Pile cp13

13
Merger, Acquisition & Restructuring

Question 1
Explain synergy in the context of Mergers and Acquisitions.
(4 Marks) (November 2012)
Answer
Synergy May be defined as follows:
V (AB) > V(A) + V (B).
In other words the combined value of two firms or companies shall be more than their individual
value. This may be result of complimentary services economics of scale or both.
A good example of complimentary activities can a company may have a good networking of
branches and other company may have efficient production system. Thus the merged
companies will be more efficient than individual companies.
On Similar lines, economics of large scale is also one of the reason for synergy benefits. The main
reason is that, the large scale production results in lower average cost of production e.g. reduction in
overhead costs on account of sharing of central services such as accounting and finances, Office
executives, top level management, legal, sales promotion and advertisement etc.
These economics can be real arising out of reduction in factor input per unit of output,
whereas pecuniary economics are realized from paying lower prices for factor inputs to bulk
transactions.
Question 2
Explain the term 'Buy-Outs'.
Write brief notes on Leveraged Buy-Outs (LBO).

(4 Marks) (May 2007)
Answer
A very important phenomenon witnessed in the Mergers and Acquisitions scene, in recent times is one of
buy - outs. A buy-out happens when a person or group of persons gain control of a company by buying all or
a majority of its shares. A buyout involves two entities, the acquirer and the target company. The acquirer
seeks to gain controlling interest in the company being acquired normally through purchase of shares. There
are two common types of buy-outs: Leveraged Buyouts (LBO) and Management Buy-outs (MBO). LBO is the
purchase of assets or the equity of a company where the buyer uses a significant amount of debt and very
The Institute of Chartered Accountants of India
13.2
little equity capital of his own for payment of the consideration for acquisition. MBO is the purchase of a
business by its management, who when threatened with the sale of its business to third parties or frustrated
by the slow growth of the company, step-in and acquire the business from the owners, and run the business
for themselves. The majority of buy-outs is management buy-outs and involves the acquisition by incumbent
management of the business where they are employed. Typically, the purchase price is met by a small
amount of their own funds and the rest from a mix of venture capital and bank debt.
Internationally, the two most common sources of buy-out operations are divestment of parts of larger groups
and family companies facing succession problems. Corporate groups may seek to sell subsidiaries as part of
a planned strategic disposal programme or more forced reorganisation in the face of parental financing
problems. Public companies have, however, increasingly sought to dispose of subsidiaries through an
auction process partly to satisfy shareholder pressure for value maximisation.
In recessionary periods, buy-outs play a big part in the restructuring of a failed or failing businesses and in an
environment of generally weakened corporate performance often represent the only viable purchasers when
parents wish to dispose of subsidiaries.
Buy-outs are one of the most common forms of privatisation, offering opportunities for enhancing the
performances of parts of the public sector, widening employee ownership and giving managers and
employees incentives to make best use of their expertise in particular sectors.
Question 3
What is take over by reverse bid?
(3 Marks) (May 2006), (4 Marks) (November 2011)

Answer
Generally, a big company takes over a small company. When the smaller company gains
control of a larger one then it is called Take-over by reverse bid. In case of reverse takeover, a small company takes over a big company. This concept has been successfully
followed for revival of sick industries.
The acquired company is said to be big if any one of the following conditions is satisfied:
(i)
The assets of the transferor company are greater than the transferee company;
(ii) Equity capital to be issued by the transferee company pursuant to the acquisition
exceeds its original issued capital, and
(iii) The change of control in the transferee company will be through the introduction of
minority holder or group of holders.
Reverse takeover takes place in the following cases:
(1) When the acquired company (big company) is a financially weak company
(2) When the acquirer (the small company) already holds a significant proportion of shares of
the acquired company (small company)
13.3
Strategic Financial Management
(3) When the people holding top management positions in the acquirer company want to be
relived off of their responsibilities.
The concept of take-over by reverse bid, or of reverse merger, is thus not the usual case of amalgamation of
a sick unit which is non-viable with a healthy or prosperous unit but is a case whereby the entire undertaking
of the healthy and prosperous company is to be merged and vested in the sick company which is non-viable.
Question 4
Write a short note on Financial restructuring.
(5 Marks) (November 2008) (S), (4 Marks) (May 2013)
Answer
Financial restructuring, is carried out internally in the firm with the consent of its various stakeholders.
Financial restructuring is a suitable mode of restructuring of corporate firms that have incurred
accumulated sizable losses for / over a number of years. As a sequel, the share capital of such firms, in
many cases, gets substantially eroded / lost; in fact, in some cases, accumulated losses over the years
may be more than share capital, causing negative net worth. Given such a dismal state of financial
affairs, a vast majority of such firms are likely to have a dubious potential for liquidation. Can some of
these Firms be revived? Financial restructuring is one such a measure for the revival of only those
firms that hold promise/prospects for better financial performance in the years to come. To achieve the
desired objective, 'such firms warrant / merit a restart with a fresh balance sheet, which does not
contain past accumulated losses and fictitious assets and shows share capital at its real/true worth.
Question 5
What is reverse merger?
(4 Marks) (November 2010) (M)
Answer
A merger is considered to be the fusion of two Companies. The two Companies which have
merged into another Company in the same industry, normally the market share of the
company would increase. In addition to normal merger (where smaller companies merge into
larger Company), vertical merger (where to companies of different industry merge together),
there is one more hand of merger, known as Reverse Merger.
In this, two Companies are normally of the same industry but here bigger company merges
into smaller company thats why it is called reverse merger. In order to avail benefit of carry
forward of losses which are available as per tax laws, the profit making Company is merged
with companies having accumulates losses. Following three things are very important for
reverse merger.
1.
The assets of transfer company are greater than the transferee company.
2.
Equity Capital to be issued by the transferee company pursuant to the merger exceeds to
original capital.

3.
13.4
There is a change in control in the transferee company through the introduction of a

minority group or new group of shareholders.
Question 6
What is an equity curve out? How does it differ from a spin off?
Answer
Equity Curve out can be defined as partial spin off in which a company creates its own new
subsidiary and subsequently bring out its IPO. It should be however noted that parent
company retains its control and only a part of new shares are issued to public.
On the other hand in Spin off parent company does not receive any cash as shares of
subsidiary company are issued to existing shareholder in the form of dividend. Thus,
shareholders in new company remain the same but not in case of Equity curve out.
Question 7
B Ltd. is a highly successful company and wishes to expand by acquiring other firms. Its
expected high growth in earnings and dividends is reflected in its PE ratio of 17. The Board of
Directors of B Ltd. has been advised that if it were to take over firms with a lower PE ratio than
it own, using a share-for-share exchange, then it could increase its reported earnings per
share. C Ltd. has been suggested as a possible target for a takeover, which has a PE ratio of
10 and 1,00,000 shares in issue with a share price of ` 15. B Ltd. has 5,00,000 shares in
issue with a share price of ` 12.
Calculate the change in earnings per share of B Ltd. if it acquires the whole of C Ltd. by issuing shares at its
market price of `12. Assume the price of B Ltd. shares remains constant.
Answer
Total market value of C Ltd is = 1,00,000 x ` 15
PE ratio (given)
Therefore , earnings
Total market value of B Ltd. is = 5,00,000 x ` 12
PE ratio ( given)
Therefore, earnings
= ` 15,00,000
= 10
= ` 15,00,000 /10
= ` 1,50,000
= ` 60,00,000
= 17
= ` 60,00,000/17
= ` 3,52,941
The number of shares to be issued by B Ltd.

` 15,00,000 12
Total number of shares of B Ltd
= 1,25,000
= 5,00,000 + 1,25,000 = 6,25,000
13.5
The EPS of the new firm is
= (` 3,52,941+`1,50,000)/6,25,000
= ` 0.80
The present EPS of B Ltd is
= ` 3,52,941 /5,00,000
= ` 0.71
So the EPS affirm B will increase from Re. 0.71 to ` 0.80 as a result of merger.
Question 8
ABC Company is considering acquisition of XYZ Ltd. which has 1.5 crores shares outstanding
and issued. The market price per share is ` 400 at present. ABC's average cost of capital is
12%.Available information from XYZ indicates its expected cash accruals for the next 3 years
as follows:
Year
` Cr.
1
250
300
400
Calculate the range of valuation that ABC has to consider. (PV factors at 12% for years 1 to 3 respectively:
0.893, 0.797 and 0.712).
Answer
VALUATION BASED ON MARKET PRICE
Market Price per share
` 400
Thus value of total business is (` 400 x 1.5 Cr.)
` 600 Cr.
VALUATION BASED ON DISCOUNTED CASH FLOW

Present Value of cash flows
(` 250 cr x 0.893) + (` 300 cr. X 0.797) + ( ` 400 cr. X 0.712 ) = ` 747.15 Cr.
Value of per share (` 747.15 Cr. / 1.5 Cr)
` 498.10 per share
RANGE OF VALUATION
Per Share
`
Total
` Cr.
Minimum
400.00
600.00
Maximum
498.10
747.15
Question 9
ABC Limited is considering acquisition of DEF Ltd., which has 3.10 crore shares issued
and outstanding. The market price per share is ` 440.00 at present. ABC Ltd.'s average
13.6
cost of capital is 12%. The cash inflows of DEF Ltd. for the next three years are as under:
Year
` in crores
460.00
600.00
740.00
You are required to calculate the range of valuation that ABC Ltd. has to consider.
Take P.V.F. (12%, 3) =0.893, 0.797, 0.712
Answer
Valuation based on Market Price
Thus value of total business is (3.10 crore x ` 440)
Valuation based on Discounted Cash Flow
Present Value of cash flows
(` 460 Crore x 0.893) + (` 600 Crore X 0.797) +
(` 740 Crore X 0.712 ) =
Value of per share (` 1415.86 Crore / 3.10 Crore)
Range of valuation
Minimum
Maximum
Per Share (`)

440.00
456.73
` 440.00
` 1,364.00 Crore
` 1,415.86 Crore
` 456.73 per share
Total (` Crore)
1364.00
1415.86
Question 10
Elrond Limited plans to acquire Doom Limited. The relevant financial details of the two
firms prior to the merger announcement are:
Elrond Limited
Doom Limited
` 50
` 25
20 lakhs
10 Lakhs
Market price per share

Number of outstanding shares
The merger is expected to generate gains, which have a present value of ` 200 lakhs. The
exchange ratio agreed to is 0.5.
What is the true cost of the merger from the point of view of Elrond Limited?
Answer
Shareholders of Doom Ltd. will get 5 lakh share of Elrond Limited, so they will get:
13.7
5 lakh
= 20% of shares Elrond Limited
20 lakh + 5 lakh
The value of Elrond Ltd. after merger will be:

= `50 x 20 lakh + `25 x 10 lakh + `200 lakh
= `1000 lakh + `250 lakh + `200 lakh = `1450 lakh
True Cost of Merger will be:
(`1450 x 20%)
`290 lakhs `250 lakhs = `40 lakhs
Question 11
X Ltd. reported a profit of `65 lakhs after 35% tax for the financial year 2007-08. An analysis
of the accounts revealed that the income included extraordinary items `10 lakhs and an
extraordinary loss `3 lakhs. The existing operations, except for the extraordinary items, are
expected to continue in the future; in addition, the results of the launch of a new product are
expected to be as follows:
` lakhs
Sales
60
Material costs
Labour Costs
15
10
Fixed costs
You are required to :

(a) Compute the value of the business, given that the capitalization rate is 15%.
(b) Determine the market price per equity share, with X Ltd.s share capital being comprised
of 1,00,000 11% preference shares of ` 100 each and 40,00,000 equity shares of ` 10
each and the P/E ratio being 8 times. .
(10 Marks) (June 2009) (M)
Answer
(a) Profit before tax
65
1 0.35
100
Less:
Extraordinary income
(10)
Add:
Extraordinary losses
3
93
Profit from new product

Sales
Less:
60
Material costs
15

Labour costs
10
Fixed costs
13.8
(33)
27
Expected profits before taxes
120
Taxes @ 35%
(42)
Profit after taxes
78
Capitalization rate
15%
78
=
0.15
Value of business
520
(b) Future maintainable profits (After Tax)

Less:
78
Preference share dividends

100,000 shares of `100 @ 11%
(11)
67
Earning per share =
` 67,00,000 =
` 1.675
` 40,00,000
PE ratio
`13.40
Question 12
Eagle Ltd. reported a profit of ` 77 lakhs after 30% tax for the financial year 2011-12. An
analysis of the accounts revealed that the income included extraordinary items of ` 8 lakhs
and an extraordinary loss of `10 lakhs. The existing operations, except for the extraordinary
items, are expected to continue in the future. In addition, the results of the launch of a new
product are expected to be as follows:
` In lakhs
Sales
70
Material costs
Labour costs
20
12
Fixed costs
10
You are required to:

(i)
Calculate the value of the business, given that the capitalization rate is 14%.
(ii) Determine the market price per equity share, with Eagle Ltd.s share capital being
comprised of 1,00,000 13% preference shares of `100 each and 50,00,000 equity shares
of `10 each and the P/E ratio being 10 times.
13.9
Answer
(i)
Computation of Business Value

(` Lakhs)
110
77
1 0.30
Less: Extraordinary income
Add: Extraordinary losses
Profit before tax
Profit from new product

Sales
Less: Material costs
Labour costs
Fixed costs
(8)
10
112
(` Lakhs)
70
20
12
10
Less: Taxes @30%

Future Maintainable Profit after taxes
Relevant Capitalisation Factor
Value of Business (`98/0.14)
(42)
28
140.00
42.00
98.00
0.14
700
(ii) Determination of Market Price of Equity Share

Future maintainable profits (After Tax)
` 98,00,000
Less: Preference share dividends 1,00,000 shares of ` 100 @ 13%
` 13,00,000
Earnings available for Equity Shareholders
` 85,00,000
50,00,000
No. of Equity Shares

