CHAPTER 14

12
MERGERS, ACQUISITIONS &
CORPORATE
RESTRUCTURING
LEARNING OUTCOMES
After going through the chapter student shall be able to understand
 Conceptual Framework
 Rationale
 Forms
 Financial Framework
 Takeover Defensive Tactics
 Reverse Merger
 Divestiture
 Financial Restructuring
 Ownership Restructuring
 Unlocking the value through Mergers & Acquisitions and Business
Restructuring
 Mergers and Acquisitions Failures
 Cross Border Mergers
 Special Purpose Acquisition Companies (SPACs)

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1. CONCEPTUAL FRAMEWORK
Restructuring of business is an integral part of modern business enterprises. The globalization and
liberalization of Control and Restrictions has generated new waves of competition and free trade.
This requires Restructuring and Re-organisation of business to create new synergies to face the
competitive environment and changed market conditions.
Restructuring usually involves major organizational changes such as shift in corporate strategies.
Restructuring can be internally in the form of new investments in plant and machinery, Research
and Development of products and processes, hiving off non-core businesses, divestment, sell-offs,
de-merger etc. Restructuring can also take place externally through Mergers and Acquisitions
(M&As), by forming joint-ventures and having strategic alliances with other firms.
The aspects relating to expansion or contraction of a firm’s operations or changes in its assets or
financial or ownership structure are known as corporate re-structuring. While there are many forms
of corporate re-structuring, mergers, acquisitions and takeovers, financial restructuring and re-
organisation, divestitures de-mergers and spin-offs, leveraged buyouts and management buyouts
are some of the most common forms of corporate restructuring.
The most talked about subject of the day is Mergers & Acquisitions (M&A). In developed economies,
corporate Mergers and Acquisition is a regular feature. In Japan, the US and Europe, hundreds of
mergers and acquisition take place every year. In India, too, mergers and acquisition have become
a part of corporate strategy today.
Mergers, acquisitions and corporate restructuring of businesses in India have grown by leaps and
bounds in the last decade. From about $4.5 billion in 2004, the market for corporate control zoomed
to $ 13 billion in 2005 and reached to record $56.2 billion in 2016. This tremendous growth was
attributed to the fact that the foreign investors were looking for an alternative destination, preferably
a growing economy as their own country was reeling under the pressure of recession. This was
caused by the tough macro-economic climate created due to Euro Zone crisis and other domestic
reasons such as inflation, fiscal deficit and currency depreciation.
The terms ‘mergers; ‘acquisitions’ and ‘takeovers’ are often used interchangeably in common
parlance. However, there are differences. While merger means unification of two entities into one,
acquisition involves one entity buying out another and absorbing the same. In India, in legal sense
merger is known as ‘Amalgamation’.
The amalgamations can be by merger of companies within the provisions of the Companies Act, and
acquisition through takeovers. While takeovers are regulated by SEBI, Mergers and Acquisitions

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(M&A) deals fall under the Companies Act. In cross border transactions, international tax
considerations also arise.

Halsburry’s Laws of England defined amalgamation as a blending of two or more existing

undertakings, the shareholders of each amalgamating company becoming substantially the
shareholders in the amalgamating company. Accordingly, in a merger, two or more companies
combine into a single unit.
The term “amalgamation” is used when two or more companies are amalgamated or where one is
merged with another or taken over by another. In Inland Steam Navigation Workers Union vs. R.S.
Navigation Company Ltd., it was observed that in case of amalgamation, the rights and liabilities of
a company are amalgamated into another so that the transferee company becomes vested with all
rights and liabilities of the transferor company.
An acquisition is when both the acquiring and acquired companies are still left standing as separate
entities at the end of the transaction. A merger results in the legal dissolution of one of the
companies, and a consolidation dissolves both of the parties and creates a new one, into which
the previous entities are merged.
In India corporate takeovers were started by Swaraj Paul when he tried to takeover Escorts. The
other major takeovers are that of Ashok Leyland by the Hindujas Shaw Wallace, Dunlop, and Falcon
Tyres by the Chabbria Group; Ceat Tyres by the Goenkas; and Consolidated Coffee by Tata Tea.
The BIFR arranged for the takeover of companies by giants like ITC, McDowells, Lakshmi Machine
Works, and the Somani Group.
Many new companies are being incorporated as a result of the fast-growing industrialization of the
country which is mainly dependent on agriculture. With the new trends of globalization, not only in
this country but also worldwide, there has been increasing interaction of companies and persons of
one country with those of other countries. Today, corporate restructuring has gained momentum as
a result, undertakings and companies are merging, demerging, divesting and taking over, both
unregistered and registered in India as well as outside India.

Against this corporate backdrop, mergers and acquisitions have to be encouraged in the interest of
the general public and for the promotion of industry and trade. At the same time the government has
to safeguard the interest of the citizens, the consumers and the investors on the one hand and the
shareholders, creditors and employees/workers on the other.
Chapter XV (Section 230 to 240) of Companies Act, 2013 (the Act) contains provisions on
‘Compromises, Arrangements and Amalgamations’, that covers compromise or arrangements,
mergers and amalgamations, Corporate Debt Restructuring, demergers, fast track mergers for small

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companies/holding subsidiary companies, cross border mergers, takeovers, amalgamation of

companies in public interest etc.

Special restructuring processes such as ‘Reconstruction’ of sick industrial companies envisaged by

the Sick Industries (Special Provisions) Act, 1985 and ‘Revival’ of financially unviable companies
envisaged by sec 72A of the Income Tax Act, 1961. However, all such mergers and acquisitions are
also governed or controlled through relevant provisions of the Foreign Exchange Management Act,
1999; Income Tax Act, 1961; Industries (Development and Regulation) Act, 1951, the Competition
Act 2002; the restrictions imposed by other relevant Acts including SEBI Act, 1992, as the case may
be.
“Generally, where only one company is involved in a scheme and the rights of the shareholders and
creditors are varied, it amounts to reconstruction or reorganization or scheme of arrangement.
In an amalgamation, two or more companies are fused into one by merger or by one taking over the
other. Amalgamation is a blending of two or more existing undertakings into one undertaking, the
shareholders of each blending company become substantially the shareholders of the company
which is to carry on the blended undertaking. There may be amalgamation either by the transfer of
two or more undertakings to a new company, or by the transfer of one or more undertaking to an
existing company. Strictly, ‘amalgamation’ does not cover the mere acquisition of share capital of
the other company which remains in existence and continues its undertaking but the context in which
the term is used may show that it is intended to include such an acquisition.”

2. RATIONALE FOR MERGERS AND ACQUISITIONS

The most common reasons for Mergers and Acquisition (M&A) are:
• Synergistic operating economics: 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. Synergy is the increase in performance of the combined firm over what the
two firms are already expected or required to accomplish as independent firms (Mark L
Sirower of Boston Consulting Group, in his book “The Synergy Trap”). This may be the result
of complimentary services or economies of scale or both.
A good example of complimentary activities can be a company having a good network of
branches and other company having an efficient production system. Thus, the merged
companies will be more efficient than individual companies.

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On similar lines, economies of large scale is also one of the reasons 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 economies 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 for bulk
transactions. Other factors for Synergies are as follows:

• Diversification: Merger between two unrelated companies would lead to reduction in

business risk, which in turn will increase the market value consequent upon the reduction in
discount rate/ required rate of return. Normally, greater the combination of statistically
independent or negatively correlated income streams of merged companies, higher will be
the reduction in business risk in comparison to companies having income streams which are
positively correlated to each other.
• Taxation: The provisions of set off and carry forward of losses as per Income Tax Act may
be another strong reason for the merger and acquisition. Thus, there will be Tax saving or
reduction in tax liability of the merged firm. Similarly, in the case of acquisition the losses of
the target company will be allowed to be set off against the profits of the acquiring company.
• Growth: Merger and acquisition mode enables the firm to grow at a rate faster than the other
mode viz., organic growth. The reason being the shortening of ‘Time to Market’. The acquiring
company avoids delays associated with purchasing of building, site, setting up of the plant
and hiring personnel etc.
• Consolidation of Production Capacities and increasing market power: Due to reduced
competition, marketing power increases. Further, production capacity is increased by the
combination of two or more plants. The following table shows the key rationale for some of
the well-known transactions which took place in India in the recent past.
Rationale for M & A
Instantaneous growth, Snuffing out • Airtel – Loop Mobile (2014)
competition, Increased market share. (Airtel bags top spot in Mumbai Telecom Circle)
Acquisition of a competence or a • Google – Motorola (2011)
capability (Google got access to Motorola’s 17,000
issued patents and 7500 applications)

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Entry into new markets/product • Airtel – Zain Telecom (2010)

segments (Airtel enters 15 nations of African Continent in
one shot)
Access to funds • Ranbaxy – Sun Pharma (2014)
(Daiichi Sankyo sold Ranbaxy to generate
funds)
Tax benefits • Burger King (US) – Tim Hortons (Canada)
(2014)
(Burger King could save taxes in future)
Instantaneous growth, Snuffing out • Facebook – Whatsapp (2014)
competition, Increased market share. (Facebook acquired its biggest threat in chat
space)
Acquisition of a competence or a • Flipkart – Myntra (2014)
capability (Flipkart poised to strengthen its competency
in apparel e-commerce market)
Entry into new markets/product • Cargill – Wipro (2013)
segments (Cargill acquired Sunflower Vanaspati oil
business to enter Western India Market)
Access to funds • Jaypee – Ultratech (2014)
(Jaypee sold its cement unit to raise funds for
cutting off its debt)
Tax benefits • Durga Projects Limited (DPL) – WBPDCL
(2014)
(DPL’s loss could be carry forward and setoff)

3. FORMS (TYPES) OF MERGERS

A merger is generally understood to be a fusion of two companies. The term “merger” means the
dissolution of one or more companies or firms or proprietorships to form or get absorbed into another
company. By concept, merger increases the size of the undertakings. Following are the major types
of mergers:
(i) Horizontal Merger: The two companies which have merged are in the same industry,
normally the market share of the new consolidated company would be larger and it is possible
that it may move closer to being a monopoly or a near monopoly to avoid competition.
(ii) Vertical Merger: This merger happens when two companies that have ‘buyer-seller’
relationship (or potential buyer-seller relationship) come together.

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(iii) Conglomerate Mergers: Such mergers involve firms engaged in unrelated type of
business operations. In other words, the business activities of acquirer and the target are
neither related to each other horizontally (i.e., producing the same or competing products)
nor vertically (having relationship of buyer and supplier).In a pure conglomerate merger, there
are no important common factors between the companies in production, marketing, research
and development and technology. There may however be some degree of overlapping in one
or more of these common factors. Such mergers are in fact, unification of different kinds of
businesses under one flagship company. The purpose of merger remains utilization of
financial resources, enlarged debt capacity and also synergy of managerial functions.
(iv) Congeneric Merger: In these mergers, the acquirer and the target companies are related
through basic technologies, production processes or markets. The acquired company
represents an extension of product-line, market participants or technologies of the acquirer.
These mergers represent an outward movement by the acquirer from its current business
scenario to other related business activities within the overarching industry structure.
(v) Reverse Merger: Such mergers involve acquisition of a public (Shell Company) by a private
company, as it helps the same private company to by-pass lengthy and complex process
required to be followed in case it is interested in going public.
(vi) Acquisition: This refers to the purchase of controlling interest by one company in the share
capital of an existing company. This may be by:
(i) an agreement with majority holder of Interest.
(ii) Purchase of new shares by private agreement.
(iii) Purchase of shares in open market (open offer)
(iv) Acquisition of share capital of a company by means of cash, issuance of shares.
(v) Making a buyout offer to general body of shareholders.
When a company is acquired by another company, the acquiring company has two choices,
one, to merge both the companies into one and function as a single entity or two, to operate
the taken-over company as an independent entity with changed management and policies.
‘Merger’ is the fusion of two independent firms on co-equal terms. ‘Acquisition’ is buying out
of a company by another company and the acquired company usually loses its identity.
Normally, this process is friendly.

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Acquisition +NPV Normal gain Operating Entity

Industry gain Financial
of subsequent from the over the marke leverage improvements Value
investment market

Source: Patricial Anslinger and Thomas E Copeland, “Growth through Acquisitions : A Fresh
look, Harvard Business Review Jan. – Feb -1996.
Acquisition of one of the businesses of a company, as a going concern by an agreement need
not necessarily be routed through court, if the transfer of business is to be accomplished
without allotting shares in the transferee company to the shareholders of the transferor
company. This would tantamount to a simple acquisition. In this case the transferor company
continues to exist and no change in shareholding is expected. If the sale takes place for a
lumpsum consideration without attributing any individual values to any class of assets, such
sales are called slump sales. The capital gains arising on slump sales were being exempt
from income tax based on a decision of the Supreme Court of India.

