This note is strictly for use by students of M&A and CR of IIMK PGP BL Program

Illustrative Problems on Equity and Business Valuation

Note: All financial numbers in this note are in ₹.

Problem 1

A Ltd. is considering acquisition of B Ltd. with stock. Relevant financial information is given below.

Particulars A Ltd. B Ltd.

Present earnings 7.5 lakhs 2.5 lakhs
Equity (No. of shares) 4.0 lakhs 2.0 lakhs
EPS 1.875 1.25
P/E ratio 10 5

Answer the following questions:

a. What is the market price of each company?
b. What is the market capitalization of each company?
c. If the P/E of A Ltd. changes to 7.5, what is the market price of A Ltd?
d. Does market value of A Ltd. change?
e. What would be the exchange ratio based on Market Price? (Take revised Price of A Ltd.)

Problem 2

Mark Ltd wants to acquire Mask Ltd. The following information is provided in relation to the acquiring firm
Mark Ltd. and the target Mask Ltd.

Particulars Firm Mark Limited Firm Mask Limited

Earnings after tax (`) 200 lacs 40 lacs
Number of shares outstanding 20 lacs 10 lacs
P/E ratio 10 5

Please answer the following questions:

(i) What is the swap ratio in terms of 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 that 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.

Problem 3

Following are the financial statement for A Ltd. and B Ltd. for the current financial year. Both the firms
operate in the same industry. A Ltd. wants to acquire B. Ltd. The following are the state of their financial
affairs as per the last report
Balance Sheet
Particulars A Ltd. B. Ltd.
Total Current assets 14,00,000 10,00,000
Total Fixed assets (net) 10,00,000 5,00,000
24,00,000 15,00,000
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Equity capital (of ` 100 each) 10,00,000 8,00,000

Retained earnings 2,00,000
14% Long-term debt 5,00,000 3,00,000
Total Current liabilities 7,00,000 4,00,000
24,00,000 15,00,000

Income-Statements (`)
Particulars A Ltd. B. Ltd.
Net sales 34,50,000 17,00,000
Cost of goods sold 27,60,000 13,60,000
Gross profit 6,90,000 3,40,000
Operating expenses 2,00,000 1,00,000
Interest 70,000 42,000
Earnings before taxes 4,20,000 1,98,000
Taxes (50%) 2,10,000 99,000
Earnings after taxes (EAT) 2,10,000 99,000

Additional Information
Number of equity shares A - 10,000 B - 8,000
Dividend payment ratio (D/P) 40% 60%
Market price per share (MPS) 400 150

Accordingly, they are independently in the process of negotiating a merger through an exchange of equity
shares and the PE Fund is helping the process.
You have been asked to assist in establishing equitable exchange terms, and are required to –

(i) Decompose the share prices 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
(BVPS) components.
(ii) Estimate future EPS growth rates for each firm.
(iii) Based on expected operating synergies, A Ltd. estimates that the intrinsic value of B’s equity share
would be 200 per share on its acquisition. You are required to develop a range of justifiable equity
share exchange ratios that can be offered by A Ltd. to B Ltd. ‘s shareholders. Based on your analysis
in parts (i) and (ii) would you expect the negotiated terms to be closer to the upper, or the lower
exchange ratio limits? Why?
(iv) Calculate the post-merger EPS based on an exchange ratio of 0.4:1 being offered by A Ltd.
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 A’s pre-merger P/E ratio will continue after the
merger, estimates the post-merger market price. Show the resulting accretion or dilution in pre-merger
market prices.

Problem 4

Fat Ltd. wants to acquire Lean Ltd. to gain more critical mass before they can approach a PE Fund for
further expansion of business. The balance sheet of Lean Ltd. as on 31.03.2016 is as follows:

Liabilities Assets
(1) Shareholders Fund: (1) Non-current Assets:
(a) Share Capital (a) Fixed Assets
(i) 60,000 Equity Shares of `10 each 6,00,000 (i) Tangible Assets:
— Plant and Equipment 11,00,000
(b) Reserve & Surplus
(i) Retained Earnings 2,00,000
(2) Non-Current Liabilities: (2) Current Assets:
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Long Term Borrowings - 12% (a) Inventories 1,70,000

Debenture 2,00,000 (b) Trade Receivables
— Sundry Debtors 30,000
(c) Cash and Cash
Equivalents 20,000
(3) Current Liabilities:
(a) Trade Payables - Sundry Creditors 3,20,000
Total 13,20,000 Total 13,20,000

Additional information:
(i) Shareholders of Lean Ltd. will get one share in Fat Ltd. for every two shares. External liabilities are
expected to be settled at ` 3,00,000. Shares of Fat Ltd. would be issued at its current price of ` 15 per
share. Debenture holders will get 13% convertible debentures in the purchasing companies for the
same amount. Debtors and inventories are expected to release ` 1,80,000.
(ii) Fat Ltd. has decided to operate the business of Lean Ltd. as a separate division. The division is likely
to give cash flow (after tax) to the extent of ` 3,00,000 per year for 6 years. Fat Ltd. has planned that
after 6 year this division would be damaged and disposed off for ` 1,00,000.

(iii) Company’s cost of capital is 14%

Submit a report to the managing director advising him about the financial feasibility of the acquisition.

Note:
Present value of Re. 1 for six years @ 14% interest: 0.8772, 0.7695, 0.6750, 0.5921, 0.51937 and 0.4556.

Problem 5.
The following information is relating to Fortune India Ltd. having two division Pharma division and 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. 1.4.2014 with
the objective of expanding it further with the help of a VC Fund. Details of Fortune India Ltd. as on 31.3.2014
and of Fortune Pharma Ltd. as on 1.4.2014 are given below:

Particulars Fortune Pharma Fortune India

Ltd. in lakh Ltd. in lakh
Outside Liabilities
Secured Loans 400 3,000
Unsecured Loan 2,400 800
Current Liabilities & Provision 1,300 21,200
Assets
Fixed Assets 7,740 20,400
Investments 7,600 12,300
Current Assets 8,800 30,200
Loans and Advances 900 7,300
Deferred tax / Misc. exp. 60 (200)

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:
 Transfer of Liabilities and Assets at Book value.
 Estimated profit for the year 2014-15 is 11,400 lakh for Fortune India Ltd. and 1,470 lakh for Fortune
Pharma Ltd.
 Estimated Market price of Fortune Pharma Ltd. is 24.50 per share.
 Average P/E ratio of FMCG sector is 42 and Pharma sector is 25, which is to be expected for both the
companies.
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Please calculate the following:

(i) The Ratio in which shares of Fortune Pharma are to be issued to the shareholders of Fortune India
Ltd.
(ii) Expected Market price of Fortune India Ltd.
(iii) Book value per share of both the Companies after demerger.

Illustration 6.
The following information is provided relating to the acquiring company X Ltd. and the target company Y Ltd.
X Ltd. Y Ltd.
No. of shares (F.V. Rs 10 each) 10.00 lakhs 7.5 lakhs
Market capitalization (Rs.) 500.00 lakhs 750.00 lakhs
P/E ratio (Times) 10 5
Reserve and surplus (Rs.) 300.00 lakhs 165.00 lakhs
Promoter’s holding (No. of shares) 4.75 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 Earnings, Book
value and Market price of share of each company:

(i) Calculate the swap ratio and also calculate Promoters holding percentage after acquisition.
(ii) What is the EPS of X Ltd. after acquisition of Y Ltd?
(iii) What is the expected market price per share and market capitalization of X Ltd. after acquisition,
assuming P/E ratio of firm X Ltd. remains unchanged.
(iv) Calculate free float market capitalization of the merged fair.