Earning per share =
` 85,00,000
=
50,00,000
PE ratio
` 1.70
10
` 17
Question 13
The equity shares of XYZ Ltd. are currently being traded at ` 24 per share in the market. XYZ
Ltd. has total 10,00,000 equity shares outstanding in number; and promoters' equity holding in
the company is 40%.
PQR Ltd. wishes to acquire XYZ Ltd. because of likely synergies. The estimated present value
of these synergies is ` 80,00,000.
13.10
Further PQR feels that management of XYZ Ltd. has been over paid. With better motivation,
lower salaries and fewer perks for the top management, will lead to savings of ` 4,00,000 p.a.
Top management with their families are promoters of XYZ Ltd. Present value of these savings
would add ` 30,00,000 in value to the acquisition.
Following additional information is available regarding PQR Ltd.:
Earnings per share
:`4
Total number of equity shares outstanding
: 15,00,000
Market price of equity share
: ` 40
Required:
(i)
What is the maximum price per equity share which PQR Ltd. can offer to pay for XYZ Ltd.?
(ii) What is the minimum price per equity share at which the management of XYZ Ltd. will be
willing to offer their controlling interest?
(4 + 2 = 6 Marks) (May 2014)
Answer
(a) Calculation of maximum price per share at which PQR Ltd. can offer to pay for XYZ Ltd.s
share
Market Value (10,00,000 x ` 24)
Synergy Gain
Saving of Overpayment
` 2,40,00,000
` 80,00,000
` 30,00,000
` 3,50,00,000
Maximum Price (` 3,50,00,000/10,00,000)
` 35
(b) Calculation of minimum price per share at which the management of XYZ Ltd.s will be
willing to offer their controlling interest
Value of XYZ Ltd.s Management Holding
(40% of 10,00,000 x ` 24)
` 96,00,000
Add: PV of loss of remuneration to top management
` 30,00,000
` 1,26,00,000
No. of Shares
Minimum Price (` 1,26,00,000/4,00,000)
4,00,000
` 31.50
Question 14
Following information is given in respect of WXY Ltd., which is expected to grow at a rate of
20% p.a. for the next three years, after which the growth rate will stabilize at 8% p.a. normal
level, in perpetuity.
13.11

For the year ended
March 31, 2014
` 7,500 Crores
` 3,000 Crores
` 2,250 Crores
` 750 Crores
` 600 Crores
Revenues
Cost of Goods Sold (COGS)
Operating Expenses
Capital Expenditure
Depreciation (included in COGS & Operating Expenses)
During high growth period, revenues & Earnings before Interest & Tax (EBIT) will grow at 20%
p.a. and capital expenditure net of depreciation will grow at 15% p.a. From year 4 onwards,
i.e. normal growth period revenues and EBIT will grow at 8% p.a. and incremental capital
expenditure will be offset by the depreciation. During both high growth & normal growth
period, net working capital requirement will be 25% of revenues.
The Weighted Average Cost of Capital (WACC) of WXY Ltd. is 15%.
Corporate Income Tax rate will be 30%.
Required:
Estimate the value of WXY Ltd. using Free Cash Flows to Firm (FCFF) & WACC methodology.
The PVIF @ 15 % for the three years are as below:
Year
t1
t2
t3
PVIF
0.8696
0.7561
0.6575
Answer
Determination of forecasted Free Cash Flow of the Firm (FCFF)
(` in crores)
Revenue
COGS
Operating Expenses
Depreciation
EBIT
Tax @30%
EAT
Capital Exp. Dep.
Working Capital
Free Cash Flow (FCF)
Yr. 1
Yr. 2
Yr 3
Terminal Year
9000.00
3600.00
1980.00
720.00
2700.00
810.00
1890.00
172.50
375.00
1342.50
10800.00
4320.00
2376.00
864.00
3240.00
972.00
2268.00
198.38
450.00
1619.62
12960.00
5184.00
2851.20
1036.80
3888.00
1166.40
2721.60
228.13
540.00
1953.47
13996.80
5598.72
3079.30
1119.74
4199.04
1259.71
2939.33
259.20
2680.13
13.12
Present Value (PV) of FCFF during the explicit forecast period is:
FCFF (` in crores)
PVF @ 15%
PV (` in crores)
1342.50
0.8696
1167.44
1619.62
0.7561
1224.59
1953.47
0.6575
1284.41
3676.44
PV of the terminal, value is:
2680.13
0.15 - 0.08 (1.15)3
= ` 38287.57 Crore x 0.6575 = ` 25174.08 Crore
The value of the firm is :

` 3676.44 Crores + ` 25174.08 Crores = ` 28,850.52 Crores
Question 15
ABC Co. is considering a new sales strategy that will be valid for the next 4 years. They want
to know the value of the new strategy. Following information relating to the year which has just
ended, is available:
Income Statement
Sales
Gross margin (20%)
Administration, Selling & distribution expense (10%)
PBT
Tax (30%)
PAT
Balance Sheet Information
Fixed Assets
Current Assets
Equity
`
20,000
4,000
2,000
2,000
600
1,400
8,000
4,000
12,000
If it adopts the new strategy, sales will grow at the rate of 20% per year for three years. The
gross margin ratio, Assets turnover ratio, the Capital structure and the income tax rate will
remain unchanged.
Depreciation would be at 10% of net fixed assets at the beginning of the year.
The Companys target rate of return is 15%.
Determine the incremental value due to adoption of the strategy.
13.13
Answer
Projected Balance Sheet
Fixed Assets (40%) of Sales
Current Assets (20%) of Sales
Total Assets
Equity
Year 1
Year 2
Year 3
Year 4
9,600
11,520
13,824
13,824
4,800
5,760
6,912
6,912
14,400
14,400
17,280
17,280
20,736
20,736
20,736
20,736
Projected Cash Flows:Year 1
Year 2
Year 3
Year 4
24,000
28,800
34,560
34,560
PBT (10%) of sale

PAT (70%)
2,400
1,680
2,880
2,016
3,456
2,419.20
3,456
2,419.20
Depreciation
Addition to Fixed Assets
800
2,400
960
2,880
1,152
3,456
1,382
1,382
Increase in Current Assets

Operating cash flow
800
(720)
960
(864)
1,152
(1,036.80)
2,419.20
Sales
Projected Cash Flows:Present value of Projected Cash Flows:Cash Flows
PV at 15%
PV
-720
0.870
-626.40
-864
0.756
-653.18
-1,036.80
0.658
-682.21
-1,961.79
Residual Value
2419.20/0.15 = 16,128
=
16128/(1.15)3
16128/1.521 = 10603.55
Total shareholders value
10,603.55 1,961.79 =
Pre strategy value
1,400 / 0.15 = 9,333.33
Value of strategy
8,641.76 9,333.33 =
Present value of Residual value
Conclusion: The strategy is not financially viable
8,641.76
691.57
13.14
Question 16
Helium Ltd has evolved a new sales strategy for the next 4 years. The following information is
given:
Income Statement
` in thousands
Sales
40,000
Gross Margin at 30%
12,000
Accounting, administration and distribution expense at 15%
6,000
Profit before tax
6,000
Tax at 30%
1,800
Profit after tax
4,200
Balance sheet information

Fixed Assets
10,000
Current Assets
6,000
Equity
15,000
As per the new strategy, sales will grow at 30 percent per year for the next four years. The
gross margin ratio will increase to 35 percent. The Assets turnover ratio and income tax rate
will remain unchanged.
Depreciation is to be at 15 percent on the value of the net fixed assets at the beginning of the year.
Company's target rate of return is 14%.
Determine if the strategy is financially viable giving detailed workings.
Answers
(a) Solution if candidates have assumed that if the Equity amount is 16000 instead of
15000.
13.15

Year
Fixed Assets (25% of sales)
Current Assets (12.5% of
sales)
(In ` Thousands)
1
2
3
4
5
13000.00 16900.00 21970.00 28561.00 28561.00
6500.00
8450.00 10985.00 14280.50 14280.50
Total Assets
19500.00 25350.00 32955.00 42841.50 42841.50
Equity and Reserves
19500.00 25350.00 32955.00 42841.50 42841.50
Projected Cash Flows

(In ` Thousands)
52000.00 67600.00 87880.00 114244.00 114244.00
Sales (30% yoy)

PBT
15%
7800.00 10140.00 13182.00 17136.60 17136.60
PAT
70%
5460.00
7098.00 9227.40 11995.62 11995.62
Depreciation
15%
1500.00
1950.00 2535.00
3295.50
4284.15
4500.00
5850.00 7605.00
9886.50
4284.15
1500.00
1950.00 2535.00
3295.50
960.00
1248.00 1622.40
2109.12 11995.62
Operating Cash Flow

Present value factor @ 14%
Present value of cash flows @
14%
0.877
841.92
0.769
0.675
0.592
959.71 1095.12
1248.60
(In ` Thousands)
Total for first 4 years (A)
Residual value (11995.62/0.14)
4145.35
85683
Present value of Residual value [85683/(1.14)4] (B)
50731.21
Total Shareholders value (C) = (A) +(B)
54876.56
Pre strategy value (4200/0.14) (D)
30000.00
Value of strategy (C) (D)
24876.56
Conclusion: The strategy is financially viable.
13.16
Alternative Solution
If candidates have assumed that if the Equity amount is 16000 instead of 15000.
Year
Fixed Assets (25% of sales)
Current Assets (15% of sales)
Total Assets
Current Liability
1
13000.00
(In ` Thousands)
2
3
4
5
16900.00 21970.00 28561.00 28561.00
7800.00
10140.00 13182.00 17136.60 17136.60
20800.00
27040.00 35152.00 45697.60 45697.60
1300.00
Equity and Reserves
19500.00
1690.00
2197.00
2856.10
2856.10
25350.00 32955.00 42841.50 42841.50

(In ` Thousands)
Sales (30% yoy)
52000.00 67600.00 87880.00 114244.00 114244.00
PBT
15%
7800.00 10140.00 13182.00
17136.60
17136.60
PAT
70%
5460.00
7098.00
9227.40
11995.62
11995.62
Depreciation
15%
1500.00
1950.00
2535.00
3295.50
4284.15
4500.00
5850.00
7605.00
9886.50
4284.15
1500.00
2340.00
3042.00
3954.60
960.00
858.00
1115.40
1450.02
11995.62
0.877
0.769
0.675
0.592
0.519
841.92
659.80
752.90
858.41
6225.73
Operating Cash Flow

Present value factor @ 14%
Present value of cash flows @14%
(In ` Thousands)
Total for first 4 years (A)
3113.03
Residual value (6225.73/0.14)
44469.50
Present value of Residual value [ 44469.50/(1.14)4] (B)
26329.51
Total Shareholders value (C) = (A) +(B)
29442.54
Pre strategy value (4200/0.14) (D)
30000.00
Value of strategy (C) (D)

Conclusion: The strategy is financially not viable.
-557.46
13.17
Question 17
Cauliflower Limited is contemplating acquisition of Cabbage Limited. Cauliflower Limited has 5
lakh shares having market value of ` 40 per share while Cabbage Limited has 3 lakh shares
having market value of ` 25 per share. The EPS for Cabbage Limited and Cauliflower Limited
are ` 3 per share and ` 5 per share respectively. The managements of both the companies
are discussing two alternatives for exchange of shares as follows:
(i)
In proportion to relative earnings per share of the two companies.
(ii) 1 share of Cauliflower Limited for two shares of Cabbage Limited.

Required:
(i)
Calculate the EPS after merger under both the alternatives.
(ii) Show the impact on EPS for the shareholders of the two companies under both the
alternatives.
(10 Marks)(November 2014)
Answer
(i)
Exchange ratio in proportion to relative EPS

(in `)
Company
Existing No. of shares
EPS
Total earnings
Cauliflower Ltd.
Cabbage Ltd.
5,00,000
3,00,000
5.00
3.00
25,00,000
9,00,000
Total earnings
34,00,000
No. of shares after merger 5,00,000 + 1,80,000 = 6,80,000
Note: 1,80,000 may be calculated as = 3,00,000

EPS for Cauliflower Ltd. after merger =
3.00
5.00
34,00,000
= ` 5.00
6,80,000
Impact on EPS
Cauliflower Ltd. shareholders
EPS before merger
5.00
EPS after merger
5.00
Increase/ Decrease in EPS
0.00
Cabbage Ltd.' Shareholders

EPS before merger
3.00
13.18
EPS after the merger 5.00 x 3/5
3.00
Increase/ Decrease in EPS
0.00
(ii) Merger effect on EPS with share exchange ratio of 1 : 2

Total earnings after merger
` 34,00,000
No. of shares post merger 5,00,000 + 1,50,000 (0.5 3,00,000)

EPS 34,00,000 6,50,000
6,50,000
5.23
Impact on EPS
Cauliflower Ltd. shareholders
EPS before merger
`
5.00
EPS after merger
5.23
Increase in EPS
0.23
Cabbage Ltd. shareholders

EPS before merger
`
3.000
EPS after the merger 5.23 x 0.5

Decrease in EPS
2.615
0.385
Question 18
MK Ltd. is considering acquiring NN Ltd. The following information is available:
Company
MK Ltd.
NN Ltd.
Earning after
tax(`)
No. of Equity Shares
Market Value
Per Share(`)
60,00,000
18,00,000
12,00,000
3,00,000
200.00
160.00
Exchange of equity shares for acquisition is based on current market value as above. There is
no synergy advantage available.
(i)
Find the earning per share for company MK Ltd. after merger, and
(ii) Find the exchange ratio so that shareholders of NN Ltd. would not be at a loss.
(8 Marks) (November 2010) (S)
Answer
(i)
Earning per share of company MK Ltd after merger:Exchange ratio 160 : 200 = 4 : 5.
that is 4 shares of MK Ltd. for every 5 shares of NN Ltd.
13.19
Total number of shares to be issued = 4/5 3,00,000 = 2,40,000 Shares.

Total number of shares of MK Ltd. and NN Ltd.=12,00,000 (MK Ltd.)+2,40,000 (NN Ltd.)
= 14,40,000 Shares
Total profit after tax
= ` 60,00,000
MK Ltd.
= ` 18,00,000
NN Ltd.
= ` 78,00,000
EPS. (Earning Per Share) of MK Ltd. after merger
` 78,00,000/14,40,000 = ` 5.42 per share
(ii) To find the exchange ratio so that shareholders of NN Ltd. would not be at a Loss:
Present earning per share for company MK Ltd.
= ` 60,00,000/12,00,000 = ` 5.00
Present earning per share for company NN Ltd.
= ` 18,00,000/3,00,000 = ` 6.00
Exchange ratio should be 6 shares of MK Ltd. for every 5 shares of NN Ltd.
Shares to be issued to NN Ltd. = 3,00,000 6/5 = 3,60,000 shares
Now, total No. of shares of MK Ltd. and NN Ltd. =12,00,000 (MK Ltd.)+3,60,000 (NN Ltd.)
= 15,60,000 shares
EPS after merger = ` 78,00,000/15,60,000 = ` 5.00 per share
Total earnings available to shareholders of NN Ltd. after merger = 3,60,000 shares `
5.00 = ` 18,00,000.
This is equal to earnings prior merger for NN Ltd.
Exchange ratio on the basis of earnings per share is recommended.
Question 19
A Ltd. wants to acquire T Ltd. and has offered a swap ratio of 1:2 (0.5 shares for every one
share of T Ltd.). Following information is provided:
Profit after tax
Equity shares outstanding (Nos.)
EPS
PE Ratio
A Ltd.
T. Ltd.
`18,00,000
`3,60,000
6,00,000
1,80,000
`3
`2
10 times
7 times
`30
`14
13.20
Required:
(i)
The number of equity shares to be issued by A Ltd. for acquisition of T Ltd.
(ii) What is the EPS of A Ltd. after the acquisition?