4. FINANCIAL FRAMEWORK
4.1 Gains from Mergers or Synergy
The first step in merger analysis is to identify the economic gains from the merger. There are gains
if the combined entity is more than the sum of its parts.
That is, Combined value > (Value of acquirer + Stand-alone value of target)
The difference between the combined value and the sum of the values of individual companies is
usually attributed to synergy.
Value of acquirer + Stand-alone value of target + Value of synergy = Combined value

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There is also a cost attached to an acquisition. The cost of acquisition is the premium paid over the
market value plus other costs of integration. Therefore, the net gain is the value of synergy minus
premium paid.
VA = `100
VB = ` 50
VAB = ` 175
Where, VA = Value of Acquirer
VB = Standalone value of target
And, VAB = Combined Value
So, Synergy = VAB – (VA + VB) = 175 - (100 + 50) = 25

If premium is ` 10, then, Net gain = Synergy – Premium = 25 – 10 = 15

Acquisition need not be made with synergy in mind. It is possible to make money from non-
synergistic acquisitions as well. As can be seen from the Exhibit, operating improvements are a big
source of value creation. Better post-merger integration could lead to abnormal returns even when
the acquired company is in unrelated business. Obviously, managerial talent is the single most
important instrument in creating value by cutting down costs, improving revenues, operating profit
margin and cash flow position, etc. Many a time, executive compensation is tied to the performance
in the post-merger period. Providing equity stake in the company induces executives to think and
behave like shareholders.

Exhibit: Merger gains

Transaction cost
Value of synergy

Stand alone Value

Combined value

Value of acquirer

Source : Patricia L Anslinger and Thomas E Copeland, ‘Growth Through Acquisitions : A

Fresh Look’, Harvard Business Review, Jan–Feb., 1996.

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4.2 Scheme of Amalgamation or Merger

The scheme of any arrangement or proposal for a merger is the heart of the process and has to be
drafted with care.

There is no prescribed form for a scheme, and it is designed to suit the terms and conditions relevant
to the proposal and should take care of any special feature peculiar to the arrangement.
An essential component of a scheme is the provision for vesting all the assets and liabilities of the
transferor company in its transferee company. If the transferee company does not want to take over
any asset or liability, the transferor company before finalizing the draft scheme should dispose off
or settle them. Otherwise, the scheme would be considered defective and incomplete, and the court
would not sanction it.
It is equally important to define the effective date from which the scheme is intended to come into
operation. This would save time and labour in explaining to the court the intention behind using
several descriptions in the scheme. For accounting purposes, the amalgamation shall be affected
with reference to the audited accounts and balance sheets as on a particular date (which precedes
the date of notification) of the two companies and the transactions thereafter shall be pooled into a
common account.
Another aspect relates to the valuation of shares to decide the exchange ratio. Objections have
been raised as to the method of valuation even in cases where the scheme had been approved by
a large majority of shareholders and the financial institutions as lenders. The courts have declared
their unwillingness to engage in a study of fitness of the mode of valuation. A High Court stated:
“There are bound to be differences of opinion as to what the correct value of the shares of the
company is. Simply because it is possible to value the share in a manner different from the one
adopted in each case, it cannot be said that the valuation agreed upon has been unfair.” Similarly,
in the case of Hindustan Lever the Supreme Court held that it would not interfere with the valuation
of shares when more than 99 per cent of the shareholders have approved the scheme and the
valuations having been perused by the financial institutions.

4.3 Financial Evaluation

Financial evaluation addresses the following issues:
(a) What is the maximum price that should be paid for the target company?

(b) What are the principal areas of Risk?

(c) What are the cash flow and balance sheet implications of the acquisition? And,

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(d) What is the best way of structuring the acquisition?

4.4 Arranging Finance for Acquisition

Once the Definitive Agreement is signed, the Company Secretarial aspects relating to putting
through the acquisition process will be taken up by the legal and secretarial department of both the
companies. Side by side, the CFO of the acquiring company will move to the next stage which is
‘Financing the Acquisition’.
One of the most important decisions is how to pay for the acquisition – cash or stock or part of each
and this would be part of the Definitive Agreement. If the acquisition is an ‘all equity deal’, the CFO’s
can breathe easy. However, if cash payout is significant, the acquirer has to plan for financing the
deal. Sometimes acquirers do not pay all of the purchase consideration as, even though they could
have sufficient funds. This is part of the acquisition strategy to keep the war chest ready for further
acquisitions. Another reason to pay by shares would be when the acquirer considers that their
company’s shares are ‘overpriced’ in the market.
Financing the acquisition can be quite challenging where the acquisition is an LBO. Many times,
strong companies plan to shore up their long-term funds subsequent to the takeover. The immediate
funding is accomplished with bridge financing.

5. TAKEOVER DEFENSIVE TACTICS

Normally acquisitions are made friendly, however when the process of acquisition is unfriendly (i.e.,
hostile) such acquisition is referred to as ‘takeover’. Hostile takeover arises when the Board of
Directors of the acquiring company decide to approach the shareholders of the target company
directly through a Public Announcement (Tender Offer) to buy their shares consequent to the
rejection of the offer made to the Board of Directors of the target company.

5.1 Take Over Strategies

Other than Tender Offer the acquiring company can also use the following techniques:

• Street Sweep: This refers to the technique where the acquiring company accumulates larger
number of shares in a target before making an open offer. The advantage is that the target
company is left with no choice but to agree to the proposal of acquirer for takeover.

• Bear Hug: When the acquirer threatens the target company to make an open offer, the board
of target company agrees to a settlement with the acquirer for change of control.

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• Strategic Alliance: This involves disarming the acquirer by offering a partnership rather than
a buyout. The acquirer should assert control from within and takeover the target company.

• Brand Power: This refers to entering into an alliance with powerful brands to displace the
target’s brands and as a result, buyout the weakened company.

5.2 Defensive Tactics

A target company can adopt a number of tactics to defend itself from hostile takeover through a
tender offer.
• Divestiture - In a divestiture the target company divests or spins off some of its businesses
in the form of an independent, subsidiary company. Thus, reducing the attractiveness of the
existing business to the acquirer.
• Crown jewels - When a target company uses the tactic of divestiture it is said to sell the
crown jewels. In some countries such as the UK, such tactic is not allowed once the deal
becomes known and is unavoidable.
• Poison pill - The tactics used by the acquiring company to make itself unattractive to a
potential bidder is called poison pills. For instance, the acquiring company may issue
substantial amount of convertible debentures to its existing shareholders to be converted at
a future date when it faces a takeover threat. The task of the bidder would become difficult
since the number of shares having voting control of the company increases substantially.
• Poison Put - In this case the target company issues bonds that encourage the holder to cash
in at higher prices. The resultant cash drainage would make the target unattractive.
• Greenmail - Greenmail refers to an incentive offered by management of the target company
to the potential bidder for not pursuing the takeover. The management of the target company
may offer the acquirer a higher price for its shares than the market price.
• White knight - In this a target company offers to be acquired by a friendly company to escape
from a hostile takeover. The possible motive for the management of the target company to
do so is not to lose the management of the company as the hostile acquirer may change the
management.

• White squire - This strategy is essentially the same as white knight and involves sell out of
shares to a company that is not interested in the takeover. Consequently, the management
of the target company retains its control over the company.

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• Golden parachutes - When a company offers hefty compensations to its managers if they
get ousted due to takeover, the company is said to offer golden parachutes. This reduces
acquirer’s interest for takeover.
• Pac-man defence - This strategy aims at the target company making a counter bid for the
acquirer company. This would force the acquirer to defend itself and consequently may call
off its proposal for takeover.
It is needless to mention that hostile takeovers, as far as possible, should be avoided as they are
more difficult to consummate. In other words, friendly takeover is a better course of action to follow.

6. REVERSE MERGER
In ordinary cases, the company taken over is the smaller company; in a 'reverse takeover', a smaller
company gains control of a larger one. The concept of takeover 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. A company becomes a sick
industrial company when there is erosion in its net worth. This alternative is also known as taking
over by reverse bid.
The three tests to be fulfilled before an arrangement can be termed as a reverse takeover are
specified as follows:

(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 through the introduction of a minority holder
or group of holders.
This type of merger is also known as ‘back door listing’. This kind of merger has been started as an
alternative to go for public issue without incurring huge expenses and passing through the
cumbersome process. Thus, it can be said that reverse merger leads to the following benefits for
the acquiring company:

• Easy access to capital market.

• Increase in visibility of the company in corporate world.
• Tax benefits on carry forward losses acquired (public) company.

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• Cheaper and easier route to become a public company.

7. DIVESTITURE
It means a company selling one of the portions of its divisions or undertakings to another company
or creating an altogether separate company. There are various reasons for divestment or demerger
viz.,
(i) To pay attention on core areas of business;

(ii) The Division’s/business may not be sufficiently contributing to the revenues;

(iii) The size of the firm may be too big to handle;
(iv) The firm may be requiring cash urgently in view of other investment opportunities.

7.1 Seller’s Perspective

It is necessary to remember that for every buyer there must be a seller. Although the methods of
analysis for selling are the same as for buying, the selling process is termed divestiture. The
decision to sell a company is at least as important as buying one but selling generally lacks the kind
of planning that goes into buying. Quite often, the decision and the choice of the buyer is arbitrary,
resulting in a raw deal for the selling company’s shareholders. It is important to understand that
selling needs the same skillset required for buying. At some point of time the executives of a
company may have to take the decision to divest a division There is nothing wrong in selling a
division if it is worth more to someone else. The decision to sell may be prompted by poor growth
prospects for a division or consolidation in the industry. Given the fact that the need to sell may arise
any time, it makes sense for executives to be prepared. More specifically, executives need to know
their company’s worth. Consideration may be given to strengths and weakness in production,
marketing, general management, value of synergy to potential buyers, value of brand equity, skill
base of the organization, etc.
To summarise, the following are some of the ‘sell-side’ imperatives.
• Competitor’s pressure is increasing.
• Sale of company seems to be inevitable because company is facing serious problems like:
 No access to new technologies and developments
 Strong market entry barriers. Geographical presence could not be enhanced
 Badly positioned on the supply and/or demand side

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 Critical mass could not be realised

 Inefficient utilisation of distribution capabilities
 New strategic business units for future growth could not be developed
 Not enough capital to complete the project
• Window of opportunity: Possibility to sell the business at an attractive price
• Focus on core competencies
• In the best interest of the shareholders – where a large well known firm brings-up the
proposal, the target firm may be more than willing to give-up.

7.2 Different Forms

Different ways of divestment or demerger or divestitures are as follows:
7.2.1 Sell off / Partial Sell off
A sell off is the sale of an asset, factory, division, product line or subsidiary by one entity to another
for a purchase consideration payable either in cash or in the form of securities. Partial Sell off, is a
form of divestiture, wherein the firm sells its business unit or a subsidiary to another because it is
deemed to be unfit with the company’s core business strategy.
Normally, sell-offs are done because the subsidiary doesn't fit into the parent company's core
strategy. The market may be undervaluing the combined businesses due to a lack of synergy
between the parent and the subsidiary. So, the management and the board decide that the
subsidiary is better off under a different ownership. Besides getting rid of an unwanted subsidiary,
sell-offs also raise cash, which can be used to pay off debts. In the late 1980s and early 1990s,
corporate raiders used debt to finance acquisitions. Then, after making a purchase they used to sell-
off its subsidiaries to raise cash to service the debt. The raiders' method certainly makes sense if
the sum of the parts is greater than the whole. When it isn't, deals are unsuccessful.
7.2.2 Spin-off
In this case, a part of the business is separated and created as a separate firm. The existing
shareholders of the firm get proportionate ownership. So, there is no change in ownership and the
same shareholders continue to own the newly created entity in the same proportion as previously in
the original firm. The management of spin-off division is however, parted with. Spin-off does not
bring fresh cash. The reasons for spin off may be:
(i) To give separate identity to a part/division.

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(ii) To avoid the takeover attempt by a predator by making the firm unattractive to him since a
valuable division is spun-off.

(iii) To create separate Regulated and unregulated lines of business.

Example: Kishore Biyani led Future Group spin off its consumer durables business, Ezone, into a
separate entity in order to maximise value from it.
7.2.3 Split-up
This involves breaking up of the entire firm into a series of spin off (by creating separate legal
entities). The parent firm no longer legally exists and only the newly created entities survive. For
instance, a corporate firm has 4 divisions namely A, B, C, D. All these 4 divisions shall be split-up
to create 4 new corporate firms with full autonomy and legal status. The original corporate firm is to
be wound up. Since de-merged units are relatively smaller in size, they are logistically more
convenient and manageable. Therefore, it is understood that spin-off and split-up are likely to
enhance shareholders value and bring efficiency and effectiveness.
7.2.4 Equity Carve outs
This is like spin off, however, some shares of the new company are sold in the market by making a
public offer, so this brings cash. More and more companies are using equity carve-outs to boost
shareholder value. A parent firm makes a subsidiary public through an initial public offering (IPO) of
shares, amounting to a partial sell-off. A new publicly listed company is created, but the parent keeps a
controlling stake in the newly traded subsidiary.
A carve-out is a strategic avenue a parent firm may take when one of its subsidiaries is growing
faster and carrying higher valuations than other businesses owned by the parent. A carve-out
generates cash because shares in the subsidiary are sold to the public, but the issue also unlocks
the value of the subsidiary unit and enhances the parent's shareholder value.
The new legal entity of a carve-out has a separate board, but in most carve-outs, the parent retains
some control over it. In these cases, some portion of the parent firm's board of directors may be
shared. Since the parent has a controlling stake, meaning that both firms have common
shareholders, the connection between the two is likely to be strong. That said, sometimes companies
carve-out a subsidiary not because it is doing well, but because it is a burden. Such an intention
won't lead to a successful result, especially if a carved-out subsidiary is too loaded with debt or
trouble, even when it was a part of the parent and lacks an established track record for growing
revenues and profits.

