaluating whether a particular merger should be undertaken.Valuation :The principal incentive for a merger is that the business value of the combined business isexpected to be greater than the sum of the independent business values of the mergingentities. The difference between the combined value and the sum of the values of individualcompanies is the synergy gain attributable to the M&A transaction. Hence,Value of acquirer + Stand alone value of Target + Value of Synergy = Combined Value.There is also a cost attached to an acquisition. The cost of acquisition is the price premiumpaid over the market value plus other costs of integration. Therefore, the net gain is thevalue of synergy minus premium paid.Suppose VA = Rs. 200, VB = Rs. 50 and VAB = Rs. 300, where VA and VB are the values ofcompanies A and B before merger respectively and VAB is the combined value after merger.Therefore, Synergy = VAB ± ( VA + VB ) = Rs. 50.If the premium is Rs. 20,Net gain from merger of A and B will be Rs. 30 (i.e. Rs. 50 ± Rs. 20). One of the essentialsteps in M&A is the valuation of the Target Company. Analysts use a wide range of modelsin practice for measuring the value of the Target firm. These models often make verydifferent assumptions about pricing, but they do share some common characteristics andcan be classified in broader terms. There are several advantages to such a classification : itis easier to understand where individual models fit into the bigger picture, why they providedifferent results and where they have fundamental errors in logic.Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  10. 10. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNTThere are only three approaches to value a business or business interest. However, thereare numerous techniques within each one of the approaches that the analysts may considerin performing a valuation.Income ApproachUnder this approach two primary used methods to value a business interest include :a) Discounted Cash flow methodb) Capitalized Cash flow methodEach of these methods depend on the present value of an enterprise¶s future cash flows. Discounted Cash flow TechniqueThe Discounted Cash flow valuation is based upon the notion that the value of an asset isthe present value of the expected cash flows on that asset, discounted at a rate that reflectsthe riskiness of those cash flows. The nature of the cash flows will depend upon the asset :dividends for an equity share, coupons and redemption value for bonds and the post taxcash flows for a project. The Steps involved in valuation under this method are as under :Step I : Estimate free cash flows available to all the suppliers of the capital viz. equityholders, preference investors and the providers of debt.Step II : Estimate a suitable Discount Rate for acquisition, which is normally representedby weighted average of the costs of all sources of capital, which are based on the marketvalue of each of the components of the capital.Step III: Cash flows computed in Step I are discounted at the rate arrived at in Step II.Step IV : Estimate the Terminal Value of the business, which is the present value of cashflows occurring after the forecast period.TV = CFt (1+ g ) , k-gwhere CFt is the cash flow in last year,g is constant growth rate andk is the discount rateStep V : Add the present value of free cash flows as arrived at in Step III and the TerminalValue as arrived at in StepIV. This will give the value of firm.Step VI: Subtract the value of debt and other obligations assumed by the acquirer to arriveat the value of equity.4.1.2 Capitalized Cash flow TechniqueThe Capitalized Cash flow technique of income approach is the abbreviated version ofDiscounted Cash flow technique where the growth rate (g) and the discount rate (k) areassumed to remain constant in perpetuity. This model is represented as under :Value of Firm = Net Cash flow in year one (k±g)Market approach:The market approach to business valuation has its origin in the economic principle ofsubstitution which says, ³Buyers would not pay more for an item than the price at whichthey can obtain an equally desirable substitute.´ The market price of the stocks of publiclytraded companies engaged in the same or similar line of business can be a valid indicator ofvalue when the transactions in which stocks are traded are sufficiently similar to permit aYesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  11. 11. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNTmeaningful comparison. The difficulty lies in identifying public companies that aresufficiently comparable to the subject company for this purpose.Suppose a company operating in the same industry as ABC with comparable size and othersituations has been sold at Rs. 500 crores in last week provides a good measurement forvaluation of business. Considering the circumstances, value of the business of ABC shouldbe around Rs. 500 crores under market approach.Asset approach:The first step in using the assets approach is to obtain a Balance Sheet as close as possibleto the valuation date. Each recorded asset including intangible assets must be identified,examined and adjusted to fair market value. Now all liabilities are to be subtracted, again atfair market value, from the value of assets derived as above to reach at the fair marketvalue of equity of the business. It is important to note here that any unrecorded assets orliabilities should also be considered while arriving at the value of business by the assetsapproach.None of the above methods is the best or none of them is the worst but each one has itsown advantages and view points different from others. All these methods should be used incombinations to arrive at proper valuation of the business.MERGER AND ACQUISTIONQ1) A Ltd. is considering the acquisition of B Ltd. Relevant financial information is givenbelow. A Ltd. B Ltd.Equity (No. of shares) 10,00,000 6,00,000NPAT 50,00,000 18,00,000Market Price Rs. 42 Rs.28a. What is the present EPS of both the companies?b. What should be P/E ratio of both the companiesc. If the proposed merger takes place what would be the new earnings per share for XYZ Ltd. (assuming the merger takes place by exchange of equity shares and the exchange ratio is based on the current market prices)?d. What should be the exchange ratio if ABC Ltd. want to ensure the same earnings to members as before the merger took place?Q2) OMEGA Ltd. is considering the acquisition of SOUND Ltd. Relevant financial informationis given below. OMEGA.LTD SOUND LTDNPAT Rs. 2,00,000 Rs. 60,000Equity (No. of shares) 40,000 10,000Market Price Rs. 15 Rs.12Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  12. 12. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNT 1. What is the present EPS of both the companies? 2. What should be P/E ratio of both the comapnies 3. If the proposed merger takes place what would be the new earnings per share for XYZ Ltd. (assuming the merger takes place by exchange of equity shares and the exchange ratio is based on the P/E 4. What should be the exchange ratio if ABC Ltd. want to ensure the same earnings to members as before the merger took place?Q3) Sound Ltd. is considering the acquisition of Light Ltd. Relevant financial information isgiven below. SOUND.LTD LIGHT LTDNPAT Rs. 450 Lacs Rs. 90 LacsEquity (No. of shares) Rs. 90 Lacs Rs. 18 LacsMarket Price Rs. 60 Rs.46 a. What is the present EPS of both the companies? b. What should be P/E ratio of both the comapnies c. If the proposed merger takes place what would be the new earnings per share for XYZ Ltd. (assuming the merger takes place by exchange of equity shares and the exchange ratio is based on the EPS) d. What should be the exchange ratio if ABC Ltd. want to ensure the same earnings to members as before the merger took place?4) A Ltd. is considering the acquisition of B Ltd. Relevant financial information is given below. A LTD B LTDNPAT Rs 75 Lacs Rs. 40 LacsEquity (No. of shares) 40,00,000 32,00,000Market Price Rs. 18.75 Rs.7.5 1. What is exchange ratio. 2. How many new shares would be issued a. if the exchange takes place as per market price b. if the exchange takes place as per EPS c. if the exchange takes place as per P/E. 3. what are earnings per share of the surviving company immediately following the merger. 5) P wants to acquire Q by exchange 0.5 shares for every share of Q. The relevant information data is given as below: P LTD Q LTDNPAT Rs 9,00,000 Rs. 1,80,000Equity (No. of shares) 3,00,000 90,000Market Price Rs.36 Rs.20Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  13. 13. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNTCalculate: a. EPS and P/E of both firms before acquisition b. The no of equity shares required to be issued by P for acquiring Q c. EPS of P after acquisition d. MPS of P after acquisition assuming its P/E multiple remains unchanged e. Market value of the merged entity 6) A Ltd is considering the acquisition of B Ltd. Relevant financial information is given below. A LTD B LTDNPAT Rs 75,00,000 Rs. 25,00,000Equity (No. of shares) 40 Lac 20 LacP/E 10 5Answer the following question: a. What is market price of each company. b. What is the market capitalization of each company c. If P/E of A Ltd changes to 7.5, what is the market price of A Ltd. d. Does the market value of A Ltd change e. What would be ration based on MPS (Take the revised MPS)HOMEWORK SECTION:Q1) Ajay Limited wants to acquire Vijay Limited. Exchange ratio is decided as 14/39 i.e. 0.359The following financial data is available: Ajay VijayNPAT Rs 9,00,000 Rs 1,80,000Equity (No. of shares) 3,00,000 90,000MPS Rs 36 Rs 20Calculate : a. EPS and PE ratio of both the firms before acquisition b. The number of shares required to be issued by Ajay for acquiring Vijay. c. EPS of Ajay after Acquisition d. Market price of the share of Ajay after acquisition ; assuming P/E ratio remains unchanged e. The market value of the merged entityQ2) XYZ Ltd is planning to acquire PQR Ltd . Since the current EPS is Rs 5 for ABC company,the management is keen to get EPS of Rs 6 at least post meger. They seek your advice on thepossible exchange ratio that would give the merged entity an EPS of Rs 6. It is also provided thatthe acquisition would result in the Synergy of 200 Lac. The following financial data is given:Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  14. 14. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNT XYZ LTD PQR LTDEPS Rs 5 per share Rs 4 per shareEquity (No. of shares) 200 Lac 80 LacMPS Rs 100 Rs 70Q3)X Ltd is considering the acquisition with Y Ltd. With stock . Relevant financial informationis given below: X LTD Y LTDPresent Earnings (Amount Rs in Lacs) Rs 75 Rs 40Equity (No. of shares) 40 Lac 32 LacEPS 1.875 1.25P/E ratio 10 6Market price per share Rs 18.75 Rs 7.5X Ltd is thinking of four possibilities of the exchange ratio: a. Exchange Ratio as per market price b. To offer a premium of 30% over the market price of Y Ltd. c. Exchange ratio as per EPS. d. Exchange Ratio as per P/E In each of the case, calculate 1. Ratio of exchange 2. EPS of the post merger 3. Number of new shares to be issuedQ4) Large Company is considering the acquisition of small company in a stock ±for- stocktransaction in which target company is valued at Rs 85 for each of its common stock. Theacquiring company does not expect any change in P/E ratio multiple after merger and choose tovalue the target company conservatively by assuming no earning growth due to synergy.Calculate: 1. The purchase price premium 2. The exchange ratio 3. The no of new shares issued by the acquiring company 4. Post merger EPS of the combined entity 5. Premerger EPS of the acquiring company 6. Pre merger P/E ratio 7. Post merger share price The following additional information is available:Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.
  15. 15. CA.CS. Naveen. Rohatgi TYBMS: FINANCIAL MANAGEMNT Large SmallEarning Rs 2,50,000 Rs 72,500Equity (No. of shares) 1,10,000 20,000MPS Rs 52 Rs 64Q5) AIM Ltd is considering merger with MAX Ltd . There is no synergy gains form themerging. Complete the following table if AIM wishes an EPS of Rs 2.80 per share after merger .Particulars AIM LTD MAX LTD MERGED ENTITYEarnings after tax Rs 0.1 million Rs 0.25 million ?Outstanding of shares 50,000 1,00,000 ?EPS (Rs) 2 2.5 2.8P/E ratio 10 5 ?Market price Rs 20 Rs 12.5 ?Total market value ? ? ? (a) Compute the above table (b) Calculate the exchange viz no of shares of AIM given to XYZ shareholder (c) What is the cost of merger to AIM Ltd.Yesterdays failures are todays seeds That must be diligently planted to be able to abundantlyharvest Tomorrows success.

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