(iii) Determine the equivalent earnings per share of T Ltd.
(iv) What is the expected market price per share of A Ltd. after the acquisition, assuming its
PE multiple remains unchanged?
(v) Determine the market value of the merged firm.
Answer
(i)
(ii)
(iii)
(iv)
The number of shares to be issued by A Ltd.:

The Exchange ratio is 0.5
So, new Shares = 1,80,000 x 0.5 = 90,000 shares.
EPS of A Ltd. After a acquisition:
Total Earnings
(` 18,00,000 + ` 3,60,000)
No. of Shares
EPS
(6,00,000 + 90,000)
`21,60,000
6,90,000
(` 21,60,000)/6,90,000)
`3.13
Equivalent EPS of T Ltd.:

No. of new Shares
0.5
EPS
`3.13
Equivalent EPS (` 3.13 x 0.5)
`1.57
New Market Price of A Ltd. (P/E remaining unchanged):

Present P/E Ratio of A Ltd.
Expected EPS after merger
`3.13
Expected Market Price (`3.13 x 10)

(v)
10 times
`31.30
Market Value of merged firm:

Total number of Shares
6,90,000
Expected Market Price
`31.30
Total value (6,90,000 x 31.30)
`2,15,97,000
Question 20
ABC Ltd. is intending to acquire XYZ Ltd. by merger and the following information is available in
respect of the companies:
Number of equity shares
ABC Ltd.
XYZ Ltd.
10,00,000
6,00,000
13.21
Earnings after tax (`)

Market value per share (`)
50,00,000
18,00,000
42
28
Required:
(i)
What is the present EPS of both the companies?
(ii) If the proposed merger takes place, what would be the new earning per share for ABC
Ltd.? Assume that the merger takes place by exchange of equity shares and the
exchange ratio is based on the current market price.
(iii) What should be exchange ratio, if XYZ Ltd. wants to ensure the earnings to members are
as before the merger takes place?
Answer
(i)
Earnings per share = Earnings after tax /No. of equity shares

ABC Ltd. = ` 50,00,000/10,00,000 = ` 5
XYZ Ltd. = ` 18,00,000 / 6,00,000 = ` 3
(ii) Number of Shares XYZ limiteds shareholders will get in ABC Ltd. based on market value
per share = ` 28/ 42 6,00,000 = 4,00,000 shares
Total number of equity shares of ABC Ltd. after merger = 10,00,000 + 4,00,000 =
14,00,000 shares
Earnings per share after merger = ` 50,00,000 + 18,00,000/14,00,000 = ` 4.86
(iii) Calculation of exchange ratio to ensure shareholders of XYZ Ltd. to earn the same as
was before merger:
Shares to be exchanged based on EPS = (` 3/` 5) 6,00,000 = 3,60,000 shares
EPS after merger = (` 50,00,000 + 18,00,000)/13,60,000 = ` 5
Total earnings in ABC Ltd. available to shareholders of XYZ Ltd. = 3,60,000 ` 5 =
` 18,00,000.
Thus, to ensure that Earning to members are same as before, the ratio of exchange should be
0.6 share for 1 share.
Question 21
XYZ Ltd. is considering merger with ABC Ltd. XYZ Ltd.s shares are currently traded at ` 25.
it has 2,00,000 shares outstanding and its earning after taxes (EAT) amount to ` 4,00,000.
ABC Ltd. has 1,00,000 shares outstanding; its current market price is ` 12.50 and its EAT is
` 1,00,000. The merger will be effected by means of a stock swap (exchange). ABC Ltd. has
agreed to a plan under which XYZ Ltd. will offer the current market value of ABC Ltd.s shares.

(i)
13.22
What is the pre-merger earnings per share (EPS) and P/E ratios of both the companies?
(ii) If ABC Ltd.s P/E ratio is 8, what is its current market price? What is the exchange ratio?
What will XYZ Ltd.s post merger EPS be?
(iii) What must the exchange ratio be for XYZ Ltd.s pre-merger and post-merger EPS to be
the same?
Answer
Merger and EPS
Company
XYZ
ABC
Rs.
Rs.
25.00
12.50
No. of equity shares outstanding
2,00,000
1,00,000
Earning after tax
4,00,000
1,00,000
Market price of equity shares
(i)
EPS = `
` 1,00,000
4,00,000
,
=
2,00,000 shares 1,00,000 shares
P/E ratio = ` 25/2, 12.50/1
2.00
1.00
12.5
12.5
(ii) (a) If ABC Ltd. P/E ratio is 8, its current market price will be ` 8 only (8 1).
(b) Then the exchange ratio will be 8/25 i.e. 32/100. For every 100 shares of
ABC, 32 shares of XYZ will be issued (1,00,000 32)/100 = 32,000 shares of
XYZ will be issued to all the shareholders of ABC Ltd.
(c) Post merger EPS of XYZ Ltd. = Total earning/Total shares = 5,00,000/2,32,000
equity shares = ` 2.16.
(iii) Total earnings ` 5,00,000/EPS ` 2 = 2,50,000 equity shares i.e. 50,000 shares of
XYZ will have to be issued to the shareholders of ABC i.e. one share of XYZ will be
issued for every two shares held by ABC shareholders.
Then pre-merger and post-merger EPS of XYZ will be same as follows:
Pre-merger EPS of XYZ
` 2.00
Post-merger EPS of XYZ
` 5,00,000/2,50,000 equity shares

= ` 2.00
Question 22
LMN Ltd is considering merger with XYZ Ltd. LMN Ltd's shares are currently traded at
` 30.00 per share. It has 3,00,000 shares outstanding. Its earnings after taxes (EAT) amount
to ` 6,00,000. XYZ Ltd has 1,60,000 shares outstanding and its current market price is
` 15.00 per share and its earnings after taxes (EAT) amount to ` 1,60,000. The merger is
13.23
decided to be effected by means of a stock swap (exchange). XYZ Ltd has agreed to a
proposal by which LMN Ltd will offer the current market value of XYZ Ltd's shares.
Find out:
(i)
The pre-merger earnings per share (EPS) and price/earnings (P/E) ratios of both the
companies.
(ii) If XYZ Ltd's P/E Ratio is 9.6, what is its current Market Price? What is the Exchange
Ratio? What will LMN Ltd's post-merger EPS be?
(iii) What should be the exchange ratio, if LMN Ltd's pre-merger and post- merger EPS are to
be the same?
Answer
(i)
Pre-merger EPS and P/E ratios of LMN Ltd. and XYZ Ltd.
Particulars
Earnings after taxes
Number of shares outstanding
EPS
P/E Ratio (times)
(ii)
LMN Ltd.
6,00,000
3,00,000
2
30
15
Current Market Price of XYZ Ltd. if P/E ratio is 9.6 = ` 1 9.6 = ` 9.60
Exchange ratio =
30
= 3.125
9.60
Post merger EPS of LMN Ltd.
6,00,000 + 1,60,000
3,00,000 + (1,60,000/3.125)
7,60,000
= 2.16
=
3,51,200
=
(iii)
Desired Exchange Ratio

Total number of shares in post-merged company
7,60,000
Post - merger earnings
=
= 3,80,000
2
Pr e - merger EPS of LMN Ltd.
Number of shares required to be issued to XYZ Ltd.
= 3,80,000 3,00,000 = 80,000

Therefore, the exchange ratio should be
80,000 : 1,60,000
XYZ Ltd.
1,60,000
1,60,000
1
15
15
13.24
80,000
= 0.50
1,60,000
Question 23
K. Ltd. is considering acquiring N. Ltd., the following information is available :
Company
K. Ltd.
N. Ltd.
Profit after Tax

50,00,000
15,00,000
Number of Equity shares

10,00,000
2,50,000
Market value per share

200.00
160.00
Exchange of equity shares for acquisition is based on current market value as above. There is
no synergy advantage available :
Find the earning per share for company K. Ltd. after merger.
Find the exchange ratio so that shareholders of N. Ltd. would not be at a loss.
Answer
(i)
Earning per share for company K. Ltd. after Merger:

Exchange Ratio 160 : 200 = 4: 5
That is 4 shares of K. Ltd. for every 5 shares of N. Ltd.
Total number of shares to be issued =
4
2,50,000 = 2,00,000 shares
5
Total number of shares of K. Ltd. and N .Ltd.
= 10,00,000
K. Ltd.
+ 2,00,000
N. Ltd
12,00,000
Total profit after Tax =
50,00,000
K. Ltd.
15,00,000
N Ltd.
65,00,000
E.P.S. (Earning per share) of K. Ltd. after Merger

=
` 65,00,000
= ` 5.42 Per Share
12,00,000
(ii) To find the Exchange Ratio so that shareholders of N. Ltd. would not be at a Loss:
Present Earnings per share for company K. Ltd.
` 50,00,000
` 5.00
=
` 10,00,000
13.25
Present Earnings Per share for company N. Ltd.

` 15,00,000
` 6.00
=
` 2,50,000
Exchange Ratio should be 6 shares of K. Ltd. for every 5 shares of N Ltd.

Shares to be issued to N. Ltd.
2,50,000 6
= 3,00,000 Shares
5
Total No. of Shares of K.Ltd. and N. Ltd.
=
10,00,000
K. Ltd.
+ 3,00,000
N. Ltd
13,00,000
E.P.S. After Merger
65,00,000
13,00,000
= ` 5.00 Per Share
Total Earnings Available to Shareholders of N. Ltd. after Merger

= ` 3,00,000 ` 5.00 = ` 15,00,000
This is equal to Earnings prior Merger for N. Ltd.
Exchange Ratio on the Basis of Earnings per Share is recommended.
Question 24
M Co. Ltd., is studying the possible acquisition of N Co. Ltd., by way of merger. The following
data are available in respect of the companies:
Particulars
Earnings after tax (`)
No. of equity shares
Market value per share (`)
(i)
M Co. Ltd.
80,00,000
16,00,000
200
N Co. Ltd.
24,00,000
4,00,000
160
If the merger goes through by exchange of equity and the exchange ratio is based on the
current market price, what is the new earning per share for M Co. Ltd.?
(ii) N Co. Ltd. wants to be sure that the earnings available to its shareholders will not be
diminished by the merger. What should be the exchange ratio in that case?
Answer
(i)
Calculation of new EPS of M Co. Ltd.

No. of equity shares to be issued by M Co. Ltd. to N Co. Ltd.
= 4,00,000 shares ` 160/` 200 = 3,20,000 shares
13.26
Total no. of shares in M Co. Ltd. after acquisition of N Co. Ltd.

= 16,00,000 + 3,20,000 = 19,20,000
Total earnings after tax [after acquisition]
= 80,00,000 + 24,00,000 = 1,04,00,000
EPS
` 1,04,00,000
= ` 5.42
19,20,000 equity shares
(ii) Calculation of exchange ratio which would not diminish the EPS of N Co. Ltd. after
its merger with M Co. Ltd.
Current EPS:
M Co. Ltd. =
` 80,00,000
=`5
N Co. Ltd. =
` 24,00,000
=`6
Exchange ratio = 6/5 = 1.20

No. of new shares to be issued by M Co. Ltd. to N Co. Ltd.
= 4,00,000 1.20 = 4,80,000 shares
Total number of shares of M Co. Ltd. after acquisition
= 16,00,000 + 4,80,000 = 20,80,000 shares
` 1,04,00,000
=`5
EPS [after merger] =
20,80,000 shares
Total earnings in M Co. Ltd. available to new shareholders of N Co. Ltd.
= 4,80,000 ` 5 = ` 24,00,000
Recommendation: The exchange ratio (6 for 5) based on market shares is beneficial to
shareholders of 'N' Co. Ltd.
Question 25
The following information is provided related to the acquiring Firm Mark Limited and the target
Firm Mask Limited:
Earning after tax (`)

Number of shares outstanding
P/E ratio (times)
Firm
Mark Limited
Firm
Mask Limited
2,000 lakhs
400 lakhs
200 lakhs
100 lakhs
10
13.27
Required:
(i)
What is the Swap Ratio based on current market prices?
(ii) What is the EPS of Mark Limited after acquisition?

(iii) What is the expected market price per share of Mark Limited after acquisition, assuming
P/E ratio of Mark Limited remains unchanged?
(iv) Determine the market value of the merged firm.
(v) Calculate gain/loss for shareholders of the two independent companies after acquisition.
Answer
(i)
Particulars
Mark Ltd.
Mask Ltd.
EPS
` 2,000 Lakhs/ 200 lakhs

= ` 10
` 400 lakhs / 100 lakhs

`4
Market Price
` 10 10 = ` 100
` 4 5 = ` 20
The Swap ratio based on current market price is

` 20 / ` 100 = 0.2 or 1 share of Mark Ltd. for 5 shares of Mask Ltd.
No. of shares to be issued = 100 lakh 0.2 = 20 lakhs.
(ii) EPS after merger

=
` 2,000 lakhs ` 400 lakhs

= ` 10.91
200 lakhs 20 lakhs
(iii) Expected market price after merger assuming P / E 10 times.