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7.2.5 Demerger or Division of Family-Managed Business

Around 80 per cent of private sector companies in India are family-managed companies. The family-
owned companies are, under extraordinary pressure to yield control to professional managements,
as, in the emerging scenario of a liberalised economy the capital markets are broadening, with
attendant incentives for growth. So, many of these companies are arranging to hive off their
unprofitable businesses or divisions with a view to meeting a variety of succession problems.
Even otherwise, a group of such family-managed companies may undertake restructuring of its
operations with a view also to consolidating its core businesses. For this, the first step that may need
to be taken is to identify core and non-core operations within the group. The second step may involve
reducing interest burden through debt restructuring along with sale of surplus assets. The proceeds
from the sale of assets may be employed for expanding by acquisitions and rejuvenation of its
existing operations. The bottom line is that an acquisition must improve economies of scale, lower
the cost of production, and generate and promote synergies. Besides acquisitions, therefore, the
group may necessarily have to take steps to improve productivity of its existing operations.

8. FINANCIAL RESTRUCTURING
Financial restructuring refers to the kind of internal changes made by the management in Assets
and Liabilities of a company with the consent of its various stakeholders. This is a suitable mode of
restructuring for corporate entities who have suffered from sizeable losses over a period of time.
Consequent upon losses the share capital or net worth of such companies get substantially eroded.
In fact, in some cases, the accumulated losses are even more than the share capital and thus leads
to negative net worth, putting the firm on the verge of liquidation. In order to revive such firms,
financial restructuring is one of the techniques that brings health into such firms having potential and
promise for better financial performance in the years to come. To achieve this desired objective,
such firms need to re-start with a fresh balance sheet free from losses and fictitious assets and show
share capital at its true worth.
To nurse back such firms a plan of restructuring needs to be formulated involving a number of legal
formalities (which includes consent of court, and other stake-holders viz., creditors, lenders and
shareholders etc.). An attempt is made to do refinancing and rescue financing. In restructuring
normally equity shareholders make the maximum sacrifice by foregoing certain accrued benefits,
followed by preference shareholders and debenture holders, lenders, and creditors etc. The sacrifice
may be in the form of waving a part of the sum payable to various liability holders. The foregone
benefits may be in the form of new securities with lower coupon rates to reduce future liabilities. The

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sacrifice may also lead to the conversion of debt into equity. Sometime, creditors, apart from
reducing their claim, may also agree to convert their dues into securities to avert pressure of
payment. These measures will lead to better financial liquidity. The financial restructuring leads to
significant changes in the financial obligations and capital structure of a corporate firm, leading to a
change in the financing pattern, ownership and control and payment of various financial charges.
In a nutshell it may be said that financial restructuring (also known as internal re-construction) is
aimed at reducing the debt/payment burden of the corporate firm. This results into:
(i) Reduction/Waiver in the claims from various stakeholders;

(ii) Real worth of various properties/assets by revaluing them timely;

(iii) Utilizing profit accruing on account of appreciation of assets to write off accumulated losses
and fictitious assets (such as preliminary expenses and cost of issue of shares and
debentures) and creating provision for bad and doubtful debts. In practice, the financial re-
structuring scheme is drawn in such a way that all the above requirements of write off are
duly met. The following illustration is a good example of financial restructuring.
Illustration 1
The following is the Balance-sheet of XYZ Ltd. as on March 31st, 2013.
(` in lakh)
Liabilities Amount Assets Amount
6 lakh Equity Shares of `100/- each 600 Land & Building 200
2 Lakh 14% Preference shares of `100/- 200 Plant & Machinery 300
each Furniture & Fixtures 50
13% Debentures 200 Inventory 150
Debenture Interest accrued and Payable 26 Sundry debtors 70
Loan from Bank 74 Cash at Bank 130
Trade Creditors 300 Preliminary Expenses 10
Cost of Issue of debentures 5
Profit & Loss A/c 485
1,400 1,400

The Company did not perform well and has suffered sizable losses during the last few years.
However, it is now felt that the company can be nursed back to health by proper financial
restructuring and consequently the following scheme of reconstruction has been devised:

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(i) Equity shares are to be reduced to ` 25/- per share, fully paid up;
(ii) Preference shares are to be reduced (with Dividend rate of 10%) to equal number of shares
of `50 each, fully paid up.
(iii) Debenture holders have agreed to forego interest accrued to them. Beside this, they have
agreed to accept new debentures carrying a coupon rate of 9%.

(iv) Trade creditors have agreed to forgo 25 per cent of their existing claim; for the balance sum
they have agreed to convert their claims into equity shares of ` 25/- each.
(v) In order to make payment for bank loan and augment the working capital, the company issues
6 lakh equity shares at ` 25/- each; the entire sum is required to be paid on application. The
existing shareholders have agreed to subscribe to the new issue.
(vi) While Land and Building is to be revalued at ` 250 lakh, Plant & Machinery is to be written
down to ` 104 lakh. A provision amounting to ` 5 lakh is to be made for bad and doubtful
debts.
You are required to show the impact of financial restructuring/re-construction. Also, prepare the new
balance sheet assuming the scheme of re-construction is implemented in letter and spirit.
Solution
Impact of Financial Restructuring
(i) Benefits to XYZ Ltd.

` in lakhs
(a) Reduction of liabilities payable
Reduction in Equity Share capital (6 lakh shares x `75 per share) 450
Reduction in Preference Share capital (2 lakh shares x `50 per 100
share)
Waiver of outstanding Debenture Interest 26
Waiver from Trade Creditors (`300 lakhs x 0.25) 75
651
(b) Revaluation of Assets
Appreciation of Land and Building (`250 lakhs - `200 lakhs) 50
701

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14.20 ADVANCED FINANCIAL MANAGEMENT

(ii) Amount of ` 701 lakhs utilized to write off losses, fictious assets and over- valued assets.
` in lakhs
Writing off Profit and Loss account 485
Cost of issue of debentures 5
Preliminary expenses 10
Provision for bad and doubtful debts 5
Revaluation of Plant and Machinery (`300 lakhs – `104 lakhs) 196
701

Balance sheet of XYZ Ltd as at_______ (after re-construction)

(` in lakhs)
Liabilities Amount Assets Amount
21 lakhs Equity Shares of `25/- each 525 Land & Building 250
2 lakhs 10% Preference shares of `50/- 100 Plant & Machinery 104
each
9% Debentures 200 Furnitures & 50
Fixtures
Inventory 150
Sundry debtors 70
-5 65
Cash-at-Bank 206
(Balancing figure)*
825 825

*Opening Balance of ` 130/- lakhs + Sale proceeds from issue of new equity shares ` 150/-
lakhs – Payment of bank loan of ` 74/- lakhs = ` 206 lakhs.
It is worth mentioning that financial restructuring is unique in nature and is company specific. It is
carried out, in practice when all shareholders sacrifice and understand that the restructured firm
(reflecting its true value of assets, capital and other significant financial para meters) can now be
nursed back to health. This type of corporate restructuring helps in the revival of firms that otherwise
would have faced closure/liquidation.

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9. OWNERSHIP RESTRUCTURING
9.1 Going Private
This refers to the situation wherein a listed company is converted into a private company by buying
back all the outstanding shares from the markets.
Example:
The Essar group successfully completed Essar Energy Plc delisting process from London Stock
Exchange in 2014.
Going private is a transaction or a series of transactions that convert a publicly traded company into
a private entity. Once a company goes private, its shareholders are no longer able to trade
their stocks in the open market.
A company typically goes private when its stakeholders decide that there are no longer significant
benefits to be garnered as a public company. Privatization will usually arise either when a company's
management wants to buy out the public shareholders and take the company privately (a
management buyout), or when a company or individual makes a tender offer to buy most or all of
the company's stock. Going private transactions generally involve a significant amount of debt.

9.2 Management Buyouts

Buyouts initiated by the management team of a company are known as management buyouts. In
this type of acquisition, the company is bought by its own management team.
MBOs are considered as a useful strategy for exiting those divisions that do not form part of core
business of the entity.

9.3 Leveraged Buyout (LBO)

An acquisition of a company or a division of another company which is financed entirely or partially
(50% or more) using borrowed funds is termed as a leveraged buyout. The target company no longer
remains public after the leveraged buyout; hence the transaction is also known as going private. The
deal is usually secured by the acquired firm’s physical assets.
The intention behind an LBO transaction is to improve the operational efficiency of a firm and
increase the volume of its sales, thereby increasing the cash flow of the firm. This extra cash flow
generated will be used to pay back the debt in LBO transaction. After an LBO, the target entity is
managed by private investors, which makes it easier to have a close control over its operational
activities. The LBOs do not stay permanent. Once the LBO is successful in increasing its profit

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14.22 ADVANCED FINANCIAL MANAGEMENT

margin and improving its operational efficiency, the debt is paid back and it will go public again.
Companies that are in a leading market position with proven demand for product, have a strong
management team, strong relationships with key customers and suppliers and steady growth are
likely to become the target for LBOs. In India the first LBO took place in the year 2000 when Tata
Tea acquired Tetley in the United Kingdom. The deal value was ` 2135 crores out of which almost
77% was financed by the company using debt. The intention behind this deal was to get direct access
to Tetley’s international market. One of the largest LBO deals in terms of deal value (7.6 billion) by
an Indian company is the buyout of Corus by Tata Steel.

9.4 Equity buyback

This refers to the situation wherein a company buys back its own shares back from the market. This
results in reduction in the equity capital of the company. This strengthens the promoter’s position by
increasing his stake in the equity of the company.
The buyback is a process in which a company uses its surplus cash to buy shares from the public.
It is almost the opposite of initial public offer in which shares are issued to the public for the first
time. In buyback, shares which have already been issued are bought back from the public and once
the shares are bought back, they get absorbed and cease to exist.
For example, a company has one crore outstanding shares and owing a huge cash pile of ` 5 crores.
Since, the company has very limited investment options it decides to buy back some of its
outstanding shares from the shareholders, by utilizing some portion of its surplus cash. Accordingly,
it purchases 10 lakh shares from the existing shareholders by paying ` 20 per share utilizing total
cash of ` 2 crore. The process of buyback can be shown with the help of following diagram:

INITIAL PUBLIC OFFER (IPO) BUY-BACK

COMPANY COMPANY
SHARES
C S
CASH

INVESTORS INVESTORS

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Example
Cairn India bought back 3.67 crores shares and spent nearly ` 1230 crores by
May 2014.
Effects of Buyback

There are several effects or consequences of buyback some of which are as follows:
(i) It increases the proportion of shares owned by controlling shareholders as the number of
outstanding shares decreases after the buyback.
(ii) Earning Per Share (EPS) escalates as the number of shares reduces leading the market price
of shares to step up.
(iii) A share repurchase also effects a company’s financial statements as follows:
(a) In balance sheet, a share buyback will reduce the company’s total assets position as
cash holdings will be reduced and consequently as shareholders' equity reduced it
results in reduction on the liabilities side by the same amount.
(b) Amount spent on share buybacks shall be shown in Statement of Cash Flows in the
“Financing Activities” section, as well as from the Statement of Changes in Equity
or Statement of Retained Earnings.
(iv) Ratios based on performance indicators such as Return on Assets (ROA) and Return on
Equity (ROE) typically improve after a share buyback. This can be understood with the help
of following Statement showing Buyback Effect of a hypothetical company using ` 1.50 crore
of cash out of total cash of ` 2.00 for buyback.
Before Buyback After Buyback (`)
Cash (`) 2,00,00,000 50,00,000
Assets (`) 5,00,00,000 3,50,00,000
Earnings (`) 20,00,000 20,00,000
No. of Shares outstanding (Nos.) 10,00,000 9,00,000
Return on Assets (%) 4.00% 5.71%
Earnings Per Share (EPS) (`) 2.00 2.22

As visible from the above figure, the company's cash pile has been reduced from ` 2 crore to ` 50
lakh after the buyback because cash is an asset, this will lower the total assets of the company from
` 5 crore to ` 3.5 crore. Now, this leads to an increase in the company’s ROA, even though earnings
have not changed. Prior to the buyback, its ROA was 4% but after the repurchase, ROA increases

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14.24 ADVANCED FINANCIAL MANAGEMENT

to 5.71%. A similar effect can be seen in the EPS, which increases from ` 2.00 to
` 2.22.