= ` 10.91 10 = ` 109.10
(iv) Market value of merged firm
= ` 109.10 market price 220 lakhs shares = 240.02 crores
(v) Gain from the merger
Post merger market value of the merged firm
` 240.02 crores
Less: Pre-merger market value

Mark Ltd. 200 Lakhs ` 100 = 200 crores
Mask Ltd. 100 Lakhs ` 20 = 20 crores
` 220.00 crores
Gain from merger
` 20.02 crores
13.28
Appropriation of gains from the merger among shareholders:

Mark Ltd.
Mask Ltd.
Post merger value
218.20 crores
21.82 crores
Less: Pre-merger market value
200.00 crores
18.20 crores
20.00 crores
Gain to Shareholders
1.82 crores
Question 26
Simple Ltd. and Dimple Ltd. are planning to merge. The total value of the companies are
dependent on the fluctuating business conditions. The following information is given for the
total value (debt + equity) structure of each of the two companies.
Business Condition
Probability
Simple Ltd. ` Lacs
Dimple Ltd. ` Lacs
High Growth
Medium Growth
0.20
0.60
820
550
1050
825
Slow Growth
0.20
410
590
The current debt of Dimple Ltd. is ` 65 lacs and of Simple Ltd. is ` 460 lacs.
Calculate the expected value of debt and equity separately for the merged entity.
Answer
Compute Value of Equity
Simple Ltd.
High Growth
Medium Growth
` in Lacs
Slow Growth
Debit + Equity
820
550
410
Less: Debt
460
460
460
Equity
360
90
-50
Since the Company has limited liability the value of equity cannot be negative therefore the value
of equity under slow growth will be taken as zero because of insolvency risk and the value of debt
is taken at 410 lacs. The expected value of debt and equity can then be calculated as:
Simple Ltd.
` in Lacs
High Growth
Debt
Medium Growth
Slow Growth
Prob.
Value
Prob.
Value
Prob.
Value
0.20
460
0.60
460
0.20
410
Expected Value
450
13.29
Equity
0.20
360
0.60
90
0.20
550
820
126
410
576
Dimple Ltd.
` in Lacs
High Growth
Medium Growth
Slow Growth
Expected Value
Prob.
Value
Prob.
Value
Prob.
Value
Equity
0.20
985
0.60
760
0.20
525
758
Debt
0.20
65
0.60
65
0.20
65
65
590
823
1050
825
Expected Values
` in Lacs
Equity
Simple Ltd.
Dimple Ltd.
126
Debt
Simple Ltd.
450
758
Dimple Ltd.
65
515
884
Question 27
Longitude Limited is in the process of acquiring Latitude Limited on a share exchange basis.
Following relevant data are available:
Profit after Tax (PAT)
` in Lakhs
Number of Shares
Lakhs
Earning per Share (EPS)
Price Earnings Ratio (P/E Ratio)
Longitude Limited Latitude Limited

140
60
15
16
15
10
(Ignore Synergy)
You are required to determine:
(i)
Pre-merger Market Value per Share, and
(ii) The maximum exchange ratio Longitude Limited can offer without the dilution of
(1) EPS and
(2) Market Value per Share
13.30
Calculate Ratio/s up to four decimal points and amounts and number of shares up to two
decimal points.
Answer
(i)
Pre Merger Market Value of Per Share

P/E Ratio X EPS
Longitude Ltd.
` 8 X 15 = ` 120.00
Latitude Ltd.
` 5 X 10 = ` 50.00
(ii) (1) Maximum exchange ratio without dilution of EPS

Pre Merger PAT of Longitude Ltd.
` 140 Lakhs
Pre Merger PAT of Latitude Ltd.
` 60 Lakhs
Combined PAT
` 200 Lakhs
Longitude Ltd. s EPS
`8
Maximum number of shares of Longitude after merger (`

200 lakhs/` 8)
25 Lakhs
Existing number of shares
15 Lakhs
Maximum number of shares to be exchanged
10 Lakhs
Maximum share exchange ratio 10:16 or 5:8

(2) Maximum exchange ratio without dilution of Market Price Per Share
Pre Merger Market Capitalization of Longitude Ltd.
(` 120 15 Lakhs)
Pre Merger Market
(` 50 16 Lakhs)
Capitalization
of
Latitude
Ltd.
Combined Market Capitalization

Current Market Price of share of Longitude Ltd.
` 1800 Lakhs
` 800 Lakhs
` 2600 Lakhs
` 120
Maximum number of shares to be exchanged of Longitude

(surviving company )(` 2600 Lakhs/` 120)
21.67 Lakhs
Current Number of Shares of Longitude Ltd.

Maximum number of shares to be exchanged (Lakhs)
15.00 Lakhs
6.67 Lakhs
Maximum share exchange ratio 6.67:16 or 0.4169:1

Note: Since in the question figures given of PAT of both companies are not
matching with figures of EPS X Number of Shares. Hence, if students computed
PAT by using this formula then alternative answer shall be as follows:
(1) Maximum exchange ratio without dilution of EPS
13.31
Pre Merger PAT of Longitude Ltd.
` 120 Lakhs
Pre Merger PAT of Latitude Ltd.
` 80 Lakhs
Combined PAT
` 200 Lakhs
Longitude Ltd. s EPS
`8
Maximum number of shares of Longitude after merger (` 200

lakhs/` 8)
25 Lakhs
Existing number of shares
15 Lakhs
10 Lakhs
Maximum share exchange ratio 10:16 or 5:8

(2) Maximum exchange ratio without dilution of Market Price Per Share
Pre Merger Market
(` 120 15 Lakhs)
Capitalization
Pre Merger Market

(` 50 16 Lakhs)
of
Capitalization
Longitude
Ltd.
` 1800 Lakhs
Latitude
Ltd.
` 800 Lakhs
of
Combined Market Capitalization
` 2600 Lakhs
Current Market Price of share of Longitude Ltd.

(surviving company )(` 2600 Lakhs/` 120)
of Longitude
Current Number of Shares of Longitude Ltd.

Maximum number of shares to be exchanged (Lakhs)
` 120
21.67 Lakhs
15.00 Lakhs
6.67 Lakhs
Maximum share exchange ratio 6.67:16 or 0.4169:1

Question 28
Following information is provided relating to the acquiring company Mani Ltd. and the target
company Ratnam Ltd:
Earnings after tax (` lakhs)
No. of shares outstanding (lakhs)
P/E ratio ( No. of times)
Required:
(i)
Mani Ltd.
2,000
200
10
Ratnam Ltd.
4,000
1,000
5
What is the swap ratio based on current market prices?
(ii) What is the EPS of Mani Ltd. after the acquisition?

(iii) What is the expected market price per share of Mani Ltd. after the acquisition, assuming
its P/E ratio is adversely affected by 10%?
13.32
(iv) Determine the market value of the merged Co.

(v) Calculate gain/loss for the shareholders of the two independent entities, due to the
merger.
(10 Marks) (June 2009) (M)
Answer
(i)
SWAP ratio based on current market prices:

EPS before acquisition:
Mani Ltd. : `2,000 lakhs / 200 lakhs:
Ratnam Ltd.: `4,000 lakhs / 1,000 lakhs:
Market price before acquisition:
Mani Ltd.: `10 10
Ratnam Ltd.: `4 5
SWAP ratio: 20/100 or 1/5 i.e.
(ii) EPS after acquisition:
` (2,000 4,000) Lakhs

(200 200) Lakhs
(iii) Market Price after acquisition:
EPS after acquisition :
P/E ratio after acquisition 10 0.9
Market price of share (` 15 X 9)
(iv) Market value of the merged Co.:
`135 400 lakhs shares
` 10
` 4
` 100
` 20
0.20
`15.00
`15.00
9
`135.00
` 540.00 Crores
or ` 54,000 Lakhs
(v) Gain/loss per share:
` Crore
Mani Ltd.
Ratnam Ltd.
Total value before Acquisition
200
200
Value after acquisition

Gain (Total)
270
70
270
70
No. of shares (pre-merger) (lakhs)
200
1,000
35
Gain per share (`)

Question 29
P Ltd. is considering take-over of R Ltd. by the exchange of four new shares in P Ltd. for every
five shares in R Ltd. The relevant financial details of the two companies prior to merger
13.33
announcement are as follows:

P Ltd
R Ltd
Profit before Tax (` Crore)
15
13.50
No. of Shares (Crore)
25
15
P/E Ratio
12
Corporate Tax Rate 30%

You are required to determine:
(i)
Market value of both the company.
(ii) Value of original shareholders.

(iii) Price per share after merger.
(iv) Effect on share price of both the company if the Directors of P Ltd. expect their own premerger P/E ratio to be applied to the combined earnings.
Answer
P Ltd.
15
R Ltd.
13.50
(` in crore)
4.50
4.05
Profit after Tax (` in crore)
10.50
9.45
10.50
= ` 0.42
25
9.45
= ` 0.63
15
Profit before Tax (` in crore)

Tax 30%
Earning per Share (` )

Price of Share before Merger (EPS x P/E
Ratio)
(i)
` 0.42 x 12 = ` 5.04
0.63 x ` 9 = ` 5.67
Market Value of company

P Ltd. = ` 5.04 x 25 Crore = ` 126 crore
R Ltd. = ` 5.67 x 15 Crore = ` 85.05 crore
Combined = ` 126 + ` 85.05 = ` 211.05 Crores
After Merger
P Ltd.
No. of Shares
25 crores
R Ltd.
4
5
15x = 12 crores

Combined
13.34
37 crores
% of Combined Equity Owned
25
x100 67.57%
37
12
x100 = 32.43%
37
(ii) Value of Original Shareholders

P Ltd.
` 211.05 crore x 67.57%
R Ltd.
` 211.05 crore x 32.43%
= ` 142.61
= ` 68.44
(iii) Price per Share after Merger

`19.95crore
= ` 0.539 per share
EPS =
37crore
P/E Ratio = 12
Market Value Per Share = ` 0.539 X 12 = ` 6.47
Total Market Value = ` 6.47 x 37 crore = ` 239.39 crore
239.39 crore
MarketValue
Price of Share =
=
= ` 6.47
37 crore
Number of Shares
(iv) Effect on Share Price
P Ltd.
Gain/loss (-) per share = ` 6.47 ` 5.04 = ` 1.43
6.47 5.04
i.e.
100 = 0.284 or 28.4%
5.04
Share price would rise by 28.4%
R Ltd.
6.47 x
4
= ` 5.18
5
Gain/loss (-) per share = ` 5.18 ` 5.67 = (-` 0.49)

5.18 5.67
i.e.
100 (-) 0.0864 or (-) 8.64%
5.67
Share Price would decrease by 8.64%.
Question 30
XY Ltd. which is specialized in manufacturing garments is planning for expansion to handle a
new contract which it expects to obtain. An investment bank have approached the company
and asked whether the Co. had considered venture Capital financing. In 2001, the company
13.35
borrowed `100 lacs on which interest is paid at 10% p.a. The Company shares are unquoted
and it has decided to take your advice in regard to the calculation of value of the Company
that could be used in negotiations using the following available information and forecast.
Companys forecast turnover for the year to 31st March, 2005 is `2,000 lacs which is mainly
dependent on the ability of the Company to obtain the new contract, the chance for which is
60%, turnover for the following year is dependent to some extent on the outcome of the year
to 31st March, 2005. Following are the estimated turnovers and probabilities:
Year - 2005
Turnover
Year - 2006
Prob.
Turnover
` (in lacs)
Prob.
`(in lacs)
2,000
0.6
1,500
1,200
2,500
0.7
3,000
0.3
0.3
2,000
0.5
0.1
1,800
1,500
0.5
0.6
1,200
0.4
Operating costs inclusive of depreciation are expected to be 40% and 35% of turnover
respectively for the years 31st March, 2005 and 2006. Tax is to be paid at 30%. It is assumed
that profits after interest and taxes are free cash flows. Growth in earnings is expected to be
405 for the years 2007, 2008 and 2009 which will fall to 105 each year after that. Industry
average cost of equity (net of tax) is 15%.
Answer
Estimation of earnings for the years ended 31st March, 2005 & 2006
Prob.
(` In lacs)
Turnover Expected
Turnover
2500
1050
3000
540
Prob.
Turnover
0.6
2000
Expected
Turnover
1200
0.3
1500
450
0.3 0.5
0.3 0.5
2000
1800
300
270
0.1
1200
120
0.1 0.6
1500
90
0.1 0.4
1200
48
0.6 0.7
0.6 x 0.3
1770
Operating Costs (40%)
(708)
2298
(35%)
(804)

Interest 100 1
13.36
(10)
(10)
1052
1484
Tax
316
445
Earnings/Cash flows
736
1039
Profit after Interest
Estimated Cash flows for 2007, 2008 & 2009:2007 -
1039 1.4 = 1455/-
2008 -
1455 1.4 = 2037/-
2009 -
2037 1.4 = 2852/-
Discounted Cash flows for the year 2005-2009

Year
Cash flows
Disc. Factor at 15%
PV
2005
736
0.870
640
2006
1039
0.756
785
2007
2008
1455
2037
0.658
0.572
957
1165
2009
2852
0.497
1417
4964
Estimates of value of Cash flows from 2010 to infinity

Earnings in 2010
In todays money
2852 1.1 = 3137

3137 0.497 = 1559
Po = D1/(Ke G)
= 1559/0.15- 0.10 = 31180/Present value of all future estimated cash flows:2005 - 2009
4964
2009 onwards
31180
36144
Company valuation is 36144/Note: Few printing errors have crept in this question viz 40% growth in earnings has
appeared as 405 likewise 10% growth in earnings has been wrongly printed as 105. The
answer provided above pertains to 40% and 10% growth.
Question 31
Yes Ltd. wants to acquire No Ltd. and the cash flows of Yes Ltd. and the merged entity are
given below:
13.37
Year
Yes Ltd.
Merged Entity
1
175
400
2
200
450
3
320
525
4
340
590
(` In lakhs)
5
350
620
Earnings would have witnessed 5% constant growth rate without merger and 6% with merger
on account of economies of operations after 5 years in each case. The cost of capital is 15%.
The number of shares outstanding in both the companies before the merger is the same and
the companies agree to an exchange ratio of 0.5 shares of Yes Ltd. for each share of No Ltd.
PV factor at 15% for years 1-5 are 0.870, 0.756; 0.658, 0.572, 0.497 respectively.
(i) Compute the Value of Yes Ltd. before and after merger.
(ii) Value of Acquisition and
(iii) Gain to shareholders of Yes Ltd.
Answer
(i)
Working Notes:
Present Value of Cash Flows (CF) upto 5 years
Year
End
CF of Yes Ltd.
(` lakhs)
PVF
@15%
PV of CF
(` lakhs)
1
2
3
4
5
175
200
320
340
350
0.870
0.756
0.658
0.572
0.497
152.25
151.20
210.56
194.48
173.95
882.44
CF of Merged PV of CF of
Entity
Merged Entity
(` lakhs)
(` lakhs)
400
348.00
450
340.20
525
345.45
590
337.48
620
308.14
1679.27
PV of Cash Flows of Yes Ltd. after the forecast period

TV5 =
CF5 (1 g) 350(1 0.05) 367.50

=
=
= `3675 lakhs
Ke g
0.15 0.05
0.10
PV of TV5 = `3675 lakhs x 0.497 = `1826.475 lakhs

PV of Cash Flows of Merged Entity after the forecast period
TV5 =
CF5 (1 g) 620(1 0.06) 657.20

=
=
= `7302.22 lakhs
Ke g
0.15 0.06
0.09
PV of TV5 = `7302.22 lakhs x 0.497 = `3629.20 lakhs
13.38
Value of Yes Ltd.

PV of CF (1-5 years)
Add: PV of TV5
Before merger (`lakhs)

882.440
1826.475
2708.915
After merger (`lakhs)

1679.27
3629.20
5308.47
(ii) Value of Acquisition

= Value of Merged Entity Value of Yes Ltd.
= `5308.47 lakhs `2708.915 lakhs = `2599.555 lakhs
(iii) Gain to Shareholders of Yes Ltd.
Share of Yes Ltd. in merged entity = `5308.47 lakhs x
1
= `3538.98 lakhs
1.5
Gain to shareholder = Share of Yes Ltd. in merged entity Value of Yes Ltd. before
merger
= `3538.98 lakhs - `2708.915 = `830.065 lakhs
Question 32
AB Ltd. has recently approached the shareholders of CD Ltd. which is engaged in the same
line of business as that of AB Ltd. with a bid of 4 new shares in AB Ltd. for every 5 CD Ltd.
shares or a cash alternative of `360 per share. Past records of earnings of CD Ltd. had been
poor and the companys shares have been out of favour with the stock market for some time.
Pre bid information for the year ended 31.3.2006 are as follows:
Equity share capital
Number of shares
Pre-tax profit
P/E Ratio
Estimated post tax cost of Equity Capital per Annum
AB Ltd in lakhs CD Ltd. in lakhs

60
170
24
17
125
110
11
7
12%
10%
Both AB Ltd. and CD Ltd. pay income tax at 30%. Current earnings growth forecast is 4% for
the foreseeable future of both the Companies.
Assuming no synergy exists, you are required to evaluate whether proposed share to share
offer is likely to be beneficial to the shareholders of both the companies using merger terms
available. AB Ltd.s directors might expect their own pre bid P/E ratio to be applied to
combined earnings.
Also comment on the value of the two Companies from the constant growth form of dividend
valuation model assuming all earnings are paid out as dividends.(14 Marks) (November 2007)
13.39
Answer
Alternative 1 (when number of shares are 2.4 and 1.7 lakhs respectively)
Evaluation:Background calculations:(Figures in lakhs)
AB Ltd. CD Ltd.
Total
PBT
125
110
235
PAT
87.5
77
164.5
36.46
45.29
11
Pre-bid Price Per Share
401.06
317.03
Market value of the company
962.54
538.95
1,501.49
2.4
1.36
3.76
% combined company owned by
63.83%
36.17%
Value to the original Shareholders
958.40
543.09
Post bid Price per share to original shareholders i.e.,

2.40 lakhs and 1.70 lakhs shareholders respectively.
399.33
319.46
Pre bid EPS

P/E ratio
No. of New Shares Post bid
1,501.49
(Note: The Post bid Price per share to new shareholders as per terms of acquisition works
out to `399.33 for both the companies)
These figures suggest post bid acquisition share price of `399.33 for AB Ltd., and 319.46 for
CD Ltd.s. Original shareholders. The price of CD Ltd share is likely to be influenced by the
value of cash alternative.
The post bid share price of the new firm can be estimated by applying the P/E ratio to the
combined earnings of the two old companies.
In that case,
Market Value would be = 164.5 11 = 1809.50
Price per share of the combined company would be =
1,809.50
` 481.25
3.76
Therefore share of AB Ltd., shareholders would raise by `481.25 `401.06= `80.19 i.e.,
20%.
Share value of CD Ltd., shareholder expected to rise by
4
` 481.25 317.03 ` 67.97 i.e. 21.44%

5
With the cash offer the premium is
13.40
360 317.03
13.55% only
317.03
Hence shareholders of CD Ltd are gaining more from the merger in a share exchange and cash
alternative is unlikely to be accepted.
Using constant growth model the value of both the individual companies would be:
AB Ltd., share price =
36.46(1.04)
` 473.98
0.12 0.04
CD Ltd., share price =
45.29 1.04
` 785.03
0.10 0.04
On this basis market slightly undervalues AB Ltd share but share of CD Ltd., are highly
undervalued possibly because of previous disappointments. However, if AB Ltd. forecast is
believed that the AB Ltd., is getting CD Ltd. shares, it will be a cheap proposal for AB Ltd. to
acquire the CD Ltd. on share exchange basis and especially if any of the shareholder of CD
Ltd. Accept the cash offer.
The shareholders of CD Ltd. would also be benefited post merger based on share exchange
ratio since the value of their share would be going up from `317.03 to `399.33. However,
their share price would still be undervalued as compared with the share price calculated by
using constant growth model.
Alternative 2 (when number of shares are 24 and 17 lakhs respectively)
If we take into consideration the number of shares being 24 lakhs and 17 lakhs the Pre-bid
share price works out to `40.15 and `31.71 respectively, which seems to be illogical against a
cash offer @ `360/- per share. However, since many students may have solved this question
based on the figures of 24 lakhs and 17 lakhs number of shares, an alternative solution is
provided below.
Evaluation:
Background calculations:
Figures in lakhs
AB Ltd.
CD Ltd.
Total
PBT
125
110
235
PAT
Pre bid EPS
87.5
3.65
77
4.53
164.5
11
40.15
31.71
963.60
24
539.07
1502.67
13.6
37.6
63.83
36.17
P/E Ratio
Pre-bid Price per share
Market value of the company
No. of new shares Post-bid
% of combined company owned by
13.41
Value to the original shareholders

Post-bid Price to original shareholders i.e,, 24
lakhs and 17 lakhs shareholders respectively
959.15
543.52
39.96
31.97
1502.67
(Note: The Post bid price per share works out to `39.96 for both the companies)
These figures suggest Post acquisition share price of `39.96 for AB Ltd and `31.97 for CD
Ltds original shareholders. The Price of CD Ltd. Share is likely to be influenced by the value
of cash alternative.
The Post bid share price of the new firm can be estimated by applying the P/E ratio to the
combined earnings of the two old companies.
In that case,
Market-value would be = 164.5 11 = 1809.50
Price per share of the combined company
Would be =
1809.50
48.13
37.6
Shares of AB Ltd. shareholders would raise by `48.13 40.15 = 7.98 i.e., 19.87% or 20%.
4
Share value of CD Ltd., shareholders expected to raise by ` 48.13 31.71

5
= `7.40 or 23.34%.
However, with the cash offer the premium is
360 31.71
1035.29%
31.71
Hence, the shareholders of CD Ltd., are substantially benefited by cash offer and they are
unlikely to accept the share swap ratio.
Using constant growth model the value of shares of both the individual companies would be
AB Ltd. Share Price =
3.65(1.04) 3.80
= `47.5
=
0.12- 0.04 0.08
CD Ltd. Share Price =
4.53 (1.04) 4.71

= `78.5
0.10 0.04 0.06
On this basis market slightly undervalues AB Ltd. Share but share of CD Ltd., is highly
undervalued possibly because of previous disappointments. However, if AB Ltd. forecast is
believed that the AB Ltd. is getting CD Ltd. share it will be a cheap proposal for AB Ltd., to
acquire CD Ltd., on share exchange basis.
The shareholders of CD Ltd., would however be more benefited by cash offer.
13.42
Question 33
The following information is provided relating to the acquiring company Efficient Ltd. and the
target Company Healthy Ltd.
No. of shares (F.V. ` 10 each)
Market capitalization
P/E ratio (times)
Reserves and Surplus
Promoters Holding (No. of shares)
Efficient Ltd.
10.00 lakhs
500.00 lakhs
10.00
300.00 lakhs
4.75 lakhs
Healthy Ltd.
7.5 lakhs
750.00 lakhs
5.00
165.00 lakhs
5.00 lakhs
Board of Directors of both the Companies have decided to give a fair deal to the shareholders
and accordingly for swap ratio the weights are decided as 40%, 25% and 35% respectively for
Earning, Book Value and Market Price of share of each company:
(i)
Calculate the swap ratio and also calculate Promoters holding % after acquisition.
(ii) What is the EPS of Efficient Ltd. after acquisition of Healthy Ltd.?
(iii) What is the expected market price per share and market capitalization of Efficient Ltd.
after acquisition, assuming P/E ratio of Firm Efficient Ltd. remains unchanged.
(iv) Calculate free float market capitalization of the merged firm.
(12 Marks) (May 2005)
Answer
Swap Ratio
Market capitalisation
No. of shares
Efficient Ltd.
Healthy Ltd.
500 lakhs
750 lakhs
10 lakhs
7.5 lakhs
` 50
P/E ratio
10
` 100
5
EPS
`5
` 20
` 50 lakh
` 150 lakh
Share capital
` 100 lakh
` 75 lakh
Reserves and surplus
` 300 lakh
` 165 lakh
Total
` 400 lakh
` 240 lakh
` 40
` 32
Profit
Book Value per share

(i) Calculation of Swap Ratio
EPS
1 : 4 i.e.
4.0 40%
1.6
13.43

Book value
Market price
1 : 0.8 i.e.
1 : 2 i.e.
0.8 25%
2.0 35%
Total
0.2
0.7
2.5
Swap ratio is for every one share of Healthy Ltd., to issue 2.5 shares of Efficient Ltd.
Hence, total no. of shares to be issued 7.5 lakh 2.5 = 18.75 lakh shares
Promoters holding = 4.75 lakh shares + (5 2.5 = 12.5 lakh shares) = 17.25 lakh i.e.
Promoters holding % is (17.25 lakh/28.75 lakh) 100 = 60%.
Calculation of EPS, Market price, Market capitalization and free float market
capitalization.
(ii) Total No. of shares
Total capital
EPS
10 lakh + 18.75 lakh = 28.75 lakh

100 lakh + 187.5 lakh = ` 287.5 lakh
Total profit
50 lakh 150 lakh
200
No. of shares
28.75 lakh
28.75
= ` 6.956
(iii) Expected market price
Market capitalization
EPS 6.956 P/E 10 = ` 69.56

= ` 69.56 per share 28.75 lakh shares
= ` 1,999.85 lakh
(iv) Free float of market capitalization
= ` 69.56 per share (28.75 lakh 40%)

= ` 799.94 lakh
Question 34
Abhiman Ltd. is a subsidiary of Janam Ltd. and is acquiring Swabhiman Ltd. which is also a
subsidiary of Janam Ltd.
The following information is given:
% Shareholding of promoter
Share capital
Free Reserves and surplus
Paid up value per share
Free float market capitalization
P/E Ratio (times)
Abhiman Ltd.
Swabhiman Ltd.
50%
60%
` 200 lacs
` 900 lacs
` 100
` 500 lacs
100 lacs
10
600 lacs
10
156 lacs
4
Janam Ltd., is interested in doing justice to both companies. The following parameters have been
assigned by the Board of Janam Ltd., for determining the swap ratio:

Book value
25%
Earning per share
50%
Market price
25%
13.44
You are required to compute

(i)
The swap ratio.
(ii) The Book Value, Earning Per Share and Expected Market Price of Swabhiman Ltd.,
(assuming P/E Ratio of Abhiman ratio remains the same and all assets and liabilities of
Swabhiman Ltd. are taken over at book value.)
Answer
SWAP RATIO
Abhiman Ltd.
(`)
200 lacs
Swabhiman Ltd.
(`)
100 lacs
900 lacs
600 lacs
1100 lacs
700 lacs
No. of shares
2 lacs
10 lacs
Book value for share
` 550
50%
` 70
60%
50%
500 lacs
40%
Share capital
Free reserves & surplus
Total
Promoters Holding
Non promoters holding
Free float market capitalization (Public)
Total Market Cap
No. of shares
Market Price
P/E ratio
EPS
1000 lacs
` 156 lacs
390 lacs
2 lacs
10 lacs
` 500
` 39
10
` 50.00
` 9.75
Calculation of SWAP Ratio

Book Value
EPS
1:0.1273
1:0.195
0.1273 25%
0.195 50%
0.031825
0.097500
Market Price
1:0.078
0.078 25%
0.019500
Total
(i)
0.148825
SWAP Ratio is 0.148825 shares of Abhiman Ltd. for every share of Swabhiman Ltd.
Total No. of shares to be issued = 10 lakh 0.148825 = 148825 shares
13.45
(ii) Book value, EPS & Market Price.

Total No. shares = 200000 +148825=348825
Total capital = `200 lakh + `148.825 lac = ` 348.825 lac
Reserves = ` 900 lac + ` 551.175 lac = ` 1451.175 lac
Book value Per Share =
EPS =
` 348.825 lac ` 1451.175 lac

= ` 516.02
3.48825 lac
Total Pr ofit
` 100 lac ` 97.50 lac
=
= ` 56.62
No. of shares
3.48825 lac
Expected market price = ` 56.62 PE Ratio= ` 56.62 10 = ` 566.20

Question 35
The following information relating to the acquiring Company Abhiman Ltd. and the target
Company Abhishek Ltd. are available. Both the Companies are promoted by Multinational
Company, Trident Ltd. The promoters holding is 50% and 60% respectively in Abhiman Ltd.
and Abhishek Ltd. :
Share Capital (`)
Abhiman Ltd.
200 lakh
Abhishek Ltd.
100 lakh
800 lakh
500 lakh
100
10
400 lakh
128 lakh
10
Free Reserve and Surplus (`)

Paid up Value per share (`)
Free float Market Capitalisation (`)
P/E Ratio (times)
Trident Ltd. is interested to do justice to the shareholders of both the Companies. For the
swap ratio weights are assigned to different parameters by the Board of Directors as follows:
Book Value
EPS (Earning per share)
Market Price
25%
50%
25%
(a) What is the swap ratio based on above weights?