10. UNLOCKING THE VALUE THROUGH MERGERS &

ACQUISITIONS AND BUSINESS RESTRUCTURING
The value is unlocked through mergers, acquisitions, and business restructuring because of
following reasons:
— Horizontal growth helps to achieve optimum size, enlarge the market share, curb competition
and use of unutilised capacity;
— Vertical combination helps to economise costs and eliminate avoidable taxes /duties;
— Diversification of business;
— Mobilising financial resources by utilising the idle funds lying with another company for the
expansion of business. (For example, nationalisation of banks provided this opportunity and
the erstwhile banking companies merged with industrial companies);

— Merger of an export, investment or trading company with an industrial company or vice versa
with a view to increase cash flow;
— Merging subsidiary company with the holding company with a view to improving cash flow;
— Taking over a ‘shell’ company which may have the necessary industrial licences etc., but
whose promoters do not wish to proceed with the project.
— An amalgamation may also be resorted to for the purpose of nourishing a sick unit in the
group and this is normally a merger for keeping up the image of the group.
— The business restructuring helps the company in:
 Positioning the company to be more competitive,

 Surviving an adverse economic climate,

 positioning the company into in an entirely new direction.

11. PREMIUM AND DISCOUNT

Premiums and discounts are typically attached to a business valuation, based on the situation.
These could be market share premium, controlling stake premium, brand value premium, small

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player discount or unlisted company discount. In addition, it may be required to work out various
potential scenarios in each methodology and arrive at the likely probabilities of each while deriving
the values.
Timing is very critical while divesting a business since valuation depends on the timing. Timing of
sale is crucial keeping in mind economic cycles (deal valuation takes into consideration GDP growth
rates), stock market situations (which would decide market multiples) and global situations (like a
war or terrorist attacks).
In times like the above, the price expectations between the buyer and the seller would widely vary.
For example, during a bullish stock market, there could be a situation where there are more buyers
but not sellers due to the low valuation.
The basis for M&A is the expectation of several future benefits arising out of synergies between
businesses. There is a risk involved in realizing this synergy value. This could be due to corporate,
market, economic reasons, or wrong estimation of the benefits/synergies. A key case in point here
is the high valuations at which internet companies were acquired in the year 2000 (such as Satyam
Infoway acquisition of India World).
As observed in the chapter on Corporate Valuation it is also important to try and work out valuations
from as many of the above methods as possible. Then try to see which methodology is to be taken
in and which are to be rejected that helps to derive a range of values for the transaction in different
situations in case one is called upon to assist in advising the transaction valuation. Some methods
like Net Asset Value or past Earnings Based methods may prove inadequate in case of growing
businesses or those with intangible assets.

12. MERGERS AND ACQUISITIONS FAILURES

There are five principal steps in a successful M&A programme.
1. Manage the pre-acquisition phase.
2. Screening candidates.
3. Eliminate those who do not meet the criteria and value the rest.
4. Negotiate.
5. Post-merger integration.
During the pre-acquisition phase, the acquirer should maintain secrecy about its intentions.
Otherwise, the resulting price increase due to rumours may kill the deal.

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Academic studies indicate that success in creating value through acquisitions in a competitive
market is extremely difficult. Jensen and Ruback (1983) highlighted this point by summarizing results
from mergers and acquisitions over a period of 11 years. They found that in case of a merger, the
average return, around the date of announcement, to shareholders of the acquired company is 20
per cent, whereas the average return to the shareholders of acquiring company is 0 per cent. Another
study by McKinsey indicates that 61 per cent of the 116 acquisitions studied were failures, 23 per
cent were successes. Despite such statistics why do companies acquire? Why do mergers fail? The
reasons for merger failures can be numerous. Some of the key reasons are:

• Acquirers generally overpay.

• The value of synergy is over-estimated.
• Poor post-merger integration; and
• Psychological barriers.
Companies often merge in the fear that the bigger competitors have economies of scale and may
destroy them by exercising a stranglehold on raw material supply, distribution etc. What they do not
realize is the drawbacks of being big. The acquiring company’s executives would have drawn up
elaborate plans for the target without consulting its executives which leads to resentment and
managerial attrition. This can be avoided by honest discussions with the target company’s
executives.
Most companies merge with the hope that the benefits of synergy will be realized. Synergy will be
there only if the merged entity is managed better after the acquisition than it was managed before.
It is the quality of the top management that determines the success of the merger. Quite often the
executives of the acquiring company lose interest in the target company due to its smallness. The
small company executives get bogged down repairing vision and mission statements, budgets, forecasts,
profit plans which were hitherto unheard of. The elaborateness of the control system depends on the size
and culture of the company. To make a merger successful:
• Decide what tasks need to be accomplished in the post-merger period,

• Choose managers from both the companies (and from outside),

• Establish performance yardstick and evaluate the managers on that yardstick; and
• Motivate them.

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13. ACQUISITION THROUGH SHARES

The acquirer can pay the target company in cash or exchange shares in consideration. The analysis
of acquisition for shares is slightly different. The steps involved in the analysis are:

• Estimate the value of acquirer’s (self) equity.

• Estimate the value of target company’s equity.
• Calculate the maximum number of shares that can be exchanged with the target company’s
shares; and
• Conduct the analysis for pessimistic and optimistic scenarios.
Exchange ratio is the number of acquiring firm’s shares exchanged for each share of the selling
firm’s stock. Suppose company A is trying to acquire company B’s 100,000 shares at ` 230. So, the
cost of acquisition is ` 230,00,000. Company A has estimated its value at ` 200 per share. To get
one share of company B, A has to exchange (230/200) 1.15 share, or 115,000 shares for 100,000
shares of B. The relative merits of acquisition for cash or shares should be analyzed after giving due
consideration to the impact on EPS, capital structure, etc.
Normally, when shares are issued as payment to the selling company’s shareholders, stockholders
will find the merger desirable only if the value of their shares is higher with the merger than without
the merger. The number of shares that the buying company will issue in acquiring the selling
company is determined as follows:

(1) The acquiring company will compare its value per share with and without the merger.
(2) The selling company will compare its value with the value of shares that they would receive
from acquiring company under the merger.

(3) The managements of acquiring company and selling company will negotiate the final terms
of the merger in the light of (1) and (2); the ultimate terms of the merger will reflect the relative
bargaining position of the two companies.
The fewer of acquiring company’s shares that it issues to the acquired company, the better off the
shareholders of the acquiring company are and worse off are the shareholders of acquired company.
However, for the merger to be effective, the shareholders of both the acquiring and acquired
company will have to anticipate some benefits from the merger even though their share swap deal
is subject to synergy risk for both.

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Impact of Price Earning Ratio: The reciprocal of cost of equity is Price-Earning (P/E) ratio. The
cost of equity, and consequently the P/E ratio reflects risk as perceived by the shareholders. The
risk of merging entities and the combined business can be different. In other words, the combined
P/E ratio can very well be different from those of the merging entities. Since market value of a
business can be expressed as product of earning and P/E ratio (P/E x E = P), the value of combined
business is a function of combined earning and combined P/E ratio. A lower combined P/E ratio can
offset the gains of synergy or a higher P/E ratio can lead to higher value of business, even if there
is no synergy. In ascertaining the exchange ratio of shares due care should be exercised to take the
possible combined P/E ratio into account.
Illustration 2
Company X is contemplating the purchase of Company Y, Company X has 3,00,000 shares having
a market price of ` 30 per share, while Company Y has 2,00,000 shares selling at ` 20 per share.
The EPS are ` 4.00 and ` 2.25 for Company X and Y respectively. Managements of both companies
are discussing two alternative proposals for exchange of shares as indicated below:
(i) in proportion to the relative earnings per share of two companies.
(ii) 0.5 share of Company X for one share of Company Y (0.5:1).

You are required:

(i) to calculate the Earnings Per share (EPS) after merger under two alternatives; and
(ii) to show the impact of EPS for the shareholders of two companies under both the alternatives.
Solution
Working Notes: Calculation of total earnings after merger
Particulars Company X Company Y Total
Outstanding shares 3,00,000 2,00,000
EPS (`) 4 2.25
Total earnings (`) 12,00,000 4,50,000 16,50,000

(i) (a) Calculation of EPS when exchange ratio is in proportion to relative EPS of two
companies
Company X 3,00,000
Company Y 2,00,000 x 2.25/4 1,12,500
Total number of shares after merger 4,12,500

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Company X
EPS before merger = `4
EPS after merger = ` 16,50,000/4,12,500 shares = `4
Company Y
EPS before merger = ` 2.25
EPS after merger
2.25
= EPS of Merged Entity after merger x Share Exchange ratio on EPS basis = ` 4×
4 = ` 2.25

(b) Calculation of EPS when share exchange ratio is 0.5 : 1

Total earnings after merger = ` 16,50,000
Total number of shares after merger = 3,00,000 + (2,00,000 x 0.5) = 4,00,000 shares
EPS after merger = ` 16,50,000/4,00,000 = ` 4.125
(ii) Impact of merger on EPS for shareholders of Company X and Company Y
(a) Impact on Shareholders of Company X
(`)
EPS before merger 4.000
EPS after merger 4.125
Increase in EPS 0.125

(b) Impact on Shareholders of Company Y

(`)
Equivalent EPS before merger 2.2500
Equivalent EPS after merger 2.0625
Decrease in EPS 0.1875
Illustration 3
A Ltd. is studying the possible acquisition of B Ltd. by way of merger. The following data are
available:
Firm After-tax earnings No. of equity shares Market price per share
A Ltd. ` 10,00,000 2,00,000 ` 75
B Ltd. ` 3,00,000 50,000 ` 60

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(i) If the merger goes through by exchange of equity shares and the exchange ratio is set
according to the current market prices, what is the new earnings per share for A Ltd.
(ii) B Ltd. wants to be sure that its earning per share is not diminished by the merger. What
exchange ratio is relevant to achieve the objective?
Solution
(i) The current market price is the basis of exchange of equity shares, in the proposed merger,
shareholders of B Ltd. will get only 40,000 shares in all or 4 shares of A Ltd. for every 5
shares held by them, i.e.,
50,000 × 60
= 40,000
75
The total number of shares in A Ltd. will then be 2,40,000 and, ignoring any synergistic effect,
the profit will be ` 13,00,000.The new earning per share (EPS) of A Ltd. will be ` 5.42, i.e.,
` 13,00,000/2,40,000.
(ii) The present earnings per share of B Ltd. is `6/- (` 3,00,000 ÷ 50,000) and that of A Ltd. is
`5/-, i.e., ` 10,00,000 ÷ 2,00,000.If B Ltd. wants to ensure that, even after merger, the earning
per share of its shareholders should remain unaffected, then the exchange ratio will be 6
shares for every 5 shares.
The total number of shares of A Ltd. that will produce ` 3,00,000 profit is 60,000, (3,00,000
÷ 5), to be distributed among, shareholders of B Ltd., giving a ratio of 6 shares in A for 5
shares in B.
Proof:
The shareholders of B Ltd. will get in all 60,000 share for 50,000 shares. It means after
` 13,00,000
merger, their earning per share will be ` 5/-, i.e. .
2,60,000

In all they will get ` 3,00,000, i.e., 60,000 x 5, as before.

Illustration 4
Simpson Ltd. is considering a merger with Wilson Ltd. The data below are in the hands of both Board
of Directors. The issue at hand is how many shares of Simpson should be exchanged for Wilson
Ltd. Both boards are considering three possibilities 20,000, 25,000 and 30,000 shares. You are
required to construct a table demonstrating the potential impact of each scheme on each set of
shareholders:

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Simpson Ltd. Wilson Ltd. Combined Post

merger Firm ‘A’
1. Current earnings per year 2,00,000 1,00,000 3,50,000
2. Shares outstanding 50,000 10,000 ?
3. Earnings per share (`) (1÷ 2) 4 10 ?
4. Price per share (`) 40 100 ?
5. Price-earning ratio [4 ÷ 3] 10 10 10
6. Value of firm (`) 20,00,000 10,00,000 35,00,000
7. Expected Annual growth rate in
earnings in foreseeable future 0 0 0

Solution
The following table demonstrates the potential impact of the three possible schemes, on each set of
shareholders:-

Number of Exchange Number of Fraction of Value of Fraction of Value of

Simpson ratio Simpson Simpson shares Simpson shares
Ltd.’s shares [(1)/10,000 Ltd.’s Ltd. (Post owned by Ltd. owned by
issued to shares of shares merger) Wilson (combined Simpson
shareholders Wilson outstanding owned by Ltd.’s Post- Ltd.’s
of Wilson Ltd.] after Wilson Ltd.’s shareholders merger shareholders
Ltd. merger shareholders [(4)x owned by [(6) x
[50,000+(1)] [(1)/(3)] 35,00,000] Simpson 35,00,000]
Ltd.’s
share-
holders
[50,000/(3)]
(1) (2) (3) (4) (5) (6) (7)
20,000 2 70,000 2/7 10,00,000 5/7 25,00,000
25,000 2.5 75,000 1/3 11,66,667 2/3 23,33,333
30,000 3 80,000 3/8 13,12,500 5/8 21,87,500

14. CROSS-BORDER M&A

Cross-border M&A is a popular route for global growth and overseas expansion. Cross-border M&A
is also playing an important role in global M&A. This is especially true for developing countries such

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14.32 ADVANCED FINANCIAL MANAGEMENT

as India. Kaushik Chatterjee, CFO, of Tata Steel in an interview with McKinsey Quarterly in
September 2009 articulates this point very clearly. To the following question

The Quarterly: Last year was the first in which Asian and Indian companies acquired more
businesses outside of Asia than European or US multinationals acquired within it. What’s behind the
Tata Group’s move to go global?