(b) What is the Book Value, EPS and expected Market price of Abhiman Ltd. after
acquisition of Abhishek Ltd. (assuming P.E. ratio of Abhiman Ltd. remains unchanged
and all assets and liabilities of Abhishek Ltd. are taken over at book value).
(c) Calculate:
(i)
Promoters revised holding in the Abhiman Ltd.
(ii) Free float market capitalization.
13.46
(iii) Also calculate No. of Shares, Earning per Share (EPS) and Book Value (B.V.), if
after acquisition of Abhishek Ltd., Abhiman Ltd. decided to :
(a) Issue Bonus shares in the ratio of 1 : 2; and
(b) Split the stock (share) as ` 5 each fully paid.
(20 Marks) (June 2009) (S)
Answer
(a) Swap Ratio
Abhiman Ltd.
Abhishek Ltd.
Share Capital
Free Reserves
200 Lakh
800 Lakh
100 Lakh
500 Lakh
Total
No. of Shares
1000 Lakh
2 Lakh
600 Lakh
10 Lakh
` 500
50%
` 60
60%
Non promoters holding

Free Float Market Cap. i.e.
50%
400 Lakh
40%
128 Lakh
relating to Publics holding

Hence Total market Cap.
800 Lakh
320 Lakh
2 Lakh
10 Lakh
` 400
` 32
4
EPS
10
40
Profits (` 2 X 40)
80
80
Book Value per share

Promoters holding
No. of Shares
Market Price
P/E Ratio
(` 8 X 10)
Calculation of Swap Ratio

Book Value
1 : 0.12 i.e.
0.12 x 25%
0.03
EPS
Market Price
1 : 0.2
1 : 0.08
0.20 x 50%
0.08 x 25%
0.10
0.02
0.15
Total
Swap ratio is for every one share of Abhishek Ltd., to issue 0.15 shares of Abhiman Ltd.
Hence total no. of shares to be issued
10 Lakh x 0.15 = 1.50 lakh shares
13.47
(b) Book Value , EPS & Market Price

Total No of Shares
2 Lakh + 1.5 Lakh = 3.5 Lakh
Total Capital
` 200 Lakh + ` 100 Lakh = ` 300 Lakh
Reserves
` 800 Lakh + ` 500 Lakh = ` 1,300 Lakh
Book Value
` 300 Lakh + ` 1,300 Lakh = ` 457.14 per share

3.5 Lakh
` 80 Lakh ` 80 Lakh ` 160 Lakh
Total Profit
=
=
No. of Share
3.5 Lakh
3.5
EPS
= ` 45.71
Expected Market Price
EPS (` 45.71) x P/E Ratio (10) = ` 457.10
(c) (1) Promoters holding

Promoters Revised
Abhiman 50% i.e.
1.00 Lakh shares
Holding
Abhishek 60% i.e.
0.90 Lakh shares
Total
1.90 Lakh shares
Promoters % = 1.90/3.50 x 100 = 54.29%

(2) Free Float Market Capitalisation
Free Float Market
= (3.5 Lakh 1.9 Lakh) x ` 457.10
Capitalisation
= ` 731.36 Lakh
(3) (i) & (ii)

Revised Capital
` 350 Lakh + ` 175 Lakh = ` 525 Lakh
No. of shares before Split (F.V ` 100) 5.25 Lakh

No. of Shares after Split (F.V. Rs 5 ) 5.25 x 20 = 105 Lakh
EPS
160 Lakh / 105 Lakh = 1.523
Book Value
Cap. ` 525 Lakh + ` 1125 Lakh

No. of Shares =105 Lakh
= ` 15.714 per share
Question 36
You have been provided the following Financial data of two companies:
Earnings after taxes
Krishna
Ltd.
Rama
Ltd.
` 7,00,000
` 10,00,000
Equity shares (outstanding)

EPS
P/E ratio
13.48
` 2,00,000
` 4,00,000
3.5
2.5
10 times
14 times

` 35
` 35
Company Rama Ltd. is acquiring the company Krishna Ltd., exchanging its shares on a oneto-one basis for company Krishna Ltd. The exchange ratio is based on the market prices of the
shares of the two companies.
Required:
(i) What will be the EPS subsequent to merger?
(ii) What is the change in EPS for the shareholders of companies Rama Ltd. and Krishna
Ltd.?
(iii) Determine the market value of the post-merger firm. PE ratio is likely to remain the same.
(iv) Ascertain the profits accruing to shareholders of both the companies.
Answer
(i)
Exchange Ratio
1:1
New Shares to be issued

Total shares of Rama Ltd. (4,00,000+2,00,000)
2,00,000
6,00,000
Total earnings (` 10,00,000 + ` 7,00,000)

(ii)
(iii)
` 17,00,000
New EPS (` 17,00,000/6,00,000)
` 2.83
Existing EPS of Rama Ltd.
` 2.50
Increase in EPS of Rama Ltd (` 2.83 ` 2.50)
` 0.33
Existing EPS of Krishna Ltd.
` 3.50
Decrease in EPS of Krishna Ltd. (` 3.50 ` 2.83)

P/E ratio of new firm (expected to remain same)
` 0.67
14 times
New market price (14 ` 2.83)

Total No. of Shares
` 39.62
6,00,000
Total market Capitalization (6,00,000 ` 39.62)
` 2,37,72,000
Existing market capitalization (` 70,00,000 + ` 1,40,00,000)
` 2,10,00,000
Total gain
27,72,000
(iv)
No. of shares after merger
Rama Ltd.
Krishna Ltd
Total
4,00,000
2,00,000
6,00,000
13.49
Market price
` 39.62
` 39.62
` 39.62
Total Mkt. Values
` 1,58,48,000
` 79,24,000
` 2,37,72,000
Existing Mkt. values
` 1,40,00,000
` 70,00,000
` 2,10,00,000
Gain to share holders
18,48,000
` 9,24,000
27,72,000
or ` 27,72,000 3 = ` 9,24,000 to Krishna Ltd. and ` 18,48,000 to Rama Ltd. (in 2: 1

ratio)
Question 37
T Ltd. and E Ltd. are in the same industry. The former is in negotiation for acquisition of the
latter. Important information about the two companies as per their latest financial statements is
given below:
T Ltd.
E Ltd.
12 Lakhs
6 Lakhs
580
--
--
240
Earning before interest, depreciation and tax (EBIDAT) (` Lakhs)
400.86
115.71
Market Price/share (` )
220.00
110.00
` 10 Equity shares outstanding

Debt:
10% Debentures (` Lakhs)
12.5% Institutional Loan (` Lakhs)
T Ltd. plans to offer a price for E Ltd., business as a whole which will be 7 times EBIDAT
reduced by outstanding debt, to be discharged by own shares at market price.
E Ltd. is planning to seek one share in T Ltd. for every 2 shares in E Ltd. based on the market
price. Tax rate for the two companies may be assumed as 30%.
Calculate and show the following under both alternatives - T Ltd.'s offer and E Ltd.'s plan:
(i)
Net consideration payable.
(ii) No. of shares to be issued by T Ltd.

(iii) EPS of T Ltd. after acquisition.
(iv) Expected market price per share of T Ltd. after acquisition.
(v) State briefly the advantages to T Ltd. from the acquisition.
Calculations (except EPS) may be rounded off to 2 decimals in lakhs.
(16 Marks) (May 2010) (S)
13.50
Answer
As per T Ltd.s Offer
` in lakhs
(i)
Net Consideration Payable

7 times EBIDAT, i.e. 7 x ` 115.71 lakh
809.97
Less: Debt
240.00
569.97
(ii) No. of shares to be issued by T Ltd

` 569.97 lakh/` 220 (rounded off) (Nos.)
2,59,000
(iii) EPS of T Ltd after acquisition

Total EBIDT (` 400.86 lakh + ` 115.71 lakh)
Less: Interest (` 58 lakh + ` 30 lakh)
516.57
88.00
428.57
Less: 30% Tax
128.57
Total earnings (NPAT)

Total no. of shares outstanding (12 lakh + 2.59 lakh)
EPS (` 300 lakh/ 14.59 lakh)
300.00
14.59 lakh
` 20.56
(iv) Expected Market Price:
` in lakhs
Pre-acquisition P/E multiple:
EBIDAT
400.86
Less: Interest ( 580 X
10
)
100
58.00
342.86
Less: 30% Tax
102.86
240.00
No. of shares (lakhs)

EPS
Hence, PE multiple
220
20
Expected market price after acquisition (` 20.56 x 11)
12.00
` 20.00
11
` 226.16
13.51
As per E Ltds Plan
` in lakhs
(i)
Net consideration payable

660
6 lakhs shares x ` 110

(ii) No. of shares to be issued by T Ltd
3 lakh
` 660 lakhs ` 220

(iii) EPS of T Ltd after Acquisition
NPAT (as per earlier calculations )
300.00
Total no. of shares outstanding (12 lakhs + 3 lakhs)
15 lakh
Earning Per Share (EPS) ` 300 lakh/15 lakh
` 20.00
220.00
(iv) Expected Market Price (` 20 x 11)

(v) Advantages of Acquisition to T Ltd
Since the two companies are in the same industry, the following advantages could
accrue:
- Synergy, cost reduction and operating efficiency.
- Better market share.
- Avoidance of competition.
Question 38
The following information is relating to Fortune India Ltd. having two division, viz. Pharma
Division and Fast Moving Consumer Goods Division (FMCG Division). Paid up share capital of
Fortune India Ltd. is consisting of 3,000 Lakhs equity shares of Re. 1 each. Fortune India Ltd.
decided to de-merge Pharma Division as Fortune Pharma Ltd. w.e.f. 1.4.2009. Details of
Fortune India Ltd. as on 31.3.2009 and of Fortune Pharma Ltd. as on 1.4.2009 are given
below:
Particulars
Fortune Pharma Ltd.
Fortune India Ltd.
400 lakh
3,000 lakh
Unsecured Loans
2,400 lakh
800 lakh
Current Liabilities & Provisions
1,300 lakh
21,200 lakh
7,740 lakh
7,600 lakh
20,400 lakh
12,300 lakh
Outside Liabilities
Secured Loans
Assets
Fixed Assets
Investments
Current Assets
Loans & Advances
Deferred tax/Misc. Expenses
13.52
8,800 lakh
30,200 lakh
900 lakh
60 lakh
7,300 lakh
(200) lakh
Board of Directors of the Company have decided to issue necessary equity shares of Fortune
Pharma Ltd. of Re. 1 each, without any consideration to the shareholders of Fortune India Ltd.
For that purpose following points are to be considered:
1.
2.
Transfer of Liabilities & Assets at Book value.

Estimated Profit for the year 2009-10 is ` 11,400 Lakh for Fortune India Ltd. & ` 1,470
lakhs for Fortune Pharma Ltd.
3. Estimated Market Price of Fortune Pharma Ltd. is ` 24.50 per share.
4. Average P/E Ratio of FMCG sector is 42 & Pharma sector is 25, which is to be expected
for both the companies.
Calculate:
1. The Ratio in which shares of Fortune Pharma are to be issued to the shareholders of
Fortune India Ltd.
2. Expected Market price of Fortune India Ltd.
3. Book Value per share of both the Companies immediately after Demerger.
Answer
Share holders funds
(` Lakhs)
Fortune India Ltd.
Fortune Pharma Ltd.
Fortune India (FMCG) Ltd.
Assets
70,000
25,100
44,900
Outside liabilities
25,000
4,100
20,900
Net worth
45,000
21,000
24,000
Particulars
1.
Calculation of Shares of Fortune Pharma Ltd. to be issued to shareholders of

Fortune India Ltd.
Estimated Profit (` in lakhs)
Estimated market price (`)
Estimated P/E
Estimated EPS (`)
No. of shares lakhs
Fortune Pharma Ltd.

1,470
24.5
25
0.98
1,500
Hence, Ratio is 1 share of Fortune Pharma Ltd. for 2 shares of Fortune India Ltd.
13.53
2.
Expected market price of Fortune India Ltd.

11,400
3,000
3.8
42
159.60
Estimated Profit (` in lakhs)

No. of equity shares (` in lakhs)
Estimated EPS (`)
Estimated P/E
Estimated market price (`)
3.
Book value per share

Net worth (`in lakhs)
No. of shares (` in lakhs)
Book value of shares
Fortune Pharma Ltd.
21,000
24,000
1,500
3,000
` 14
`8
Question 39
H Ltd. agrees to buy over the business of B Ltd. effective 1st April, 2012.The summarized
Balance Sheets of H Ltd. and B Ltd. as on 31st March 2012 are as follows:
Balance sheet as at 31st March, 2012 (In Crores of Rupees)
Liabilities:
H. Ltd
B. Ltd.
Paid up Share Capital

-Equity Shares of `100 each
-Equity Shares of `10 each
Reserve & Surplus
Total
Assets:
Net Fixed Assets
Net Current Assets
Deferred Tax Assets
Total
350.00
6.50
950.00
25.00
1,300.00
31.50
220.00
0.50
1,020.00
60.00
29.00
2.00
1,300.00
31.50
H Ltd. proposes to buy out B Ltd. and the following information is provided to you as part of
the scheme of buying:
(1) The weighted average post tax maintainable profits of H Ltd. and B Ltd. for the last 4
years are ` 300 crores and ` 10 crores respectively.
(2) Both the companies envisage a capitalization rate of 8%.
13.54
(3) H Ltd. has a contingent liability of ` 300 crores as on 31st March, 2012.
(4) H Ltd. to issue shares of `100 each to the shareholders of B Ltd. in terms of the
exchange ratio as arrived on a Fair Value basis. (Please consider weights of 1 and 3 for
the value of shares arrived on Net Asset basis and Earnings capitalization method
respectively for both H Ltd. and B Ltd.)
You are required to arrive at the value of the shares of both H Ltd. and B Ltd. under:
(i) Net Asset Value Method
(ii) Earnings Capitalisation Method
(iii) Exchange ratio of shares of H Ltd. to be issued to the shareholders of B Ltd. on a Fair
value basis (taking into consideration the assumption mentioned in point 4 above.)
Answer
(i)
Net asset value

H Ltd.
` 1300 Crores ` 300 Crores

= ` 285.71
3.50 Crores
B Ltd.
` 31.50 Crores
= ` 48.46
0.65 Crores
(ii) Earning capitalization value

H Ltd.
` 300 Crores / 0.08

= ` 1071.43
3.50 Crores
B Ltd.
` 10 Crores / 0.08
= ` 192.31
0.65 Crores
(iii) Fair value

H Ltd.
B Ltd.
` 285.71 1 ` 1071.43 3
= ` 875
4
` 48.46 1 ` 192.31 3
= ` 156.3475
4
Exchange ratio
`156.3475/ `875 = 0.1787

H Ltd should issue its 0.1787 share for each share of B Ltd.
Note: In above solution it has been assumed that the contingent liability will materialize at its
full amount.
13.55
Question 40
Reliable Industries Ltd. (RIL) is considering a takeover of Sunflower Industries Ltd. (SIL). The
particulars of 2 companies are given below:
Reliable Industries Ltd
Sunflower Industries Ltd.
Earnings After Tax (EAT)
`20,00,000
`10,00,000
Equity shares O/s

Earnings per share (EPS)
10,00,000
10,00,000
10
Particulars
PE Ratio (Times)
Required:
(i)
What is the market value of each Company before merger?
(ii)
Assume that the management of RIL estimates that the shareholders of SIL will accept
an offer of one share of RIL for four shares of SIL. If there are no synergic effects, what
is the market value of the Post-merger RIL? What is the new price per share? Are the
shareholders of RIL better or worse off than they were before the merger?
(iii)
Due to synergic effects, the management of RIL estimates that the earnings will
increase by 20%. What are the new post-merger EPS and Price per share? Will the
shareholders be better off or worse off than before the merger? (8 Marks) (May 2006)
Answer
(i)
Market value of Companies before Merger

Particulars
EPS
P/E Ratio
Market Price Per Share
Equity Shares
Total Market Value
RIL
`2
10
` 20
10,00,000
2,00,00,000
(ii) Post Merger Effects on RIL
`
Post merger earnings
Exchange Ratio (1:4)
30,00,000
No. of equity shares o/s (10,00,000 + 2,50,000)

EPS: 30,00,000/12,50,000
12,50,000
PE Ratio
Market Value 10 x 2.4
2.4
10
24
SIL
Re.1
5
`5
10,00,000
50,00,000
Total Value (12,50,000 x 24)
3,00,00,000
Gains From Merger:
`
3,00,00,000
Post-Merger Market Value of the Firm
13.56
Less: Pre-Merger Market Value