His response is as follows:-

“India is clearly a very large country with a significant population and a big market, and the Tata
Group’s companies in a number of sectors have a pretty significant market share. India remains the
main base for future growth for Tata Steel Group, and we have substantial investment plans in India,
which are currently being pursued but meeting our growth goals through organic means in India,
unfortunately, is not the fastest approach, especially for large capital projects, due to significant
delays on various fronts. Nor are there many opportunities for growth through acquisitions in India,
particularly in sectors like steel, where the value to be captured is limited—for example, in terms of
technology, product profiles, the product mix, and good management.”

Other major factors that motivate multinational companies to engage in cross-border M&A in Asia
include the following:
• Globalization of production and distribution of products and services.
• Integration of global economies.
• Expansion of trade and investment relationships on international level.
• Many countries are reforming their economic and legal systems and providing generous
investment and tax incentives to attract foreign investment.
• Privatization of state-owned enterprises and consolidation of the banking industry.

15. SPECIAL PURPOSE ACQUISITION COMPANIES

In recent times, the concept of Special Purpose Acquisition Companies (SPACs) has come into
existence wherein an entity is set up with the objective to raise funds through an IPO to finance a
merger or acquisition of an unidentified target within a specific time. It is commonly known as a blank
cheque company.
The main objective of SPAC is to raise money, despite not having any operations or revenues. The
money raised from the public is kept in an escrow account, which can be accessed while making the
acquisition. However, in case the acquisition is not made within stipulated period of the IPO, the

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SPAC is delisted, and the money is returned to the investors. Shareholders have the option to
redeem their shares if they are not interested in participating in the proposed merger. Finally, if the
merger is approved by shareholders, it is executed, and the target private company or companies
become public entities. Once a formal merger agreement has been executed the SPAC target is
usually publicly announced.
New investment opportunities in Indian companies have resurfaced and have set up new platform
for SPAC transactions. The implementation of SPACs might face certain challenges since India does
not have a specific regulatory framework guarding these transactions.

The current regulatory framework in India does not support the SPAC transactions. Further as per
the Companies Act, 2013, the Registrar of Companies is authorized to strike-off the name of
companies that do not commence operation within one year of incorporation. SPACs generally take
2 to 3 years to identify a target and performing due diligence and before it could get operationalized
its name can be stricken off and hence enabling provisions relating to SPAC need to be inserted in
the Companies Act in order to make it functional in India.
Though, SPACs do not find acceptance under the Securities and Exchange Board of India (SEBI)
Act as it does not meet the eligibility criteria for public listing however SEBI is planning to come out
with a framework for SPACs.
The International Financial Services Centres Authority (IFSCA), being the regulatory authority for
development and regulation of financial services, financial products and financial institutions in the
Gujarat International Finance Tec-City, has recently released a consultation paper defining critical
parameters such as offer size to public, compulsory sponsor holding, minimum application size,
minimum subscription of the offer size, etc.
SPAC approach offers several advantages over traditional IPO, such as providing companies access
to capital, even when market volatility and other conditions limit liquidity. SPACs help to lower the
transaction fees as well as expedite the timeline in becoming a public company. Raising money
through a SPAC is easier as compared to traditional IPO since the SPAC has already raised money
through an IPO. This implies the company in question only has to negotiate with a single entity, as
opposed to thousands of individual investors. This makes the process of fundraising a lot easier and
quicker than an IPO. The involvement of skilled professionals in identifying the target makes the
investment a well thought and a well governed process.
However, the merger of a SPAC with a target company presents several challenges, such as
complex accounting and financial reporting/registration requirements, to meet a public company

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readiness timeline and being ready to operate as a public company within a period of three to five
months of signing a letter of intent.

It is typically more expensive for a company to raise money through a SPAC than an IPO. Investors’
money invested in a SPAC trust to earn a suitable return for up to two years, could be put to better
use elsewhere.

TEST YOUR KNOWLEDGE

Theoretical Questions
1. Explain synergy in the context of Mergers and Acquisitions.
2. What is take over by reverse bid or Reverse Merger.
3. What is an equity curve out? How does it differ from a spin off.
4. Write a short note on Horizontal Merger and Vertical Merger.

Practical Questions
1. 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.
2. 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
Market price per share ` 50 ` 25
Number of outstanding shares 20 lakhs 10 Lakhs
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?

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3. MK Ltd. is considering acquiring NN Ltd. The following information is available:

Company Earning after No. of Equity Market Value
Tax (`) Shares Per Share (`)
MK Ltd. 60,00,000 12,00,000 200.00
NN Ltd. 18,00,000 3,00,000 160.00

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.
4. ABC Ltd. is intending to acquire XYZ Ltd. by merger and the following information is available
in respect of the companies:
ABC Ltd. XYZ Ltd.
Number of equity shares 10,00,000 6,00,000
Earnings after tax (`) 50,00,000 18,00,000
Market value per share (`) 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 same as before the merger takes place?
5. The CEO of a company thinks that shareholders always look for EPS. Therefore, he considers
maximization of EPS as his company's objective. His company's current Net Profits are `
80.00 lakhs and P/E multiple is 10.5. He wants to buy another firm which has current income
of ` 15.75 lakhs & P/E multiple of 10.
What is the maximum exchange ratio which the CEO should offer so that he could keep EPS
at the current level, given that the current market price of both the acquirer and the target
company are ` 42 and ` 105 respectively?
If the CEO borrows funds at 15% and buys out Target Company by paying cash, how much
cash should he offer to maintain his EPS? Assume tax rate of 30%.

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14.36 ADVANCED FINANCIAL MANAGEMENT

6. 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:
A Ltd. T. Ltd.
Profit after tax `18,00,000 `3,60,000
Equity shares outstanding (Nos.) 6,00,000 1,80,000
EPS `3 `2
PE Ratio 10 times 7 times
Market price per share `30 `14

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.
7. The following information is provided related to the acquiring Firm Mark Limited and the target
Firm Mask Limited:
Firm Firm
Mark Limited Mask Limited
Earning after tax (`) 2,000 lakhs 400 lakhs
Number of shares outstanding 200 lakhs 100 lakhs
P/E ratio (times) 10 5

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.

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(v) Calculate gain/loss for shareholders of the two independent companies after
acquisition.

8. XYZ Ltd. wants to purchase ABC Ltd. by exchanging 0.7 of its shares for each share of ABC
Ltd. Relevant financial data are as follows:
Equity shares outstanding 10,00,000 4,00,000
EPS (`) 40 28
Market price per share (`) 250 160

(i) Illustrate the impact of merger on EPS of both the companies.

(ii) The management of ABC Ltd. has quoted a share exchange ratio of 1:1 for the merger.
Assuming that P/E ratio of XYZ Ltd. will remain unchanged after the merger, what will
be the gain from merger for ABC Ltd.?
(iii) What will be the gain/loss to shareholders of XYZ Ltd.?
(iv) Determine the maximum exchange ratio acceptable to shareholders of XYZ Ltd.
9. XYZ Ltd., is considering merger with ABC Ltd. XYZ Ltd.’s shares are currently traded at
` 20. It has 2,50,000 shares outstanding and its earnings after taxes (EAT) amount to
` 5,00,000. ABC Ltd., has 1,25,000 shares outstanding; its current market price is ` 10 and
its EAT are ` 1,25,000. 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) 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 6.4, what is its current market price? What is the exchange
ratio? What will XYZ Ltd.’s post-merger EPS be?
(iii) What should be the exchange ratio; if XYZ Ltd.’s pre-merger and post-merger EPS are
to be the same?
10. Following information is provided relating to the acquiring company Mani Ltd. and the target
company Ratnam Ltd:
Mani Ltd. Ratnam Ltd.
Earnings after tax (` lakhs) 2,000 4,000

No. of shares outstanding (lakhs) 200 1,000

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P/E ratio (No. of times) 10 5

Required:
(i) 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%?
(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.
11. You have been provided the following Financial data of two companies:
Krishna Ltd. Rama Ltd.
Earnings after taxes ` 7,00,000 ` 10,00,000
No. of Equity shares (outstanding) 2,00,000 4,00,000
EPS 3.5 2.5
P/E ratio 10 times 14 times
Market price per share ` 35 ` 35

Company Rama Ltd. is acquiring the company Krishna Ltd., exchanging its shares on a one-
to-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.
12. 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:

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Particulars M Co. Ltd. N Co. Ltd.

Earnings after tax (`) 80,00,000 24,00,000
No. of equity shares 16,00,000 4,00,000
Market value per share (`) 200 160

(i) 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?
13. Longitude Limited is in the process of acquiring Latitude Limited on a share exchange
basis. Following relevant data are available:
Longitude Limited Latitude Limited
Profit after Tax (PAT) ` in Lakhs 120 80
Number of Shares Lakhs 15 16
Earning per Share (EPS) ` 8 5
Price Earnings Ratio (P/E Ratio) 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
Calculate Ratio/s up to four decimal points and amounts and number of shares up to two
decimal points.
14. 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
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 9

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14.40 ADVANCED FINANCIAL MANAGEMENT

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
pre-merger P/E ratio to be applied to the combined earnings.
15. 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 0.20 820 1050
Medium Growth 0.60 550 825
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.
16. Yes Ltd. wants to acquire No Ltd. and the cash flows of Yes Ltd. and the merged entity are
given below:

(` In lakhs)
Year 1 2 3 4 5
Yes Ltd. 175 200 320 340 350
Merged Entity 400 450 525 590 620

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.
You are required to:

(i) Compute the Value of Yes Ltd. before and after merger.

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(ii) Value of Acquisition and

(iii) Gain to shareholders of Yes Ltd.
17. The following information is provided relating to the acquiring company Efficient Ltd. and the
target Company Healthy Ltd.
Efficient Ltd. Healthy Ltd.
No. of shares (F.V. ` 10 each) 10.00 lakhs 7.5 lakhs
Market capitalization 500.00 lakhs 750.00 lakhs
P/E ratio (times) 10.00 5.00
Reserves and Surplus 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 Earning, Book Value and Market Price of share of each company:
(i) Calculate the swap ratio and also calculate Promoter’s 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.
18. 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 :
Abhiman Ltd. Swabhiman Ltd.
% Shareholding of promoter 50% 60%
Share capital ` 200 lacs 100 lacs
Free Reserves and surplus ` 900 lacs 600 lacs
Paid up value per share ` 100 10
Free float market capitalization ` 500 lacs 156 lacs
P/E Ratio (times) 10 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%

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Market price 25%

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 remains the same and all assets and liabilities of
Swabhiman Ltd. are taken over at book value.)
19. The following information is provided relating to the acquiring company E Ltd., and the target
company H Ltd:
E Ltd. H Ltd.
Particulars
(`) (`)
Number of shares (Face value ` 10 each) 20 Lakhs 15 Lakhs
Market Capitalization 1000 Lakhs 1500 Lakhs
P/E Ratio (times) 10.00 5.00
Reserves and surplus in ` 600.00 Lakhs 330.00 Lakhs
Promoter's Holding (No. of shares) 9.50 Lakhs 10.00 Lakhs

The Board of Directors of both the companies have decided to give a fair deal to the
shareholders. Accordingly, the weights are decided as 40%, 25% and 35% respectively for
earnings (EPS), book value and market price of share of each company for swap ratio.
Calculate the following:
(i) Market price per share, earnings per share and Book Value per share;

(ii) Swap ratio;

(iii) Promoter's holding percentage after acquisition;
(iv) EPS of E Ltd. after acquisitions of H Ltd;

(v) Expected market price per share and market capitalization of E Ltd.; after acquisition,
assuming P/E ratio of E Ltd. remains unchanged; and
(vi) Free float market capitalization of the merged firm.

20. 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 promoter’s holding is 50% and 60% respectively in Abhiman Ltd.
and Abhishek Ltd.:

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Abhiman Ltd. Abhishek Ltd.

Share Capital (`) 200 lakh 100 lakh
Free Reserve and Surplus (`) 800 lakh 500 lakh
Paid up Value per share (`) 100 10
Free float Market Capitalisation (`) 400 lakh 128 lakh
P/E Ratio (times) 10 4

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 25%
EPS (Earning per share) 50%
Market Price 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) Promoter’s revised holding in the Abhiman Ltd.
(ii) Free float market capitalization.
(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 :
(1) Issue Bonus shares in the ratio of 1 : 2; and
(2) Split the stock (share) as ` 5 each fully paid.
21. 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.
` 10 Equity shares outstanding 12 Lakhs 6 Lakhs
Debt:
10% Debentures (` Lakhs) 580 --
12.5% Institutional Loan (` Lakhs) -- 240
Earning before interest, depreciation and tax (EBIDAT) 400.86 115.71
(` Lakhs)
Market Price/share (`) 220.00 110.00

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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.
Note: Calculations (except EPS) may be rounded off to 2 decimals in lakhs.
22. 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.
` `
Outside Liabilities
Secured Loans 400 lakh 3,000 lakh
Unsecured Loans 2,400 lakh 800 lakh
Current Liabilities & Provisions 1,300 lakh 21,200 lakh
Assets
Fixed Assets 7,740 lakh 20,400 lakh
Investments 7,600 lakh 12,300 lakh
Current Assets 8,800 lakh 30,200 lakh
Loans & Advances 900 lakh 7,300 lakh
Deferred tax/Misc. Expenses 60 lakh (200) lakh

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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:
(a) Transfer of Liabilities & Assets at Book value.
(b) Estimated Profit for the year 2009-10 is ` 11,400 Lakh for Fortune India Ltd. & ` 1,470
lakhs for Fortune Pharma Ltd.
(c) Estimated Market Price of Fortune Pharma Ltd. is ` 24.50 per share.
(d) 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 (FMCG) Ltd.
3. Book Value per share of both the Companies immediately after Demerger.

23. 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 350.00
-Equity Shares of `10 each 6.50
Reserve & Surplus 950.00 25.00
Total 1,300.00 31.50
Assets:
Net Fixed Assets 220.00 0.50
Net Current Assets 1,020.00 29.00
Deferred Tax Assets 60.00 2.00
Total 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:

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(a) 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.

(b) Both the companies envisage a capitalization rate of 8%.

(c) H Ltd. has a contingent liability of ` 300 crores as on 31st March, 2012.
(d) 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.)
24. Reliable Industries Ltd. (RIL) is considering a takeover of Sunflower Industries Ltd. (SIL). The
particulars of 2 companies are given below:
Particulars Reliable Industries Ltd Sunflower Industries Ltd.
Earnings After Tax (EAT) ` 20,00,000 ` 10,00,000
Equity shares O/s 10,00,000 10,00,000
Earnings per share (EPS) 2 1
PE Ratio (Times) 10 5
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?
25. AFC Ltd. wishes to acquire BCD Ltd. The shares issued by the two companies are 10,00,000

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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 8%
additional capital investment and without any change in risk of
operations)
Current Market price per share of AFC Ltd. ` 100
Current Market price per share of BCD Ltd. ` 20
Expected Dividend per share of BCD Ltd. ` 0.60

(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%.
26. 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
Loans 100
Total 350

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14.48 ADVANCED FINANCIAL MANAGEMENT

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.:
Year ended By way of ` lakhs
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

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 0.86 0.79 0.74 0.68
You are required to:
(a) Calculate the total value of the business of XY Ltd.
(b) The number of shares to be issued by AB Ltd.; and
(c) The basis of allocation of the shares among the shareholders of XY Ltd.
27. R Ltd. and S Ltd. are companies that operate in the same industry. The financial statements
of both the companies for the current financial year are as follows:
Balance Sheet
Particulars R. Ltd. (`) S. Ltd (`)
Equity & Liabilities
Shareholders Fund
Equity Capital (` 10 each) 20,00,000 16,00,000
Retained earnings 4,00,000 -
Non-current Liabilities
16% Long term Debt 10,00,000 6,00,000

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Current Liabilities 14,00,000 8,00,000

Total 48,00,000 30,00,000
Assets
Non-current Assets 20,00,000 10,00,000
Current Assets 28,00,000 20,00,000
Total 48,00,000 30,00,000
Income Statement
Particulars R. Ltd. (`) S. Ltd. (`)
A. Net Sales 69,00,000 34,00,000
B. Cost of Goods sold 55,20,000 27,20,000
C. Gross Profit (A-B) 13,80,000 6,80,00
D. Operating Expenses 4,00,000 2,00,000
E. Interest 1,60,000 96,000
F. Earnings before taxes [C-(D+E)] 8,20,000 3,84,000
G. Taxes @ 35% 2,87,000 1,34,400
H. Earnings After Tax (EAT) 5,33,000 2,49,600

Additional Information:
No. of equity shares 2,00,000 1,60,000
Dividend payment Ratio (D/P) 20% 30%
Market price per share ` 50 ` 20

Assume that both companies are in the process of negotiating a merger through exchange of
Equity shares:
You are required to:
(i) Decompose the share price of both the companies into EPS & P/E components. 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 both the companies.
(iii) Based on expected operating synergies, R Ltd. estimated that the intrinsic value of S
Ltd. Equity share would be ` 25 per share on its acquisition. You are required to
develop a range of justifiable Equity Share Exchange ratios that can be offered by R
Ltd. to the shareholders of S Ltd. Based on your analysis on parts (i) and (ii), would

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14.50 ADVANCED FINANCIAL MANAGEMENT

you expect the negotiated terms to be closer to the upper or the lower exchange ratio
limits and why?
28. 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:
Balance Sheet
Particulars BA Ltd. (`) DA Ltd. (`)
Current Assets 14,00,000 10,00,000
Fixed Assets (Net) 10,00,000 5,00,000
Total (`) 24,00,000 15,00,000
Equity capital (`10 each) 10,00,000 8,00,000
Retained earnings 2,00,000 --
14% long-term debt 5,00,000 3,00,00
Current liabilities 7,00,000 4,00,000
Total (`) 24,00,000 15,00,000

Income Statement
BA Ltd. DA 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 1,98,00
Taxes @ 50% 2,10,000 99,000
Earnings after taxes (EAT) 2,10,000 99,000
Additional Information :
No. of Equity shares 1,00,000 80,000
Dividend payment ratio (D/P) 40% 60%
Market price per share `40 `15

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:

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(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.
(iii) Based on expected operating synergies BA Ltd. estimates that the intrinsic value of
DA’s 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.
29. During the audit of the Weak Bank (W), RBI has suggested that the Bank should either merge
with another bank or may close down. Strong Bank (S) has submitted a proposal of merger
of Weak Bank with itself. The relevant information and Balance Sheets of both the companies
are as under:
Particulars Weak Bank Strong Assigned
(W) Bank (S) Weights (%)
Gross NPA (%) 40 5 30
Capital Adequacy Ratio (CAR) 5 16 28
Total Capital/ Risk Weight Asset
Market price per Share (MPS) 12 96 32
Book value 10
Trading on Stock Exchange Irregular Frequent

Balance Sheet (` in Lakhs)

Particulars Weak Bank (W) Strong Bank (S)
Paid up Share Capital (` 10 per share) 150 500
Reserves & Surplus 80 5,500
Deposits 4,000 44,000

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14.52 ADVANCED FINANCIAL MANAGEMENT

Other Liabilities 890 2,500

Total Liabilities 5,120 52,500
Cash in Hand & with RBI 400 2,500
Balance with Other Banks - 2,000
Investments 1,100 19,000
Advances 3,500 27,000
Other Assets 70 2,000
Preliminary Expenses 50 -
Total Assets 5,120 52,500

You are required to

(a) Calculate Swap ratio based on the above weights:
(b) Ascertain the number of Shares to be issued to Weak Bank;
(c) Prepare Balance Sheet after merger; and
(d) Calculate CAR and Gross NPA of Strong Bank after merger.
30. 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) 7,00,000 Cash 50,000
Retained earnings 3,00,000 Debtors 70,000
12% Debentures 3,00,000 Inventories 2,00,000
Creditors and other liabilities 3,20,000 Plants & Eqpt. 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. Debenture holders 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

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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 company’s 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 1 2 3 4 5 6
PV 0.862 0.743 0.641 0.552 0.476 0.410

31. 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.
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?

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14.54 ADVANCED FINANCIAL MANAGEMENT

ANSWERS/ SOLUTIONS
Answers to Theoretical Questions
1. Please refer paragraph 2.
2. Please refer paragraph 6.
3. Please refer paragraph 7.2.
4. Please refer paragraph 3.

Answers to the Practical Questions

1. Total market value of C Ltd is = 1,00,000 x ` 15 = ` 15,00,000
PE ratio (given) = 10
Therefore, earnings = ` 15,00,000 /10
= ` 1,50,000
Total market value of B Ltd. is = 5,00,000 x ` 12 = ` 60,00,000
PE ratio (given) = 17
Therefore, earnings = ` 60,00,000/17
= ` 3,52,941
The number of shares to be issued by B Ltd.
` 15,00,000 ÷ 12 = 1,25,000

Total number of shares of B Ltd = 5,00,000 + 1,25,000 = 6,25,000

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
2. Shareholders of Doom Ltd. will get 5 lakh share of Elrond Limited, so they will get:
5 lakh
= = 20% of shares Elrond Limited
20 lakh + 5 lakh

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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
3. (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.
∴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

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∴ 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.

4. (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 Limited’s 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.
5. (i)
Acquirer Company Target Company
Net Profit ` 80 lakhs ` 15.75 lakhs
PE Multiple 10.50 10.00
Market Capitalization ` 840 lakhs ` 157.50 lakhs
Market Price ` 42 ` 105
No. of Shares 20 lakhs 1.50 lakhs
EPS `4 ` 10.50

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Maximum Exchange Ratio 4 : 10.50 or 1 : 2.625

Thus, for every one share of Target Company 2.625 shares of Acquirer Company.
(ii) Let x lakhs be the amount paid by Acquirer company to Target Company. Then to
maintain same EPS i.e. ` 4 the number of shares to be issued will be:
(80 lakhs + 15.75 lakhs) - 0.70 × 15% × x
=4
20 lakhs
95.75 - 0.105 x
=4
20
x = ` 150 lakhs
Thus, ` 150 lakhs shall be offered in cash to Target Company to maintain same EPS.
6. (i) 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.
(ii) EPS of A Ltd. After a acquisition:
Total Earnings (` 18,00,000 + ` 3,60,000) ` 21,60,000
No. of Shares (6,00,000 + 90,000) 6,90,000
EPS (` 21,60,000)/6,90,000) ` 3.13
(iii) Equivalent EPS of T Ltd.:
No. of new Shares 0.5
EPS ` 3.13
Equivalent EPS (` 3.13 x 0.5) ` 1.57
(iv) New Market Price of A Ltd. (P/E remaining unchanged):
Present P/E Ratio of A Ltd. 10 times
Expected EPS after merger ` 3.13
Expected Market Price (`3.13 x 10) ` 31.30
(v) 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

7. Particulars Mark Ltd. Mask Ltd.

EPS ` 2,000 Lakhs/ 200 lakhs ` 400 lakhs / 100 lakhs

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14.58 ADVANCED FINANCIAL MANAGEMENT

= ` 10 `4
Market Price ` 10 × 10 = ` 100 ` 4 × 5 = ` 20

(i) 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.
` 2,000 lakhs + ` 400 lakhs
(ii) EPS after merger = = ` 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

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 20.00 crores
Gain to Shareholders 18.20 crores 1.82 crores

8. Working Notes
(a)
XYZ Ltd. ABC Ltd.
Equity shares outstanding (Nos.) 10,00,000 4,00,000
EPS ` 40 ` 28

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Profit ` 400,00,000 ` 112,00,000

PE Ratio 6.25 5.71
Market price per share ` 250 ` 160

(b) EPS after merger

No. of shares to be issued (4,00,000 x 0.70) 2,80,000

Exiting Equity shares outstanding 10,00,000
Equity shares outstanding after merger 12,80,000
Total Profit (` 400,00,000 + ` 112,00,000) ` 512,00,000
EPS ` 40

(i) Impact of merger on EPS of both the companies

XYZ Ltd. ABC Ltd.

EPS after Merger ` 40 ` 28
EPS before Merger ` 40 ` 28*
Nil Nil
* ` 40 x 0.70
(ii) Gain from the Merger if exchange ratio is 1: 1

No. of shares to be issued 4,00,000

Exiting Equity shares outstanding 10,00,000
Equity shares outstanding after merger 14,00,000
Total Profit (` 400,00,000 + ` 112,00,000) ` 512,00,000
EPS ` 36.57
Market Price of Share (` 36.57 x 6.25) ` 228.56
Market Price of Share before Merger ` 160.00
Impact (Increase/ Gain) ` 68.56

(iii) Gain/ loss from the Merger to the shareholders of XYZ Ltd.
Market Price of Share ` 228.56
Market Price of Share before Merger ` 250.00
Loss from the merger (per share) ` 21.44

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(iv) Maximum Exchange Ratio acceptable to XYZ Ltd. shareholders

` Lakhs
Market Value of Merged Entity (` 228.57 x 1400000) 3199.98
Less: Value acceptable to shareholders of XYZ Ltd. 2500.00
Value of merged entity available to shareholders of ABC 699.98
Ltd.
Market Price Per Share 250
No. of shares to be issued to the shareholders of ABC 2.80
Ltd. (lakhs)

Thus maximum ratio of issue shall be 2.80 : 4.00 or 0.70 share of XYZ Ltd. for
one share of ABC Ltd.
Alternatively, it can also be computed as follows:

Earning after Merger (40 x 1000000 + 28 x 400000) ` 512 lakhs

PE Ratio of XYZ Ltd. 6.25
Market Value of Firm after Merger (512 x 6.25) ` 3200 lakhs
Existing Value of Shareholders of XYZ Ltd. ` 2500 lakhs
Value of Merged entity available to Shareholders of ABC Ltd. ` 700 lakhs
Market Price per Share ` 250
Total No. of shares to be issued 2.8 lakh

Thus, maximum acceptable ratio shall be 2.80:4.00 i.e. 0.70 share of XYZ Ltd.
for one share of ABC Ltd.
9. (i) Pre-merger EPS and P/E ratios of XYZ Ltd. and ABC Ltd.
Particulars XYZ Ltd. ABC Ltd.
Earnings after taxes 5,00,000 1,25,000
Number of shares outstanding 2,50,000 1,25,000
EPS 2 1
Market Price per share 20 10
P/E Ratio (times) 10 10

(ii) Current Market Price of ABC Ltd. if P/E ratio is 6.4 = ` 1 × 6.4 = ` 6.40
` 20 ` 6.40
Exchange ratio = = 3.125 or = 0.32
` 6.40 ` 20

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Post-merger EPS of XYZ Ltd.

` 5,00,000 + ` 1,25,000
=
2,50,000 + (1,25,000/ 3.125)
` 6,25,000
= = 2.16
2,90,000

(iii) Desired Exchange Ratio

Total number of shares in post-merged company
Post - merger earnings ` 6,25,000
= = = 3,12,500
Pre - merger EPS of XYZ Ltd 2

Number of shares required to be issued

= 3,12,500 – 2,50,000 = 62,500
Therefore, the exchange ratio is
62,500 : 1,25,000
62,500
= = 0.50
1,25,000

10. (i) SWAP ratio based on current market prices:

EPS before acquisition:
Mani Ltd. : `2,000 lakhs / 200 lakhs: `10
Ratnam Ltd.: `4,000 lakhs / 1,000 lakhs: ` 4
Market price before acquisition:
Mani Ltd.: `10 × 10 `100
Ratnam Ltd.: `4 × 5 ` 20
SWAP ratio: 20/100 or 1/5 i.e. 0.20
(ii) EPS after acquisition:
`(2,000 + 4,000) Lakhs
(200 + 200) Lakhs = `15.00
(iii) Market Price after acquisition:

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EPS after acquisition : `15.00

P/E ratio after acquisition 10 × 0.9 9
Market price of share (` 15 X 9) `135.00
(iv) Market value of the merged Co.:
`135 × 400 lakhs shares ` 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 270 270
Gain (Total) 70 70
No. of shares (pre-merger) (lakhs) 200 1,000
Gain per share (`) 35 7
11.
(i) Exchange Ratio 1:1
New Shares to be issued 2,00,000
Total shares of Rama Ltd. (4,00,000+2,00,000) 6,00,000
Total earnings (` 10,00,000 + ` 7,00,000) ` 17,00,000
New EPS (` 17,00,000/6,00,000) ` 2.83
(ii) 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) ` 0.67
(iii) P/E ratio of new firm (expected to remain same) 14 times
New market price (14 × ` 2.83) ` 39.62
Total No. of Shares 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

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(iv)
Rama Ltd. Krishna Ltd Total
No. of shares after merger 4,00,000 2,00,000 6,00,000
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)
12. (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
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
` 1,04,00,000
EPS = = ` 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:
` 80,00,000
M Co. Ltd. = =`5
16,00,000 equity shares
` 24,00,000
N Co. Ltd. = =`6
4,00,000 equity shares

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

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14.64 ADVANCED FINANCIAL MANAGEMENT

` 1,04,00,000
EPS [after merger] = =`5
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.
13. (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. ` 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 25 Lakhs
(` 200 lakhs/` 8)
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. ` 1800 Lakhs
(` 120 × 15 Lakhs)
Pre Merger Market Capitalization of Latitude Ltd. ` 800 Lakhs
(` 50 × 16 Lakhs)
Combined Market Capitalization ` 2600 Lakhs
Current Market Price of share of Longitude Ltd. ` 120
Maximum number of shares to be exchanged of Longitude 21.67 Lakhs
(surviving company) (` 2600 Lakhs/` 120)
Current Number of Shares of Longitude Ltd. 15.00 Lakhs
Maximum number of shares to be exchanged (Lakhs) 6.67 Lakhs

Maximum share exchange ratio 6.67:16 or 0.4169:1

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14.

P Ltd. R Ltd.
Profit before Tax (` in crore) 15 13.50
Tax 30% (` in crore) 4.50 4.05
Profit after Tax (` in crore) 10.50 9.45
Earning per Share (`) 10.50 9.45
= ` 0.42 = ` 0.63
25 15
Price of Share before Merger ` 0.42 x 12 = ` 5.04 `0.63 x 9 = ` 5.67
(EPS x P/E Ratio)

(i) ∴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. R Ltd.
No. of Shares 25 crores 4
15x = 12 crores
5
Combined 37 crores
% of Combined Equity Owned 25 12
x100 = 67.57% x100 = 32.43%
37 37
(ii) ∴ Value of Original Shareholders
P Ltd. R Ltd.
` 211.05 crore x 67.57% ` 211.05 crore x 32.43%
= ` 142.61 = ` 68.44
Alternatively, it can also be computed as follows:

Combined Value of Entity 211.05 crore

No. of shares after Merger 37 crore
Value of Per Share ` 5.70405
Value of P Ltd. Shareholders (25 crores x ` 5.70405) ` 142.60 crore
Value of R Ltd. Shareholders (12 crores x ` 5.70405) ` 68.45 crore

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(iii) ∴ Price per Share after Merger

`19.95crore
EPS = = ` 0.539 per share
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

Market Value 239.39 crore
Price of Share = = = ` 6.47
Number of Shares 37 crore

(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.
4
6.47 x = ` 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%.
15. Compute Value of Equity
Simple Ltd.
` in Lacs
High Growth Medium Growth Slow Growth
Debt + 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

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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 Medium Slow Growth Expected Value
Growth
Prob. Value Prob. Value Prob. Value
Debt 0.20 460 0.60 460 0.20 410 450
Equity 0.20 360 0.60 90 0.20 0 126
820 550 410 576

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
1050 825 590 823

Expected Values
` in Lacs
Equity Debt
Simple Ltd. 126 Simple Ltd. 450
Dimple Ltd. 758 Dimple Ltd. 65
884 515

16. (i) Working Notes:

Present Value of Cash Flows (CF) upto 5 years
Year CF of Yes PVF PV of CF CF of PV of CF of
End Ltd. @15% (` lakhs) Merged Merged
(` lakhs) Entity Entity
(` lakhs) (` lakhs)
1 175 0.870 152.25 400 348.00
2 200 0.756 151.20 450 340.20
3 320 0.658 210.56 525 345.45

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14.68 ADVANCED FINANCIAL MANAGEMENT

4 340 0.572 194.48 590 337.48

5 350 0.497 173.95 620 308.14
882.44 1679.27

PV of Cash Flows of Yes Ltd. after the forecast period

CF5 (1 + g) 350(1 + 0.05) 367.50
TV5 = = = = ` 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
CF5 (1 + g) 620(1 + 0.06) 657.20
TV5 = = = = ` 7302.22 lakhs
Ke − g 0.15 − 0.06 0.09

PV of TV5 = ` 7302.22 lakhs x 0.497 = ` 3629.20 lakhs

Value of Yes Ltd.
Before merger (` lakhs) After merger (` lakhs)
PV of CF (1-5 years) 882.440 1679.27
Add: PV of TV5 1826.475 3629.20
2708.915 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.
1
Share of Yes Ltd. in merged entity = ` 5308.47 lakhs x = ` 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
17. Swap Ratio
Efficient Ltd. Healthy Ltd.
Market capitalization 500 lakhs 750 lakhs
No. of shares 10 lakhs 7.5 lakhs

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Market Price per share ` 50 ` 100

P/E ratio 10 5
EPS `5 ` 20
Profit ` 50 lakh ` 150 lakh
Share capital ` 100 lakh ` 75 lakh
Reserves and surplus ` 300 lakh ` 165 lakh
Total ` 400 lakh ` 240 lakh
Book Value per share ` 40 ` 32

(i) Calculation of Swap Ratio

EPS 1 : 4 i.e. 4.0 × 40% 1.6

Book value 1 : 0.8 i.e. 0.8 × 25% 0.2
Market price 1 : 2 i.e. 2.0 × 35% 0.7
Total 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.
Promoter’s holding = 4.75 lakh shares + (5 × 2.5 = 12.5 lakh shares) = 17.25 lakh i.e.
Promoter’s 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 10 lakh + 18.75 lakh = 28.75 lakh
Total capital 100 lakh + 187.5 lakh = ` 287.5 lakh
Total profit 50 lakh + 150 lakh 200
EPS = = = ` 6.956
No. of shares 28.75 lakh 28.75
(iii) Expected market price EPS 6.956 × P/E 10 = ` 69.56
Market capitalization = ` 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

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18. SWAP RATIO

Abhiman Ltd. Swabhiman Ltd.
(`) (`)
Share capital 200 lacs 100 lacs
Free reserves & surplus 900 lacs 600 lacs
Total 1100 lacs 700 lacs
No. of shares 2 lacs 10 lacs
Book value for share ` 550 ` 70
Promoters Holding 50% 60%
Non promoters holding 50% 40%
Free float market capitalization (Public) 500 lacs ` 156 lacs
Total Market Cap 1000 lacs 390 lacs
No. of shares 2 lacs 10 lacs
Market Price ` 500 ` 39
P/E ratio 10 4
EPS ` 50.00 ` 9.75

Calculation of SWAP Ratio

Book Value 1:0.1273 0.1273 × 25% 0.031825
EPS 1:0.195 0.195 × 50% 0.097500
Market Price 1:0.078 0.078 × 25% 0.019500
Total 0.148825
(i) 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
(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
` 348.825 lac + ` 1451.175 lac
Book value Per Share = = ` 516.02
3.48825 lac
or ` 516.02 x 0.148825 = ` 76.80

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Total Capital 1100lac + 700 lac

or = = = ` 516.02
No. of Shares 348825
Total Pr ofit ` 100 lac + ` 97.50 lac
EPS = = = ` 56.62
No. of shares 3.48825 lac

or ` 56.62 x 0.148825 = ` 8.43

Expected market price = ` 56.62 × PE Ratio= ` 56.62 × 10 = ` 566.20
or ` 566.20 x 0.148825 = ` 84.26
19.
(i) E Ltd. H Ltd.
Market capitalisation 1000 lakhs 1500 lakhs
No. of shares 20 lakhs 15 lakhs
Market Price per share ` 50 ` 100
P/E ratio 10 5
EPS `5 ` 20
Profit ` 100 lakh ` 300 lakh
Share capital ` 200 lakh ` 150 lakh
Reserves and surplus ` 600 lakh ` 330 lakh
Total ` 800 lakh ` 480 lakh
Book Value per share ` 40 ` 32
(ii) Calculation of Swap Ratio
EPS 1 : 4 i.e. 4.0 × 40% 1.6
Book value 1 : 0.8 i.e. 0.8 × 25% 0.2
Market price 1 : 2 i.e. 2.0 × 35% 0.7
Total 2.5
Swap ratio is for every one share of H Ltd., to issue 2.5 shares of E Ltd. Hence, total
no. of shares to be issued 15 lakh × 2.5 = 37.50 lakh shares

(iii) Promoter’s holding = 9.50 lakh shares + (10× 2.5 = 25 lakh shares) = 34.50 lakh i.e.
Promoter’s holding % is (34.50 lakh/57.50 lakh) × 100 = 60%.
(iv) Calculation of EPS after merger

Total No. of shares 20 lakh + 37.50 lakh = 57.50 lakh

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14.72 ADVANCED FINANCIAL MANAGEMENT

Total profit 100 lakh + 300 lakh 400

=
EPS = = ` 6.956
No. of shares 57.50 lakh 57.50
(v) Calculation of Market price and Market capitalization after merger
Expected market price EPS 6.956 × P/E 10 = ` 69.56

Market capitalization = ` 69.56 per share ×57.50 lakh shares

= ` 3,999.70 lakh or ` 4,000 lakh

(vi) Free float of market capitalization = ` 69.56 per share × (57.50 lakh × 40%) =
` 1599.88 lakh
20. (a) Swap Ratio
Abhiman Ltd. Abhishek Ltd.
Share Capital 200 Lakh 100 Lakh
Free Reserves 800 Lakh 500 Lakh
Total 1000 Lakh 600 Lakh
No. of Shares 2 Lakh 10 Lakh
Book Value per share ` 500 ` 60
Promoter’s holding 50% 60%
Non promoter’s holding 50% 40%
Free Float Market Cap. i.e. 400 Lakh 128 Lakh
relating to Public’s holding
Hence Total market Cap. 800 Lakh 320 Lakh
No. of Shares 2 Lakh 10 Lakh
Market Price ` 400 ` 32
P/E Ratio 10 4
EPS 40 8
Profits (` 2 X 40 lakh) ` 80 lakh -
(` 8 X 10 lakh) - ` 80 lakh
Calculation of Swap Ratio
Book Value 1 : 0.12 i.e.
0.12 x 25% 0.03
EPS 1 : 0.2 0.20 x 50% 0.10
Market Price 1 : 0.080.08 x 25% 0.02
Total 0.15
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

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(b) Book Value, EPS & Market Price

Total No of Shares 2 Lakh + 1.5 Lakh = 3.5 Lakh
Total Capital ` 200 Lakh + ` 150 Lakh = ` 350 Lakh
Reserves ` 800 Lakh + ` 450 Lakh = ` 1,250 Lakh
Book Value ` 350 Lakh + ` 1,250 Lakh = ` 457.14 per share
3.5 Lakh
Total Profit ` 80 Lakh + ` 80 Lakh ` 160 Lakh
EPS = = = ` 45.71
No. of Share 3.5 Lakh 3.5
Expected Market Price EPS (` 45.71) x P/E Ratio (10) = ` 457.10
(c) (i) Promoter’s holding
Promoter’s Revised Abhiman 50% i.e. 1.00 Lakh shares
Holding Abhishek 60% i.e. 0.90 Lakh shares
Total 1.90 Lakh shares
Promoter’s % = 1.90/3.50 x 100 = 54.29%
(ii) Free Float Market Capitalisation
Free Float Market = (3.5 Lakh – 1.9 Lakh) x ` 457.10
Capitalisation = ` 731.36 Lakh
(iii) (a) & (b)
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. ` 5 ) 5.25 x 20 = 105 Lakh
EPS 160 Lakh / 105 Lakh = 1.523
Book Value Cap. ` 525 Lakh + ` 1075 Lakh
No. of Shares =105 Lakh
= ` 15.238 per share

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21. 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) 516.57
Less: Interest (` 58 lakh + ` 30 lakh) 88.00
428.57
Less: 30% Tax 128.57
Total earnings (NPAT) 300.00
Total no. of shares outstanding 14.59 lakh
(12 lakh + 2.59 lakh)
EPS (` 300 lakh/ 14.59 lakh) ` 20.56
(iv) Expected Market Price:
Pre-acquisition P/E multiple:
EBIDAT (` in lakhs) 400.86
10
Less: Interest ( 580 X )(` in lakhs) 58.00
100
342.86
Less: 30% Tax (` in lakhs) 102.86
EAT (` in lakhs) 240.00
No. of shares (lakhs) 12.00
EPS ` 20.00
220
Hence, PE multiple 11
20
Expected market price after acquisition (` 20.56 x 11) ` 226.16

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As per E Ltd’s Plan

` in lakhs
(i) Net consideration payable
6 lakhs shares x ` 110 660
(ii) No. of shares to be issued by T Ltd
` 660 lakhs ÷ ` 220 3 lakh
(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
(iv) Expected Market Price (` 20 x 11) ` 220.00

(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
22. Share holders’ funds (` Lakhs)
Particulars 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

1. Calculation of Shares of Fortune Pharma Ltd. to be issued to shareholders of

Fortune India Ltd.
Fortune Pharma Ltd.
Estimated Profit (` in lakhs) 1,470
Estimated market price (`) 24.5
Estimated P/E 25
Estimated EPS (`) 0.98
No. of shares lakhs 1,500
Hence, Ratio is 1 share of Fortune Pharma Ltd. for 2 shares of Fortune India Ltd.

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14.76 ADVANCED FINANCIAL MANAGEMENT

OR for 0.50 share of Fortune Pharma Ltd. for 1 share of Fortune India Ltd.
2. Expected market price of Fortune India (FMCG) Ltd.

Fortune India (FMCG) Ltd.

Estimated Profit (` in lakhs) 11,400
No. of equity shares (` in lakhs) 3,000
Estimated EPS (`) 3.8
Estimated P/E 42
Estimated market price (`) 159.60

3. Book value per share

Fortune Pharma Ltd. Fortune India (FMCG) Ltd.

Net worth (`in lakhs) 21,000 24,000
No. of shares (` in lakhs) 1,500 3,000
Book value of shares ` 14 `8
23. (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
* Alternatively, Contingent Liability can also be deducted from this Valuation.
(iii) Fair value
H Ltd. ` 285.71× 1 + ` 1071.43 × 3
= ` 875
4
B Ltd. ` 48.46 × 1 + ` 192.31× 3
= ` 156.3475
4
Exchange ratio `156.3475/ `875 = 0.1787

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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.
24. (i) Market value of Companies before Merger
Particulars RIL SIL
EPS `2 Re.1
P/E Ratio 10 5
Market Price Per Share ` 20 `5
Equity Shares 10,00,000 10,00,000
Total Market Value 2,00,00,000 50,00,000

(ii) Post Merger Effects on RIL

`
Post-merger earnings 30,00,000
Exchange Ratio (1:4)
No. of equity shares o/s (10,00,000 + 2,50,000) 12,50,000
EPS: 30,00,000/12,50,000 2.4
PE Ratio 10
Market Value 10 x 2.4 24
Total Value (12,50,000 x 24) 3,00,00,000

Gains From Merger: `

Post-Merger Market Value of the Firm 3,00,00,000
Less: Pre-Merger Market Value
RIL 2,00,00,000
SIL 50,00,000 2,50,00,000
Total gains from Merger 50,00,000
Apportionment of Gains between the Shareholders:
Particulars RIL (`) SIL (`)
Post-Merger Market Value:
10,00,000 x 24 2,40,00,000 --
2,50,000 x 24 - 60,00,000
Less: Pre-Merger Market Value 2,00,00,000 50,00,000
Gains from Merger: 40,00,000 10,00,000

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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.
25. (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 shareholders of BCD Ltd. the immediate gain is ` 100 – ` 20 x 4 = ` 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

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(iii) Gain to shareholders of AFC Ltd:-

Earnings of BCD Ltd. (5,00,000 x 2.50) ` 12,50,000/-
Less: Loss of earning in cash (5,00,000 x ` 22 x 0.10) ` 11,00,000/-
Net Earning ` 1,50,000/-
Number of shares 10,00,000
Net increase in earning per share 0.15
P/E ratio of AFC Ltd. = 100/8 = 12.50
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
Alternatively, it can also be computed as follows:
Post-Merger Earnings ` 81,50,000
(10,00,000 x ` 8 + 5,00,000 x ` 2.5 – 11,00,000)
 81, 50, 000  ` 8.15
EPS after Merger  
 10, 00, 000 
PE Ratio 12.50
Post Merger Price of Share (` 8.15 x 12.50) ` 101.875
Less: Price before merger ` 100.00
` 1.875
Say ` 1.88

26. Price/share of AB Ltd. for determination of number of shares to be issued

= (` 570 + ` 430)/2 = ` 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
Average value (592.40+250)/2 421.20
No. of shares in AB Ltd to be issued ` 4,21,20,000/500 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

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27. (i) Determination of EPS, P/E Ratio, ROE and BVPS of R Ltd. & S Ltd.
R Ltd. S Ltd.
EAT (`) 5,33,000 2,49,600
N 200000 160000
EPS (EAT÷N) 2.665 1.56
Market Price Per Share 50 20
PE Ratio (MPS/EPS) 18.76 12.82
Equity Fund (Equity Value) 2400000 1600000
BVPS (Equity Value ÷ N) 12 10
ROE (EAT÷ EF) or 0.2221 0.156
ROE (EAT ÷ EF) x 100 22.21% 15.60%

(ii) Determination of Growth Rate of EPS of R Ltd.& S Ltd.

R Ltd. S Ltd.
Retention Ratio (1-D/P Ratio) 0.80 0.70
Growth Rate (ROE x Retention Ratio) or 0.1777 0.1092
Growth Rate (ROE x Retention Ratio) x 100 17.77% 10.92%

(iii) Justifiable equity share exchange ratio

(a) Market Price Based = MPSS/MPSR = ` 20/ ` 50 = 0.40:1 (lower limit)
(b) Intrinsic Value Based = ` 25/ ` 50 = 0.50:1 (max. limit)
Since R Ltd. has higher EPS, PE, ROE and higher growth expectations the negotiated
term would be expected to be closer to the lower limit, based on existing share price.
28. 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.
BA Ltd. DA Ltd.
Earnings After Tax (EAT) ` 2,10,000 ` 99,000
No. of Shares (N) 100000 80000
EPS (EAT/N) ` 2.10 ` 1.2375
Market price per share (MPS) 40 15
P/E Ratio (MPS/EPS) 19.05 12.12
Equity Funds (EF) ` 12,00,000 ` 8,00,000
BVPS (EF/N) 12 10
ROE (EAT/EF) × 100 17.50% 12.37%

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 MERGERS ACQUISITIONS & CORPORATE RESTRUCTURING 14.81
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(ii) Estimation of growth rates in EPS for BA Ltd. and DA Ltd.

Retention Ratio (1-D/P ratio) 0.6 0.4
Growth Rate (ROE × Retention Ratio) 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.
(iv) Calculation of Post merger EPS and its effects
Particulars BA Ltd. DA Ltd. Combined
EAT (`) (i) 2,10,000 99,000 3,09,000
Share outstanding (ii) 100000 80000 132000*
EPS (`) (i) / (ii) 2.1 1.2375 2.341
EPS Accretion (Dilution) (Re.) 0.241 (0.301***)
(v) Estimation of Post merger Market price and other effects
Particulars BA Ltd. DA Ltd. Combined
EPS (`) (i) 2.1 1.2375 2.341
P/E Ratio (ii) 19.05 12.12 19.05
MPS (`) (i) / (ii) 40 15 44.6
MPS Accretion (`) 4.6 2.84***

* Shares outstanding (combined) = 100000 shares + (0.40 × 80000) = 132000 shares

** EPS claim per old share = ` 2.34 × 0.4 ` 0.936
EPS dilution = ` 1.2375 – ` 0.936 ` 0.3015
***S claim per old share (` 44.60 × 0.4) ` 17.84

Less: MPS per old share ` 15.00

` 2.84

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14.82 ADVANCED FINANCIAL MANAGEMENT

29. (a) Swap Ratio

Gross NPA 5:40 5/40 x 30% 0.0375
CAR 5:16 5/16 x 28% 0.0875
Market Price 12:96 12/96 x 32% 0.0400
Book Value Per Share 12:120 12/120x 10% 0.0100
0.1750

Thus, for every share of Weak Bank, 0.1750 share of Strong Bank shall be issued.
Calculation of Book Value Per Share
Particulars Weak Bank (W) Strong Bank (S)
Share Capital (` Lakhs) 150 500
Reserves & Surplus (` Lakhs) 80 5,500
230 6,000
Less: Preliminary Expenses (` Lakhs) 50 --
Net Worth or Book Value (` Lakhs) 180 6,000
No. of Outstanding Shares (Lakhs) 15 50
Book Value Per Share (`) 12 120

(b) No. of equity shares to be issued:

150
× 0.1750 = 2.625 lakh shares
10
(c) Balance Sheet after Merger
Calculation of Capital Reserve
Book Value of Shares ` 180.00 lac
Less: Value of Shares issued ` 26.25 lac
Capital Reserve ` 153.75 lac
Balance Sheet
` lac ` lac
Paid up Share Capital 526.25 Cash in Hand & RBI 2900.00
Reserves & Surplus 5500.00 Balance with other banks 2000.00
Capital Reserve 153.75 Investment 20100.00
Deposits 48000.00 Advances 30500.00
Other Liabilities 3390.00 Other Assets 2070.00
57570.00 57570.00

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 MERGERS ACQUISITIONS & CORPORATE RESTRUCTURING 14.83
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(d) Calculation CAR & Gross NPA % of Bank ‘S’ after merger
Total Capital
CAR / CRWAR =
Risky Weighted Assets
Weak Bank Strong Bank Merged
Capital Adequacy Ratio (CAR) 5% 16%
Total Capital ` 180 lac ` 6000 lac ` 6180 lac
Risky Weighted Assets ` 3600 lac ` 37500 lac ` 41100 lac

6180
CAR = × 100 = 15.04%
41100
Gross NPA
GNPA Ratio
= × 100
Gross Advances

Weak Bank Strong Bank Merged

GNPA (Given) 0.40 0.05
GNPA R GNPA S
0.40 = 0.05 =
` 3500 lac ` 27000 lac
Gross NPA ` 1400 lac ` 1350 lac ` 2750 lac

30. Calculation of Purchase Consideration

`
Issue of Share 35000 x `15 5,25,000
External Liabilities settled 5,00,000
13% Debentures 3,00,000
13,25,000
Less: Realization of Debtors and Inventories 2,00,000
Cash 50,000
10,75,000
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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31. (i) 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) ` 2,40,00,000

Synergy Gain ` 80,00,000
Saving of Overpayment ` 30,00,000
` 3,50,00,000
Maximum Price (` 3,50,00,000/10,00,000) ` 35

Alternatively, it can also be computed as follows:

Let ER be the swap ratio then,
24 × 10,00,000 + 40 × 15,00,000 + 80,00,000 + 30,00,000
40 =
15,00,000 + 10,00,000 × ER

ER = 0.875
40
MP = PE x EPS x ER = x ` 4 x 0.875 = ` 35
4
(ii) 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 4,00,000
Minimum Price (` 1,26,00,000/4,00,000) ` 31.50

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