RIL
SIL
2,00,00,000
50,00,000
2,50,00,000
Total gains from Merger
50,00,000
Apportionment of Gains between the Shareholders:

RIL(`)
SIL(`)
Post Merger Market Value:

10,00,000 x 24
2,40,00,000
--
2,50,000 x 24
Less: Pre-Merger Market Value
2,00,00,000
60,00,000
50,00,000
40,00,000
10,00,000
Particulars
Gains from Merger:
Thus, the shareholders of both the companies (RIL + SIL) are better off than before
(iii) Post-Merger Earnings:
Increase in Earnings by 20%
New Earnings: `30,00,000 x (1+0.20)
`36,00,000
No. of equity shares outstanding:
12,50,000
EPS (` 36,00,000/12,50,000)
`2.88
PE Ratio
10
Market Price Per Share:

= `2.88 x 10 = `28.80
Shareholders will be better-off than before the merger situation.
Question 41
AFC Ltd. wishes to acquire BCD Ltd. The shares issued by the two companies are 10,00,000
and 5,00,000 respectively:
(i)
Calculate the increase in the total value of BCD Ltd. resulting from the acquisition on the
basis of the following conditions:
Current expected growth rate of BCD Ltd.
7%
Expected growth rate under control of AFC Ltd., (without any additional
8%
13.57
capital investment and without any change in risk of operations)

Current Market price per share of AFC Ltd.
Current Market price per share of BCD Ltd.
Current Dividend per share of BCD Ltd.
`
`
100
Re.
0.60
20
(ii) On the basis of aforesaid conditions calculate the gain or loss to shareholders of both the
companies, if AFC Ltd. were to offer one of its shares for every four shares of BCD Ltd.
(iii) Calculate the gain to the shareholders of both the Companies, if AFC Ltd. pays `22 for
each share of BCD Ltd., assuming the P/E Ratio of AFC Ltd. does not change after the
merger. EPS of AFC Ltd. is `8 and that of BCD is `2.50. It is assumed that AFC Ltd.
invests its cash to earn 10%.
Answer
(i)
For BCD Ltd., before acquisition

The cost of capital of BCD Ltd. may be calculated by using the following formula:
Dividend
Growth %
Pr ice
Cost of Capital i.e., Ke = (0.60/20) + 0.07 = 0.10

After acquisition g (i.e. growth) becomes 0.08
Therefore, price per share after acquisition = 0.60/(0.10-0.08) = `30
The increase in value therefore is = `(30-20) x 5,00,000 = `50,00,000/(ii) To share holders of BCD Ltd. the immediate gain is `100 `20x4 = `20 per share
The gain can be higher if price of shares of AFC Ltd. rise following merger which they
should undertake.
To AFC Ltd. shareholders
(` (In lakhs)
Value of Company now
1,000
Value of BCD Ltd.
150
1,150
No. of shares
11.25
Value per share
1150/11.25= `102.22
Gain to shareholders of BCD Ltd. = `102.22 `(4 x 20) = `22.22
Gain to shareholders of AFC Ltd. = `102.22 `100.00 = `2.22

(iii) Gain to shareholders of AFC Ltd:Earnings of BCD Ltd. (5,00,000 x 2.50)
13.58
`12,50,000/-
Less: Loss of earning in cash (5,00,000 x ` 22 x 0.10)

Net Earning
`11,00,000/` 1,50,000/10,00,000
Number of shares
Net increase in earning per share
P/E ratio of AFC Ltd. = 100/8 = 12.50
0.15
Therefore, Gain per share of shareholders of AFC Ltd.

= 0.15x12.50 = `1.88
Gain to the shareholders of BCD Ltd. ` (22-20) =
`2/- per share
Question 42
AB Ltd., is planning to acquire and absorb the running business of XY Ltd. The valuation is to
be based on the recommendation of merchant bankers and the consideration is to be
discharged in the form of equity shares to be issued by AB Ltd. As on 31.3.2006, the paid up
capital of AB Ltd. consists of 80 lakhs shares of `10 each. The highest and the lowest market
quotation during the last 6 months were `570 and `430. For the purpose of the exchange, the
price per share is to be reckoned as the average of the highest and lowest market price during
the last 6 months ended on 31.3.06.
XY Ltd.s Balance Sheet as at 31.3.2006 is summarised below:
` lakhs
Sources
Share Capital
20 lakhs equity shares of `10 each fully paid
200
10 lakhs equity shares of `10 each, `5 paid
50
100
350
Loans
Total
Uses
Fixed Assets (Net)
150
Net Current Assets
200
350
An independent firm of merchant bankers engaged for the negotiation, have produced the
following estimates of cash flows from the business of XY Ltd.:
13.59
Year ended
By way of
31.3.07
after tax earnings for equity
105
31.3.08
do
120
31.3.09
Do
125
31.3.10
Do
120
31.3.11
Do
100
terminal value estimate
200
` lakhs
It is the recommendation of the merchant banker that the business of XY Ltd. may be valued
on the basis of the average of (i) Aggregate of discounted cash flows at 8% and (ii) Net assets
value. Present value factors at 8% for years
1-5:
0.93
(i)
0.86
0.79
0.74
0.68
Calculate the total value of the business of XY Ltd.
(ii) The number of shares to be issued by AB Ltd.; and

(iii) The basis of allocation of the shares among the shareholders of XY Ltd.
Answer
Price/share of AB Ltd. for determination of number of shares to be issued:
`
500
Value of XY Ltd based on future cash flow capitalization

(105x0.93)+(120x0.86)+(125x0.79)+(120x0.74)x(300x0.68)
` lakhs
592.40
Value of XY Ltd based on net assets
` lakhs
250.00
(`570 + `430)/2
Average value (592.40+250)/2

No. of shares in AB Ltd to be issued ` 4,21,20,000/500
421.20
Nos.
84240
Basis of allocation of shares

Fully paid equivalent shares in XY Ltd. (20+5) lakhs
2500000
Distribution to fully paid shareholders 84240x20/25
67392
Distribution to partly paid shareholders 84240-67392
16848
Question 43
BA Ltd. and DA Ltd. both the companies operate in the same industry. The Financial
statements of both the companies for the current financial year are as follows:
13.60
Balance Sheet
Particulars
BA Ltd.
(` )
DA Ltd.
(` )
Current Assets
14,00,000
10,00,000
Fixed Assets (Net)
10,00,000
24,00,000
5,00,000
15,00,000
10,00,000
8,00,000
2,00,000
5,00,000
-3,00,00
7,00,000
24,00,000
4,00,000
15,00,000
BA Ltd.
(` )
DA Ltd.
(` )
Net Sales
Cost of Goods sold
34,50,000
27,60,000
17,00,000
13,60,000
Gross profit
Operating expenses
6,90,000
2,00,000
3,40,000
1,00,000
Interest
Earnings before taxes
70,000
4,20,000
42,000
1,98,00
Taxes @ 50%
2,10,000
99,000
Earnings after taxes (EAT)

Additional Information :
2,10,000
99,000
No. of Equity shares
1,00,000
80,000
Dividend payment ratio (D/P)
40%
60%
`40
`15
Total (`)
Equity capital (`10 each)
Retained earnings
14% long-term debt
Current liabilities
Total (`)
Income Statement
Assume that both companies are in the process of negotiating a merger through an exchange
of equity shares. You have been asked to assist in establishing equitable exchange terms and
are required to:
(i)
Decompose the share price of both the companies into EPS and P/E components; and
also segregate their EPS figures into Return on Equity (ROE) and book value/intrinsic
value per share components.
(ii) Estimate future EPS growth rates for each company.
13.61
(iii) Based on expected operating synergies BA Ltd. estimates that the intrinsic value of DAs
equity share would be `20 per share on its acquisition. You are required to develop a
range of justifiable equity share exchange ratios that can be offered by BA Ltd. to the
shareholders of DA Ltd. Based on your analysis in part (i) and (ii), would you expect the
negotiated terms to be closer to the upper, or the lower exchange ratio limits and why?
(iv) Calculate the post-merger EPS based on an exchange ratio of 0.4: 1 being offered by BA
Ltd. and indicate the immediate EPS accretion or dilution, if any, that will occur for each
group of shareholders.
(v) Based on a 0.4: 1 exchange ratio and assuming that BA Ltd.s pre-merger P/E ratio will
continue after the merger, estimate the post-merger market price. Also show the resulting
accretion or dilution in pre-merger market prices.
Answer
Market price per share (MPS) = EPS X P/E ratio or P/E ratio = MPS/EPS
(i)
Determination of EPS, P/E ratio, ROE and BVPS of BA Ltd. and DA Ltd.
Earnings After Tax
(EAT)
No. of Shares
(N)
EPS
(EAT/N)
(MPS)
P/E Ratio
Equity Funds
(MPS/EPS)
(EF)
BVPS
(EF/N)
(EAT/EF) 100
ROE
BA Ltd.
DA Ltd.
` 2,10,000
100000
` 99,000
80000
` 2.10
40
` 1.2375
19.05
12.12
` 12,00,000
` 8,00,000
12
17.50%
10
15
12.37%
(ii) Estimation of growth rates in EPS for BA Ltd. and DA Ltd.

Retention Ratio
(1-D/P ratio)
Growth Rate
(ROE Retention Ratio)
0.6
0.4
10.50%
4.95%
(iii) Justifiable equity shares exchange ratio

(a)
Intrinsic value based
= `20 / `40
= 0.5:1 (upper limit)
(b)
Market price based
= MPSDA/MPSBA = `15 / `40 = 0.375:1 (lower limit)
Since, BA Ltd. has a higher EPS, ROE, P/E ratio and even higher EPS growth
expectations, the negotiable terms would be expected to be closer to the lower limit,
based on the existing share prices.
13.62
(iv) Calculation of post merger EPS and its effects

Particulars
EAT
BA Ltd.
(`)
Share outstanding
EPS
(`)
EPS Accretion (Dilution)
(`)
DA Ltd. Combined
(i)
2,10,000
99,000
3,09,000
(ii)
100000
80000
132000*
2.1
1.2375
2.341
(i) / (ii)
0.241 (0.301***)
(v) Estimation of Post merger Market price and other effects

Particulars
EPS
(`)
(i)
P/E Ratio
MPS
(`)
(ii)
(i) / (ii)
MPS Accretion
(`)
BA Ltd.
DA Ltd.
Combined
2.1
1.2375
2.341
19.05
40
12.12
15
19.05
44.6
4.6
2.84***
* Shares outstanding (combined)
= 100000 shares + (.40 80000)= 132000 shares
** EPS claim per old share
= `2.34 0.4
EPS dilution
= `1.2375 ` 0.936
***S claim per old share
(` 44.60 0.4)
Less: MPS per old share
` 0.936
` 0.3015
` 17.84
` 15.00
` 2.84
Question 44
A valuation done of an established company by a well-known analyst has estimated a value of
` 500 lakhs, based on the expected free cash flow for next year of ` 20 lakhs and an
expected growth rate of 5%.
While going through the valuation procedure, you found that the analyst has made the mistake
of using the book values of debt and equity in his calculation. While you do not know the book
value weights he used, you have been provided with the following information:
(i)
Company has a cost of equity of 12%,
(ii) After tax cost of debt is 6%,

(iii) The market value of equity is three times the book value of equity, while the market value
of debt is equal to the book value of debt.
You are required to estimate the correct value of the company. (8 Marks) (November 2010) (S)
13.63
Answer
Cost of capital by applying Free Cash Flow to Firm (FCFF) Model is as follows:Value of Firm = V0 =
FCFF1
K c gn
Where
FCFF1 = Expected FCFF in the year 1
Kc = Cost of capital
gn = Growth rate forever
Thus, ` 500 lakhs = ` 20 lakhs /(Kc-g)
Since g = 5%, then Kc = 9%
Now, let X be the weight of debt and given cost of equity = 12% and cost of debt = 6%,
then 12% (1 X) + 6% X = 9%
Hence, X = 0.50, so book value weight for debt was 50%
Correct weight should be 75% of equity and 25% of debt.
Cost of capital = Kc = 12% (0.75) + 6% (0.25) = 10.50%
and correct firms value = ` 20 lakhs/(0.105 0.05) = ` 363.64 lakhs.
Question 45
The valuation of Hansel Limited has been done by an investment analyst. Based on an
expected free cash flow of ` 54 lakhs for the following year and an expected growth rate of 9
percent, the analyst has estimated the value of Hansel Limited to be ` 1800 lakhs. However,
he committed a mistake of using the book values of debt and equity.
The book value weights employed by the analyst are not known, but you know that Hansel
Limited has a cost of equity of 20 percent and post tax cost of debt of 10 percent. The value of
equity is thrice its book value, whereas the market value of its debt is nine-tenths of its book
value. What is the correct value of Hansel Ltd?
Answer
Cost of capital by applying Free Cash Flow to Firm (FCFF) Model is as follows:Value of Firm = V0 =
FCFF1
K c gn
Where
FCFF1 = Expected FCFF in the year 1
Kc = Cost of capital
13.64
gn = Growth rate forever

Thus, `1800 lakhs = `54 lakhs /(Kc-g)
Since g = 9%, then Kc = 12%
Now, let X be the weight of debt and given cost of equity = 20% and cost of debt = 10%, then
20% (1 X) + 10% X = 12%
Hence, X = 0.80, so book value weight for debt was 80%
Correct weight should be 60 of equity and 72 of debt.
Cost of capital = Kc = 20% (60/132) + 10% (72/132) = 14.5455%
and correct firms value = ` 54 lakhs/(0.1454 0.09) = ` 974.73 lakhs.
Question 46
Following informations are available in respect of XYZ Ltd. which is expected to grow at a higher rate
for 4 years after which growth rate will stabilize at a lower level:
Base year information:

Revenue
- ` 2,000 crores
EBIT
- ` 300 crores
Capital expenditure
- ` 280 crores
Depreciation
- `200 crores
Information for high growth and stable growth period are as follows:
Growth in Revenue & EBIT
High Growth
Stable Growth
20%
10%
Growth in capital expenditure and 20%

depreciation
10%
Risk free rate
Capital expenditure
offset by depreciation
9%
Equity beta
1.15
Market risk premium

Pre tax cost of debt
6%
5%
13%
12.86%
Debt equity ratio
1:1
2:3
are
For all time, working capital is 25% of revenue and corporate tax rate is 30%.
What is the value of the firm?
(10 Marks) (May 2010) (M)
13.65
Answer
High growth phase :
ke = 0.10 + 1.15 x 0.06 = 0.169 or 16.9%.
kd = 0.13 x (1-0.3) = 0.091 or 9.1%.
Cost of capital = 0.5 x 0.169 + 0.5 x 0.091 = 0.13 or 13%.
Stable growth phase :
ke = 0.09 + 1.0 x 0.05 = 0.14 or 14%.
kd = 0.1286 x (1 - 0.3) = 0.09 or 9%.
Cost of capital = 0.6 x 0.14 + 0.4 x 0.09 = 0.12 or 12%.
Determination of forecasted Free Cash Flow of the Firm (FCFF)
(` in crores)
Yr. 1
Yr. 2
Yr 3
Yr. 4
Terminal Year
2,400
2,880
3,456
4,147.20
4,561.92
EBIT
EAT
360
252
432
302.40
518.40
362.88
622.08
435.46
684.29
479.00
Capital Expenditure
Less Depreciation
96
115.20
138.24
165.89
100.00
56.00
120.00
67.20
144.00
80.64
172.80
96.77
103.68
375.32
Revenue
Working Capital
Free Cash Flow (FCF)
Alternatively it can also be computed as follows:

(` in crores)
Yr. 1
Yr. 2
Yr 3
Yr. 4
Terminal Year
2,400
360
2,880
432
3,456
518.40
4,147.20
622.08
4,561.92
684.29
Add: Depreciation
252
240
302.40
288
362.88
345.60
435.46
414.72
479.00
456.19
590.40
708.48
850.18
935.19
Less: Capital Exp.
492
336
403.20
483.84
580.61
456.19
100.00
120.00
144.00
172.80
103.68
56.00
67.20
80.64
96.77
375.32
Revenue
EBIT
EAT
WC
Present Value (PV) of FCFF during the explicit forecast period is:

FCFF
(` in crores)
56.00
67.20
80.64
96.77
PVF @ 13%
13.66
PV
(` in crores)
49.56
52.62
55.88
59.32
` 217.38
0.885
0.783
0.693
0.613
Terminal Value of Cash Flow

375.32
= ` 18,766 Crores
0.12 - 0.10
PV of the terminal, value is:

` 18,766 Crores x
1
= ` 18,766 Crores x 0.613 = ` 11,503.56 Crores
(1.13) 4
The value of the firm is :

` 217.38 Crores + ` 11,503.56 Crores = ` 11,720.94 Crores
Question 47
ABC, a large business house is planning to sell its wholly owned subsidiary KLM. Another
large business entity XYZ has expressed its interest in making a bid for KLM. XYZ expects
that after acquisition the annual earning of KLM will increase by 10%.
Following information, ignoring any potential synergistic benefits arising out of possible
acquisitions, are available:
(i)
Profit after tax for KLM for the financial year which has just ended is estimated to be ` 10
crore.
(ii) KLM's after tax profit has an increasing trend of 7% each year and the same is expected
to continue.
(iii) Estimated post tax market return is 10% and risk free rate is 4%. These rates are
expected to continue.
(iv) Corporate tax rate is 30%.
XYZ
ABC
Proxy entity for KLM in

the same line of business
100 lakhs
80 lakhs
--
Current share price
` 287
` 375
--
Dividend pay out
40%
50%
50%
Debt : Equity at market values
1:2
1:3
1:4
No. of shares
13.67
P/E ratio
10
13
12
Equity beta
1. 1
1.1
Assume gearing level of KLM to be the same as for ABC and a debt beta of zero.
You are required to calculate:
(a) Appropriate cost of equity for KLM based on the data available for the proxy entity.
(b) A range of values for KLM both before and after any potential synergistic benefits to XYZ
of the acquisition.
(8 Marks) (May 2010) (M)
Answer
a.
ungreared for the proxy company = 1.1 X 4 / [ 4 + (1 0.3) ] = 0.9362
0.9362 = equity greared X 3/ [ 3 + (1 - 0.3)]

equity geared
b.
Cost of equity
P/E valuation
= 1.1546
= 0.04 + 1.1546 X (0.1 0.04) = 10.93%
(Based on earning of ` 10 Crore)
Pre synergistic value

Post synergistic value
Using proxy
Using XYZs
Entitys P/E
P/E
12 X ` 10 Crore
10 X ` 10 Crore
= ` 120 Crore
= ` 100 Crore
12 X ` 10 Crore X 1.1
10 X ` 10 Crore X 1.1
= ` 132 Crore
= ` 110 Crore
Dividend valuation model

Pre synergistic value
Post synergistic value
Based on 50% payout

0.5 X 10 X 1.07
0.1093 - 0.07
= ` 136.13 Crore
0.5 X 10 X 1.1 X 1.07
0.1093 - 0.07
= ` 149.75 Crore
Based on 40% payout

0.4X10X1.07
0.1093 - 0.07
=` 108.91 Crore
0.4 X 10 X 1.1 X 1.07
0.1093 - 0.07
= ` 119.79 Crore
Market Price
Although no information is available about the value of KLM, it may be possible to
calculate a market value based on proportion of earnings of ABC that is generated by
KLM.

Market value of ABC
= 80 Lakh Shares X ` 375 = ` 300 Crore
Post Tax earnings of ABC
= ` 300/13
13.68
= ` 23.08 Crore
If market value of ABC is allocated to KLM in the proportion of relative earning of KLM to
that of ABC, KLM would have a market value of ` 300 crore X [ 10/23.08] = ` 130 Crore.
KLMs Post Tax earning = ` 10 Crore.
If ABCs P/E ratio is applied to it, the market value of KLM becomes ` 10 Crore X 13 = `
130 Crore.
Therefore, it assumes that KLM has the same P/E ratio as that of ABC.
Range of valuation
Pre synergistic
` 100 Crore
` 136.13 Crore
Post synergistic
` 110 Crore
` 149.75 Crore
Question 48
Using the chop-shop approach (or Break-up value approach), assign a value for Cranberry
Ltd. whose stock is currently trading at a total market price of 4 million. For Cranberry Ltd,
the accounting data set forth three business segments: consumer wholesale, retail and
general centers. Data for the firms three segments are as follows:
Business Segment
Segment
Sales
Segment
Assets
Segment Operating
Income
Wholesale
Retail
225,000
720,000
600,000
500,000
75,000
150,000
2,500,000
4,000,000
700,000
General
Industry data for pure-play firms have been compiled and are summarized as follows:
Business
Segment
Capitalization/Sales
Capitalization/Assets
Capitalization/Operating
Income
Wholesale
Retail
0.85
0.7
1.2
0.7
General
0.8
0.7
4
Answer
Business Segment
Wholesale
Capital-to-Sales
0.85
Segment Sales
225000
Theoretical Values
191250
13.69
Retail
1.2
720000
864000
General
Total value
0.8
2500000
2000000
3055250
Business Segment
Capital-to-Assets
Segment Assets
Theoretical Values
Wholesale
0.7
600000
420000
Retail
0.7
500000
350000
General
0.7
4000000
2800000
3570000
Capital-toOperating Income
Operating Income
Theoretical Values
Wholesale
75000
675000
Retail
150000
1200000
General
Total value
700000
2800000
4675000
Total value
Business Segment
Average theoretical value
3055250 3570000 4675000

3766750
3
Average theoretical value of Cranberry Ltd. = 3766750

Question 49
The following is the Balance-sheet of Grape Fruit Company Ltd as at March 31st ,2011.
Liabilities
(` in lakhs)
Assets
(` in lakhs)
Equity shares of ` 100 each
600 Land and Building
200
14% preference shares of ` 100/each
200 Plant and Machinery
300
13% Debentures
200 Furniture and Fixtures
Debenture interest accrued and

payable
26 Inventory
Loan from bank
74 Sundry debtors
Trade creditors
150
70
340 Cash at bank

Preliminary expenses
Cost of issue
debentures
50
of
130
10
5
and
Profit
account
Loss
1440
13.70
525
1440
The Company did not perform well and has suffered sizable losses during the last few years.
However, it is felt that the company could be nursed back to health by proper financial
restructuring. Consequently the following scheme of reconstruction has been drawn up :
(i)
Equity shares are to be reduced to ` 25/- per share, fully paid up;
(ii)
Preference shares are to be reduced (with coupon rate of 10%) to equal number of
shares of ` 50 each, fully paid up.
(iii)
Debenture holders have agreed to forgo the accrued interest due to them. In the future,
the rate of interest on debentures is to be reduced to 9 percent.
(iv)
Trade creditors will forego 25 percent of the amount due to them.
(v)
The company issues 6 lakh of equity shares at ` 25 each and the entire sum was to be
paid on application. The entire amount was fully subscribed by promoters.
(vi)
Land and Building was to be revalued at ` 450 lakhs, Plant and Machinery was to be
written down by ` 120 lakhs and a provision of `15 lakhs had to be made for bad and
doubtful debts.
Required:
(i)
Show the impact of financial restructuring on the companys activities.
(ii) Prepare the fresh balance sheet after the reconstructions is completed on the basis of
the above proposals.
(6+4 Marks) (November 2011)
Answer
Impact of Financial Restructuring
(i)
Benefits to Grape Fruit Ltd.

(a)
Reduction of liabilities payable
` in lakhs
Reduction in equity share capital (6 lakh shares x `75 per share)
450
Reduction in preference share capital (2 lakh shares x `50 per

share)
100
Waiver of outstanding debenture Interest
26
Waiver from trade creditors (`340 lakhs x 0.25)
85
661
13.71
(b)
Revaluation of Assets
Appreciation of Land and Building (`450 lakhs - `200 lakhs)
250
Total (A)
911
(ii) Amount of `911 lakhs utilized to write off losses, fictious assets and over- valued assets.
Writing off profit and loss account
525
Cost of issue of debentures
Preliminary expenses
Provision for bad and doubtful debts
10
15
Revaluation of Plant and Machinery

(`300 lakhs `104 lakhs)
120
Total (B)
675
Capital Reserve (A) (B)
236
(ii) Balance sheet of Grape Fruit Ltd as at 31st March 2011 (after re-construction)
(` in lakhs)
Liabilities
Amoun
t
Assets
Amoun
t
12 lakhs equity shares of `25/each
300 Land & Building
450
10% Preference shares of `50/each
100 Plant & Machinery
180
Capital Reserve
9% debentures
236 Furnitures & Fixtures

200 Inventory
50
150
Loan from Bank

Trade Creditors
74 Sundry debtors
255
Cash-at-Bank
(Balancing figure)*
1165
70
-15
55
280
1165
*Opening Balance of `130/- lakhs + Sale proceeds from issue of new equity shares
`150/- lakhs.
Question 50
M/s Tiger Ltd. wants to acquire M/s. Leopard Ltd. The balance sheet of Leopard Ltd. as on
31st March, 2012 is as follows:
Liabilities
Assets
Equity Capital (70,000 shares)
13.72
Cash
50,000
Retained earnings
12% Debentures
3,00,000 Debtors
3,00,000 Inventories
Creditors and other liabilities
3,20,000 Plants & Eqpt.
70,000
2,00,000
13,00,000
16,20,000
16,20,000
Additional Information:
(i)
Shareholders of Leopard Ltd. will get one share in Tiger Ltd. for every two shares.
External liabilities are expected to be settled at ` 5,00,000. Shares of Tiger Ltd. would be
issued at its current price of ` 15 per share. Debentureholders will get 13% convertible
debentures in the purchasing company for the same amount. Debtors and inventories are
expected to realize ` 2,00,000.
(ii) Tiger Ltd. has decided to operate the business of Leopard Ltd. as a separate division.
The division is likely to give cash flows (after tax) to the extent of
` 5,00,000 per year for 6 years. Tiger Ltd. has planned that, after 6 years, this division
would be demerged and disposed of for ` 2,00,000.
(iii) The companys cost of capital is 16%.
Make a report to the Board of the company advising them about the financial feasibility of this
acquisition.
Net present values for 16% for ` 1 are as follows:
Years
PV
1
.862
2
.743
3
.641
4
.552
5
.476
6
.410

Answer
Calculation of Purchase Consideration
`
Issue of Share 35000 x `15
5,25,000
External Liabilities settled
5,00,000
3,00,000
13% Debentures
Less: Realization of Debtors and Inventories
Cash
13,25,000
2,00,000
50,000
10,75,000
13.73
Net Present Value = PV of Cash Inflow + PV of Demerger of Leopard Ltd. Cash Outflow
= ` 5,00,000 PVAF(16%,6) + ` 2,00,000 PVF(16%, 6) ` 10,75,000
= ` 5,00,000 x 3.684 + ` 2,00,000 x 0.410 ` 10,75,000
= ` 18,42,000 + ` 82,000 ` 10,75,000
= ` 8,49,000
Since NPV of the decision is positive it is advantageous to acquire Leopard Ltd.

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13

Merger, Acquisition & Restructuring

(4 Marks) (November 2012)

(8 Marks) (November 2003)

The Institute of Chartered Accountants of India

Merger, Acquisition & Restructuring

(3 Marks) (May 2006), (4 Marks) (November 2011)

The Institute of Chartered Accountants of India

Strategic Financial Management

(4 Marks) (November 2010) (M)

The Institute of Chartered Accountants of India

Merger, Acquisition & Restructuring

There is a change in control in the transferee company through the introduction of a

(4 Marks) (November 2013)

The number of shares to be issued by B Ltd.

The Institute of Chartered Accountants of India

Strategic Financial Management

The EPS of the new firm is

The present EPS of B Ltd is

Thus value of total business is (` 400 x 1.5 Cr.)

VALUATION BASED ON DISCOUNTED CASH FLOW

` 498.10 per share

The Institute of Chartered Accountants of India

Merger, Acquisition & Restructuring

(5 Marks) (May 2013)

Per Share (`)

Market price per share

The Institute of Chartered Accountants of India

Strategic Financial Management

The value of Elrond Ltd. after merger will be:

`290 lakhs `250 lakhs = `40 lakhs

You are required to :

Profit from new product

The Institute of Chartered Accountants of India

Merger, Acquisition & Restructuring

Expected profits before taxes

Profit after taxes

(b) Future maintainable profits (After Tax)

Preference share dividends

Earning per share =

Market price per share

You are required to:

The Institute of Chartered Accountants of India

Strategic Financial Management

Computation of Business Value

Profit before tax

Profit from new product

Less: Taxes @30%

(ii) Determination of Market Price of Equity Share

Less: Preference share dividends 1,00,000 shares of ` 100 @ 13%

Earnings available for Equity Shareholders

No. of Equity Shares

The Institute of Chartered Accountants of India

Merger, Acquisition & Restructuring

Total number of equity shares outstanding

Market price of equity share

Maximum Price (` 3,50,00,000/10,00,000)

Add: PV of loss of remuneration to top management

The Institute of Chartered Accountants of India

Strategic Financial Management

The Institute of Chartered Accountants of India

Merger, Acquisition & Restructuring

PV of the terminal, value is: