Chapter 13 PDF

13
Merger, Acquisition & Restructuring
Question 1
Explain synergy in the context of Mergers and Acquisitions. (4 Marks) (November 2012)
Answer
Synergy May be defined as follows:
V (AB) > V(A) + V (B).
In other words the combined value of two firms or companies shall be more than their individual
value. This may be result of complimentary services economics of scale or both.
A good example of complimentary activities can a company may have a good networking of
branches and other company may have efficient production system. Thus the merged
companies will be more efficient than individual companies.
On Similar lines, economics of large scale is also one of the reason for synergy benefits. The main
reason is that, the large scale production results in lower average cost of production e.g. reduction in
overhead costs on account of sharing of central services such as accounting and finances, Office
executives, top level management, legal, sales promotion and advertisement etc.
These economics can be “real” arising out of reduction in factor input per unit of output,
whereas pecuniary economics are realized from paying lower prices for factor inputs to bulk
transactions.
Question 2
Explain the term 'Buy-Outs'. (8 Marks) (November 2003)
Write brief notes on Leveraged Buy-Outs (LBO). (4 Marks) (May 2007)
Answer
A very important phenomenon witnessed in the Mergers and Acquisitions scene, in recent times is one of
buy - outs. A buy-out happens when a person or group of persons gain control of a company by buying all or
a majority of its shares. A buyout involves two entities, the acquirer and the target company. The acquirer
seeks to gain controlling interest in the company being acquired normally through purchase of shares. There
are two common types of buy-outs: Leveraged Buyouts (LBO) and Management Buy-outs (MBO). LBO is the
purchase of assets or the equity of a company where the buyer uses a significant amount of debt and very
© The Institute of Chartered Accountants of India

Merger, Acquisition & Restructuring 13.2
little equity capital of his own for payment of the consideration for acquisition. MBO is the purchase of a
business by its management, who when threatened with the sale of its business to third parties or frustrated
by the slow growth of the company, step-in and acquire the business from the owners, and run the business
for themselves. The majority of buy-outs is management buy-outs and involves the acquisition by incumbent
management of the business where they are employed. Typically, the purchase price is met by a small
amount of their own funds and the rest from a mix of venture capital and bank debt.
Internationally, the two most common sources of buy-out operations are divestment of parts of larger groups
and family companies facing succession problems. Corporate groups may seek to sell subsidiaries as part of
a planned strategic disposal programme or more forced reorganisation in the face of parental financing
problems. Public companies have, however, increasingly sought to dispose of subsidiaries through an
auction process partly to satisfy shareholder pressure for value maximisation.
In recessionary periods, buy-outs play a big part in the restructuring of a failed or failing businesses and in an
environment of generally weakened corporate performance often represent the only viable purchasers when
parents wish to dispose of subsidiaries.
Buy-outs are one of the most common forms of privatisation, offering opportunities for enhancing the
performances of parts of the public sector, widening employee ownership and giving managers and
employees incentives to make best use of their expertise in particular sectors.
Question 3
What is take over by reverse bid? (3 Marks) (May 2006), (4 Marks) (November 2011)
(4 Marks) (November 2014)
Answer
Generally, a big company takes over a small company. When the smaller company gains
control of a larger one then it is called “Take-over by reverse bid”. In case of reverse take-
over, a small company takes over a big company. This concept has been successfully
followed for revival of sick industries.
The acquired company is said to be big if any one of the following conditions is satisfied:
(i) The assets of the transferor company are greater than the transferee company;
(ii) Equity capital to be issued by the transferee company pursuant to the acquisition
exceeds its original issued capital, and
(iii) The change of control in the transferee company will be through the introduction of
minority holder or group of holders.
Reverse takeover takes place in the following cases:
(1) When the acquired company (big company) is a financially weak company
(2) When the acquirer (the small company) already holds a significant proportion of shares of
the acquired company (small company)

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

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

minority group or new group of shareholders.
Question 6
What is an equity curve out? How does it differ from a spin off? (4 Marks) (November 2013)
Answer
Equity Curve out can be defined as partial spin off in which a company creates its own new
subsidiary and subsequently bring out its IPO. It should be however noted that parent
company retains its control and only a part of new shares are issued to public.
On the other hand in Spin off parent company does not receive any cash as shares of
subsidiary company are issued to existing shareholder in the form of dividend. Thus,
shareholders in new company remain the same but not in case of Equity curve out.
Question 7
B Ltd. is a highly successful company and wishes to expand by acquiring other firms. Its
expected high growth in earnings and dividends is reflected in its PE ratio of 17. The Board of
Directors of B Ltd. has been advised that if it were to take over firms with a lower PE ratio than
it own, using a share-for-share exchange, then it could increase its reported earnings per
share. C Ltd. has been suggested as a possible target for a takeover, which has a PE ratio of
10 and 1,00,000 shares in issue with a share price of ` 15. B Ltd. has 5,00,000 shares in
issue with a share price of ` 12.
Calculate the change in earnings per share of B Ltd. if it acquires the whole of C Ltd. by issuing shares at its
market price of `12. Assume the price of B Ltd. shares remains constant.
(8 Marks) (November 2009) (M)
Answer
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.
Question 8
ABC Company is considering acquisition of XYZ Ltd. which has 1.5 crores shares outstanding
and issued. The market price per share is ` 400 at present. ABC's average cost of capital is
12%.Available information from XYZ indicates its expected cash accruals for the next 3 years
as follows:
Year ` Cr.
1 250
2 300
3 400
Calculate the range of valuation that ABC has to consider. (PV factors at 12% for years 1 to 3 respectively:
0.893, 0.797 and 0.712). (4 Marks) (November 2009) (M)
Answer
VALUATION BASED ON MARKET PRICE
Market Price per share ` 400
Thus value of total business is (` 400 x 1.5 Cr.) ` 600 Cr.
VALUATION BASED ON DISCOUNTED CASH FLOW
Present Value of cash flows
(` 250 cr x 0.893) + (` 300 cr. X 0.797) + ( ` 400 cr. X 0.712 ) = ` 747.15 Cr.
Value of per share (` 747.15 Cr. / 1.5 Cr) ` 498.10 per share
RANGE OF VALUATION
Per Share Total
` ` Cr.
Minimum 400.00 600.00
Maximum 498.10 747.15
Question 9
ABC Limited is considering acquisition of DEF Ltd., which has 3.10 crore shares issued
and outstanding. The market price per share is ` 440.00 at present. ABC Ltd.'s average

cost of capital is 12%. The cash inflows of DEF Ltd. for the next three years are as under:
Year ` in crores
1 460.00
2 600.00
3 740.00
You are required to calculate the range of valuation that ABC Ltd. has to consider.
Take P.V.F. (12%, 3) =0.893, 0.797, 0.712 (5 Marks) (May 2013)
Answer
Valuation based on Market Price
Market Price per share ` 440.00
Thus value of total business is (3.10 crore x ` 440) ` 1,364.00 Crore
Valuation based on Discounted Cash Flow
Present Value of cash flows
(` 460 Crore x 0.893) + (` 600 Crore X 0.797) +
(` 740 Crore X 0.712 ) = ` 1,415.86 Crore
Value of per share (` 1415.86 Crore / 3.10 Crore) ` 456.73 per share
Range of valuation
Per Share (`) Total (` Crore)
Minimum 440.00 1364.00
Maximum 456.73 1415.86
Question 10
Elrond Limited plans to acquire Doom Limited. The relevant financial details of the two
firms prior to the merger announcement are:
Elrond Limited Doom Limited
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?
Answer
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
The value of Elrond Ltd. after merger will be:
= `50 x 20 lakh + `25 x 10 lakh + `200 lakh
= `1000 lakh + `250 lakh + `200 lakh = `1450 lakh
True Cost of Merger will be:
(`1450 x 20%) `290 lakhs – `250 lakhs = `40 lakhs
Question 11
X Ltd. reported a profit of `65 lakhs after 35% tax for the financial year 2007-08. An analysis
of the accounts revealed that the income included extraordinary items `10 lakhs and an
extraordinary loss `3 lakhs. The existing operations, except for the extraordinary items, are
expected to continue in the future; in addition, the results of the launch of a new product are
expected to be as follows:
` lakhs
Sales 60
Material costs 15
Labour Costs 10
Fixed costs 8
You are required to :
(a) Compute the value of the business, given that the capitalization rate is 15%.
(b) Determine the market price per equity share, with X Ltd.’s share capital being comprised
of 1,00,000 11% preference shares of ` 100 each and 40,00,000 equity shares of ` 10
each and the P/E ratio being 8 times. . (10 Marks) (June 2009) (M)
Answer
65
(a) Profit before tax 100
1  0.35
Less: Extraordinary income (10)
Add: Extraordinary losses 3
93
Profit from new product
Sales 60
Less: Material costs 15

Labour costs 10
Fixed costs 8 (33) 27
Expected profits before taxes 120
Taxes @ 35% (42)
Profit after taxes 78
Capitalization rate 15%
78
Value of business = 520
0.15
(b) Future maintainable profits (After Tax) 78
Less: Preference share dividends
100,000 shares of `100 @ 11% (11)
67
Earning per share = ` 67,00,000 = ` 1.675
` 40,00,000
PE ratio 8
Market price per share `13.40
Question 12
Eagle Ltd. reported a profit of ` 77 lakhs after 30% tax for the financial year 2011-12. An
analysis of the accounts revealed that the income included extraordinary items of ` 8 lakhs
and an extraordinary loss of `10 lakhs. The existing operations, except for the extraordinary
items, are expected to continue in the future. In addition, the results of the launch of a new
product are expected to be as follows:
` In lakhs
Sales 70
Material costs 20
Labour costs 12
Fixed costs 10
You are required to:
(i) Calculate the value of the business, given that the capitalization rate is 14%.
(ii) Determine the market price per equity share, with Eagle Ltd.‘s share capital being
comprised of 1,00,000 13% preference shares of `100 each and 50,00,000 equity shares
of `10 each and the P/E ratio being 10 times. (8 Marks) (November 2012)

Answer
(i) Computation of Business Value
(` Lakhs)
77 110
Profit before tax
1  0.30
Less: Extraordinary income (8)
Add: Extraordinary losses 10
112
Profit from new product (` Lakhs)
Sales 70
Less: Material costs 20
Labour costs 12
Fixed costs 10 (42) 28
140.00
Less: Taxes @30% 42.00
Future Maintainable Profit after taxes 98.00
Relevant Capitalisation Factor 0.14
Value of Business (`98/0.14) 700
(ii) Determination of Market Price of Equity Share

Future maintainable profits (After Tax) ` 98,00,000
Less: Preference share dividends 1,00,000 shares of ` 100 @ 13% ` 13,00,000
Earnings available for Equity Shareholders ` 85,00,000
No. of Equity Shares 50,00,000
` 85,00,000 ` 1.70
Earning per share = =
50,00,000
PE ratio 10
Market price per share ` 17
Question 13
The equity shares of XYZ Ltd. are currently being traded at ` 24 per share in the market. XYZ
Ltd. has total 10,00,000 equity shares outstanding in number; and promoters' equity holding in
the company is 40%.
PQR Ltd. wishes to acquire XYZ Ltd. because of likely synergies. The estimated present value
of these synergies is ` 80,00,000.

Further PQR feels that management of XYZ Ltd. has been over paid. With better motivation,
lower salaries and fewer perks for the top management, will lead to savings of ` 4,00,000 p.a.
Top management with their families are promoters of XYZ Ltd. Present value of these savings
would add ` 30,00,000 in value to the acquisition.
Following additional information is available regarding PQR Ltd.:
Earnings per share :`4
Total number of equity shares outstanding : 15,00,000
Market price of equity share : ` 40
Required:
(i) What is the maximum price per equity share which PQR Ltd. can offer to pay for XYZ Ltd.?
(ii) What is the minimum price per equity share at which the management of XYZ Ltd. will be
willing to offer their controlling interest? (4 + 2 = 6 Marks) (May 2014)
Answer
(a) Calculation of maximum price per share at which PQR Ltd. can offer to pay for XYZ Ltd.’s
share
Market Value (10,00,000 x ` 24) ` 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
(b) Calculation of minimum price per share at which the management of XYZ Ltd.’s will be
willing to offer their controlling interest
Value of XYZ Ltd.’s Management Holding ` 96,00,000
(40% of 10,00,000 x ` 24)
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
Question 14
Following information is given in respect of WXY Ltd., which is expected to grow at a rate of
20% p.a. for the next three years, after which the growth rate will stabilize at 8% p.a. normal
level, in perpetuity.

For the year ended

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

Present Value (PV) of FCFF during the explicit forecast period is:
FCFF (` in crores) PVF @ 15% PV (` in crores)
1342.50 0.8696 1167.44
1619.62 0.7561 1224.59
1953.47 0.6575 1284.41
3676.44
PV of the terminal, value is:

2680.13 1
x = ` 38287.57 Crore x 0.6575 = ` 25174.08 Crore
0.15 - 0.08 (1.15)3
The value of the firm is :

` 3676.44 Crores + ` 25174.08 Crores = ` 28,850.52 Crores
Question 15
ABC Co. is considering a new sales strategy that will be valid for the next 4 years. They want
to know the value of the new strategy. Following information relating to the year which has just
ended, is available:
Income Statement `
Sales 20,000
Gross margin (20%) 4,000
Administration, Selling & distribution expense (10%) 2,000
PBT 2,000
Tax (30%) 600
PAT 1,400
Balance Sheet Information
Fixed Assets 8,000
Current Assets 4,000
Equity 12,000
If it adopts the new strategy, sales will grow at the rate of 20% per year for three years. The
gross margin ratio, Assets turnover ratio, the Capital structure and the income tax rate will
remain unchanged.
Depreciation would be at 10% of net fixed assets at the beginning of the year.
The Company’s target rate of return is 15%.
Determine the incremental value due to adoption of the strategy. (8 Marks) (May 2007)

Answer
Projected Balance Sheet
Year 1 Year 2 Year 3 Year 4
Fixed Assets (40%) of Sales 9,600 11,520 13,824 13,824
Current Assets (20%) of Sales 4,800 5,760 6,912 6,912
Total Assets 14,400 17,280 20,736 20,736
Equity 14,400 17,280 20,736 20,736
Projected Cash Flows:-
Year 1 Year 2 Year 3 Year 4
Sales 24,000 28,800 34,560 34,560
PBT (10%) of sale 2,400 2,880 3,456 3,456
PAT (70%) 1,680 2,016 2,419.20 2,419.20
Depreciation 800 960 1,152 1,382
Addition to Fixed Assets 2,400 2,880 3,456 1,382
Increase in Current Assets 800 960 1,152 -
Operating cash flow (720) (864) (1,036.80) 2,419.20
Projected Cash Flows:-
Present value of Projected Cash Flows:-
Cash Flows PV at 15% PV
-720 0.870 -626.40
-864 0.756 -653.18
-1,036.80 0.658 -682.21
-1,961.79
Residual Value - 2419.20/0.15 = 16,128

Present value of Residual value = 16128/(1.15)3
= 16128/1.521 = 10603.55
Total shareholders’ value = 10,603.55 – 1,961.79 = 8,641.76
Pre strategy value = 1,400 / 0.15 = 9,333.33
 Value of strategy = 8,641.76 – 9,333.33 = 691.57
Conclusion: The strategy is not financially viable

Question 16
Helium Ltd has evolved a new sales strategy for the next 4 years. The following information is
given:
Income Statement ` in thousands
Sales 40,000
Gross Margin at 30% 12,000
Accounting, administration and distribution expense at 15% 6,000
Profit before tax 6,000
Tax at 30% 1,800
Profit after tax 4,200
Balance sheet information
Fixed Assets 10,000
Current Assets 6,000
Equity 15,000
As per the new strategy, sales will grow at 30 percent per year for the next four years. The
gross margin ratio will increase to 35 percent. The Assets turnover ratio and income tax rate
will remain unchanged.
Depreciation is to be at 15 percent on the value of the net fixed assets at the beginning of the year.
Company's target rate of return is 14%.
Determine if the strategy is financially viable giving detailed workings.
Answers
(a) Solution if candidates have assumed that if the Equity amount is 16000 instead of
15000.


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

(In ` Thousands)
Sales (30% yoy) 52000.00 67600.00 87880.00 114244.00 114244.00
PBT 15% 7800.00 10140.00 13182.00 17136.60 17136.60
PAT 70% 5460.00 7098.00 9227.40 11995.62 11995.62
Depreciation 15% 1500.00 1950.00 2535.00 3295.50 4284.15
Addition to Fixed Assets 4500.00 5850.00 7605.00 9886.50 4284.15
Increase in Current Assets 1500.00 1950.00 2535.00 3295.50 0
Operating Cash Flow 960.00 1248.00 1622.40 2109.12 11995.62
Present value factor @ 14% 0.877 0.769 0.675 0.592
Present value of cash flows @
14% 841.92 959.71 1095.12 1248.60
(In ` Thousands)
Total for first 4 years (A) 4145.35
Residual value (11995.62/0.14) 85683
Present value of Residual value [85683/(1.14)4] (B) 50731.21
Total Shareholders value (C) = (A) +(B) 54876.56
Pre strategy value (4200/0.14) (D) 30000.00
Value of strategy (C) – (D) 24876.56
Conclusion: The strategy is financially viable.

Alternative Solution
If candidates have assumed that if the Equity amount is 16000 instead of 15000.
(In ` Thousands)
Year 1 2 3 4 5
Fixed Assets (25% of sales) 13000.00 16900.00 21970.00 28561.00 28561.00
Current Assets (15% of sales) 7800.00 10140.00 13182.00 17136.60 17136.60
Total Assets 20800.00 27040.00 35152.00 45697.60 45697.60
Current Liability 1300.00 1690.00 2197.00 2856.10 2856.10
Equity and Reserves 19500.00 25350.00 32955.00 42841.50 42841.50
(In ` Thousands)
Sales (30% yoy) 52000.00 67600.00 87880.00 114244.00 114244.00
PBT 15% 7800.00 10140.00 13182.00 17136.60 17136.60
PAT 70% 5460.00 7098.00 9227.40 11995.62 11995.62
Depreciation 15% 1500.00 1950.00 2535.00 3295.50 4284.15
Addition to Fixed Assets 4500.00 5850.00 7605.00 9886.50 4284.15
Increase in Current Assets 1500.00 2340.00 3042.00 3954.60 0
Operating Cash Flow 960.00 858.00 1115.40 1450.02 11995.62
Present value factor @ 14% 0.877 0.769 0.675 0.592 0.519
Present value of cash flows @14% 841.92 659.80 752.90 858.41 6225.73
(In ` Thousands)
Total for first 4 years (A) 3113.03
Residual value (6225.73/0.14) 44469.50
Present value of Residual value [ 44469.50/(1.14)4] (B) 26329.51
Total Shareholders value (C) = (A) +(B) 29442.54
Pre strategy value (4200/0.14) (D) 30000.00
Value of strategy (C) – (D) -557.46
Conclusion: The strategy is financially not viable.

Question 17
Cauliflower Limited is contemplating acquisition of Cabbage Limited. Cauliflower Limited has 5
lakh shares having market value of ` 40 per share while Cabbage Limited has 3 lakh shares
having market value of ` 25 per share. The EPS for Cabbage Limited and Cauliflower Limited
are ` 3 per share and ` 5 per share respectively. The managements of both the companies
are discussing two alternatives for exchange of shares as follows:
(i) In proportion to relative earnings per share of the two companies.
(ii) 1 share of Cauliflower Limited for two shares of Cabbage Limited.
Required:
(i) Calculate the EPS after merger under both the alternatives.
(ii) Show the impact on EPS for the shareholders of the two companies under both the
alternatives. (10 Marks)(November 2014)
Answer
(i) Exchange ratio in proportion to relative EPS
(in `)
Company Existing No. of shares EPS Total earnings
Cauliflower Ltd. 5,00,000 5.00 25,00,000
Cabbage Ltd. 3,00,000 3.00 9,00,000
Total earnings 34,00,000
No. of shares after merger 5,00,000 + 1,80,000 = 6,80,000
 3.00 
Note: 1,80,000 may be calculated as =  3,00,000 × 
 5.00 
34,00,000
EPS for Cauliflower Ltd. after merger = = ` 5.00
6,80,000
Impact on EPS
Cauliflower Ltd. shareholders `
EPS before merger 5.00
EPS after merger 5.00
Increase/ Decrease in EPS 0.00
Cabbage Ltd.' Shareholders

EPS after the merger 5.00 x 3/5 3.00

Increase/ Decrease in EPS 0.00
(ii) Merger effect on EPS with share exchange ratio of 1 : 2

Total earnings after merger ` 34,00,000
No. of shares post merger 5,00,000 + 1,50,000 (0.5 × 3,00,000) 6,50,000
EPS 34,00,000 ÷ 6,50,000 5.23
Impact on EPS
Cauliflower Ltd. shareholders `
EPS after merger 5.23
Increase in EPS 0.23
Cabbage Ltd. shareholders `
EPS after the merger 5.23 x 0.5 2.615
Decrease in EPS 0.385
Question 18
MK Ltd. is considering acquiring NN Ltd. The following information is available:
Company Earning after No. of Equity Shares Market Value
tax(`) 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.
(8 Marks) (November 2010) (S)
Answer
(i) Earning per share of company MK Ltd after merger:-
Exchange ratio 160 : 200 = 4 : 5.
that is 4 shares of MK Ltd. for every 5 shares of NN Ltd.

Total number of shares to be issued = 4/5  3,00,000 = 2,40,000 Shares.

Total number of shares of MK Ltd. and NN Ltd.=12,00,000 (MK Ltd.)+2,40,000 (NN Ltd.)
= 14,40,000 Shares
Total profit after tax = ` 60,00,000 MK Ltd.
= ` 18,00,000 NN Ltd.
= ` 78,00,000
 EPS. (Earning Per Share) of MK Ltd. after merger
` 78,00,000/14,40,000 = ` 5.42 per share
(ii) To find the exchange ratio so that shareholders of NN Ltd. would not be at a Loss:
Present earning per share for company MK Ltd.
= ` 60,00,000/12,00,000 = ` 5.00
Present earning per share for company NN Ltd.
= ` 18,00,000/3,00,000 = ` 6.00
 Exchange ratio should be 6 shares of MK Ltd. for every 5 shares of NN Ltd.
 Shares to be issued to NN Ltd. = 3,00,000  6/5 = 3,60,000 shares
Now, total No. of shares of MK Ltd. and NN Ltd. =12,00,000 (MK Ltd.)+3,60,000 (NN Ltd.)
= 15,60,000 shares
 EPS after merger = ` 78,00,000/15,60,000 = ` 5.00 per share
Total earnings available to shareholders of NN Ltd. after merger = 3,60,000 shares  `
5.00 = ` 18,00,000.
This is equal to earnings prior merger for NN Ltd.
 Exchange ratio on the basis of earnings per share is recommended.
Question 19
A Ltd. wants to acquire T Ltd. and has offered a swap ratio of 1:2 (0.5 shares for every one
share of T Ltd.). Following information is provided:
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. (10 Marks) (November 2007)
Answer
(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
Question 20
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
as before the merger takes place? (8 Marks) (May 2004)
Answer
(i) Earnings per share = Earnings after tax /No. of equity shares
ABC Ltd. = ` 50,00,000/10,00,000 = ` 5
XYZ Ltd. = ` 18,00,000 / 6,00,000 = ` 3
(ii) Number of Shares XYZ 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.
Question 21
XYZ Ltd. is considering merger with ABC Ltd. XYZ Ltd.’s shares are currently traded at ` 25.
it has 2,00,000 shares outstanding and its earning after taxes (EAT) amount to ` 4,00,000.
ABC Ltd. has 1,00,000 shares outstanding; its current market price is ` 12.50 and its EAT is
` 1,00,000. The merger will be effected by means of a stock swap (exchange). ABC Ltd. has
agreed to a plan under which XYZ Ltd. will offer the current market value of ABC Ltd.’s shares.

(i) What is the pre-merger earnings per share (EPS) and P/E ratios of both the companies?
(ii) If ABC Ltd.’s P/E ratio is 8, what is its current market price? What is the exchange ratio?
What will XYZ Ltd.’s post merger EPS be?
(iii) What must the exchange ratio be for XYZ Ltd.’s pre-merger and post-merger EPS to be
the same? (8 Marks) (May 2005)
Answer
Merger and EPS
Company XYZ ABC
Rs. Rs.
Market price of equity shares 25.00 12.50
No. of equity shares outstanding 2,00,000 1,00,000
Earning after tax 4,00,000 1,00,000
(i) 4,00,000 ` 1,00,000
EPS = ` , =
2,00,000 shares 1,00,000 shares 2.00 1.00
P/E ratio = ` 25/2, 12.50/1 12.5 12.5
(ii) (a) If ABC Ltd. P/E ratio is 8, its current market price will be ` 8 only (8  1).
(b) Then the exchange ratio will be 8/25 i.e. 32/100. For every 100 shares of
ABC, 32 shares of XYZ will be issued (1,00,000  32)/100 = 32,000 shares of
XYZ will be issued to all the shareholders of ABC Ltd.
(c) Post merger EPS of XYZ Ltd. = Total earning/Total shares = 5,00,000/2,32,000
equity shares = ` 2.16.
(iii) Total earnings ` 5,00,000/EPS ` 2 = 2,50,000 equity shares i.e. 50,000 shares of
XYZ will have to be issued to the shareholders of ABC i.e. one share of XYZ will be
issued for every two shares held by ABC shareholders.
Then pre-merger and post-merger EPS of XYZ will be same as follows:
Pre-merger EPS of XYZ ` 2.00
Post-merger EPS of XYZ ` 5,00,000/2,50,000 equity shares
= ` 2.00
Question 22
LMN Ltd is considering merger with XYZ Ltd. LMN Ltd's shares are currently traded at
` 30.00 per share. It has 3,00,000 shares outstanding. Its earnings after taxes (EAT) amount
to ` 6,00,000. XYZ Ltd has 1,60,000 shares outstanding and its current market price is
` 15.00 per share and its earnings after taxes (EAT) amount to ` 1,60,000. The merger is

decided to be effected by means of a stock swap (exchange). XYZ Ltd has agreed to a
proposal by which LMN Ltd will offer the current market value of XYZ Ltd's shares.
Find out:
(i) The pre-merger earnings per share (EPS) and price/earnings (P/E) ratios of both the
companies.
(ii) If XYZ Ltd's P/E Ratio is 9.6, what is its current Market Price? What is the Exchange
Ratio? What will LMN Ltd's post-merger EPS be?
(iii) What should be the exchange ratio, if LMN Ltd's pre-merger and post- merger EPS are to
be the same? (8 Marks) (May 2012)
Answer
(i) Pre-merger EPS and P/E ratios of LMN Ltd. and XYZ Ltd.
Particulars LMN Ltd. XYZ Ltd.
Earnings after taxes 6,00,000 1,60,000
Number of shares outstanding 3,00,000 1,60,000
EPS 2 1
Market Price per share 30 15
P/E Ratio (times) 15 15
(ii) Current Market Price of XYZ Ltd. if P/E ratio is 9.6 = ` 1 × 9.6 = ` 9.60
30
Exchange ratio = = 3.125
9.60
Post merger EPS of LMN Ltd.
6,00,000 + 1,60,000
=
3,00,000 + (1,60,000/3.125)
7,60,000
= = 2.16
3,51,200
(iii) Desired Exchange Ratio
Total number of shares in post-merged company
Post - merger earnings 7,60,000
= = = 3,80,000
Pr e - merger EPS of LMN Ltd. 2
Number of shares required to be issued to XYZ Ltd.
= 3,80,000 – 3,00,000 = 80,000
Therefore, the exchange ratio should be
80,000 : 1,60,000

80,000
= = 0.50
1,60,000
Question 23
K. Ltd. is considering acquiring N. Ltd., the following information is available :
Company Profit after Tax Number of Equity shares Market value per share
K. Ltd. 50,00,000 10,00,000 200.00
N. Ltd. 15,00,000 2,50,000 160.00
Exchange of equity shares for acquisition is based on current market value as above. There is
no synergy advantage available :
Find the earning per share for company K. Ltd. after merger.
Find the exchange ratio so that shareholders of N. Ltd. would not be at a loss.
Answer
(i) Earning per share for company K. Ltd. after Merger:
Exchange Ratio 160 : 200 = 4: 5
That is 4 shares of K. Ltd. for every 5 shares of N. Ltd.
4
 Total number of shares to be issued = × 2,50,000 = 2,00,000 shares
5
 Total number of shares of K. Ltd. and N .Ltd. = 10,00,000 K. Ltd.
+ 2,00,000 N. Ltd
12,00,000
Total profit after Tax = ` 50,00,000 K. Ltd.
` 15,00,000 N Ltd.
` 65,00,000
 E.P.S. (Earning per share) of K. Ltd. after Merger
` 65,00,000
= = ` 5.42 Per Share
12,00,000
(ii) To find the Exchange Ratio so that shareholders of N. Ltd. would not be at a Loss:
Present Earnings per share for company K. Ltd.
` 50,00,000
= ` 5.00
` 10,00,000

Present Earnings Per share for company N. Ltd.

` 15,00,000
= ` 6.00
` 2,50,000
 Exchange Ratio should be 6 shares of K. Ltd. for every 5 shares of N Ltd.
 Shares to be issued to N. Ltd.
2,50,000  6
= = 3,00,000 Shares
5
 Total No. of Shares of K.Ltd. and N. Ltd.
= 10,00,000 K. Ltd.
+ 3,00,000 N. Ltd
13,00,000
65,00,000
 E.P.S. After Merger = ` 5.00 Per Share
13,00,000
Total Earnings Available to Shareholders of N. Ltd. after Merger
= ` 3,00,000 × ` 5.00 = ` 15,00,000
This is equal to Earnings prior Merger for N. Ltd.
 Exchange Ratio on the Basis of Earnings per Share is recommended.
Question 24
M Co. Ltd., is studying the possible acquisition of N Co. Ltd., by way of merger. The following
data are available in respect of the companies:
Particulars 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?
Answer
(i) Calculation of new EPS of M Co. Ltd.
No. of equity shares to be issued by M Co. Ltd. to N Co. Ltd.
= 4,00,000 shares × ` 160/` 200 = 3,20,000 shares

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
` 24,00,000
N Co. Ltd. = =`6
Exchange ratio = 6/5 = 1.20
No. of new shares to be issued by M Co. Ltd. to N Co. Ltd.
= 4,00,000 × 1.20 = 4,80,000 shares
Total number of shares of M Co. Ltd. after acquisition
= 16,00,000 + 4,80,000 = 20,80,000 shares
` 1,04,00,000
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.
Question 25
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.
(v) Calculate gain/loss for shareholders of the two independent companies after acquisition.
Answer
Particulars Mark Ltd. Mask Ltd.
EPS ` 2,000 Lakhs/ 200 lakhs ` 400 lakhs / 100 lakhs
= ` 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.
(ii) EPS after merger
` 2,000 lakhs  ` 400 lakhs
= = ` 10.91
200 lakhs  20 lakhs
(iii) Expected market price after merger assuming P / E 10 times.
= ` 10.91  10 = ` 109.10
(iv) Market value of merged firm
= ` 109.10 market price  220 lakhs shares = 240.02 crores
(v) Gain from the merger
Post merger market value of the merged firm ` 240.02 crores
Less: Pre-merger market value
Mark Ltd. 200 Lakhs  ` 100 = 200 crores
Mask Ltd. 100 Lakhs  ` 20 = 20 crores ` 220.00 crores
Gain from merger ` 20.02 crores

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
Question 26
Simple Ltd. and Dimple Ltd. are planning to merge. The total value of the companies are
dependent on the fluctuating business conditions. The following information is given for the
total value (debt + equity) structure of each of the two companies.
Business Condition Probability Simple Ltd. ` Lacs Dimple Ltd. ` Lacs
High Growth 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.
(8 Marks) (May 2011)
Answer
Compute Value of Equity
Simple Ltd.
` in Lacs
High Growth Medium Growth Slow Growth
Debit + Equity 820 550 410
Less: Debt 460 460 460
Equity 360 90 -50
Since the Company has limited liability the value of equity cannot be negative therefore the value
of equity under slow growth will be taken as zero because of insolvency risk and the value of debt
is taken at 410 lacs. The expected value of debt and equity can then be calculated as:
Simple Ltd.
` in Lacs
High Growth Medium Growth Slow Growth Expected Value
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
Question 27
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 140 60
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. (8 Marks) (May 2013)
Answer
(i) Pre Merger Market Value of Per Share
P/E Ratio X EPS
Longitude Ltd. ` 8 X 15 = ` 120.00
Latitude Ltd. ` 5 X 10 = ` 50.00
(ii) (1) Maximum exchange ratio without dilution of EPS
Pre Merger PAT of Longitude Ltd. ` 140 Lakhs
Pre Merger PAT of Latitude Ltd. ` 60 Lakhs
Combined PAT ` 200 Lakhs
Longitude Ltd. ’s EPS `8
Maximum number of shares of Longitude after merger (` 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
Note: Since in the question figures given of PAT of both companies are not
matching with figures of EPS X Number of Shares. Hence, if students computed
PAT by using this formula then alternative answer shall be as follows:
(1) Maximum exchange ratio without dilution of EPS

Pre Merger PAT of Longitude Ltd. ` 120 Lakhs

Pre Merger PAT of Latitude Ltd. ` 80 Lakhs
Combined PAT ` 200 Lakhs
Longitude Ltd. ’s EPS `8
Maximum number of shares of Longitude after merger (` 200 25 Lakhs
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
Question 28
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
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. (10 Marks) (June 2009) (M)
Answer
(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
= `15.00
(200  200) Lakhs
(iii) Market Price after acquisition:
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
Question 29
P Ltd. is considering take-over of R Ltd. by the exchange of four new shares in P Ltd. for every
five shares in R Ltd. The relevant financial details of the two companies prior to merger

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
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.
(10 Marks) (November 2010) (M)
Answer
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 (EPS x P/E ` 0.42 x 12 = ` 5.04 0.63 x ` 9 = ` 5.67
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
(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
MarketValue 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%.
Question 30
XY Ltd. which is specialized in manufacturing garments is planning for expansion to handle a
new contract which it expects to obtain. An investment bank have approached the company
and asked whether the Co. had considered venture Capital financing. In 2001, the company

borrowed `100 lacs on which interest is paid at 10% p.a. The Company shares are unquoted
and it has decided to take your advice in regard to the calculation of value of the Company
that could be used in negotiations using the following available information and forecast.
Company’s forecast turnover for the year to 31st March, 2005 is `2,000 lacs which is mainly
dependent on the ability of the Company to obtain the new contract, the chance for which is
60%, turnover for the following year is dependent to some extent on the outcome of the year
to 31st March, 2005. Following are the estimated turnovers and probabilities:
Year - 2005 Year - 2006
Turnover Prob. Turnover Prob.
` (in lacs) `(in lacs)
2,000 0.6 2,500 0.7
3,000 0.3
1,500 0.3 2,000 0.5
1,800 0.5
1,200 0.1 1,500 0.6
1,200 0.4
Operating costs inclusive of depreciation are expected to be 40% and 35% of turnover
respectively for the years 31st March, 2005 and 2006. Tax is to be paid at 30%. It is assumed
that profits after interest and taxes are free cash flows. Growth in earnings is expected to be
405 for the years 2007, 2008 and 2009 which will fall to 105 each year after that. Industry
average cost of equity (net of tax) is 15%. (10 Marks) (November 2007)
Answer
Estimation of earnings for the years ended 31st March, 2005 & 2006
(` In lacs)
Prob. Turnover Expected Prob. Turnover Expected
Turnover Turnover
0.6 2000 1200 0.6 х 0.7 2500 1050
0.6 x 0.3 3000 540
0.3 1500 450 0.3 х 0.5 2000 300
0.3 х 0.5 1800 270
0.1 1200 120 0.1 х 0.6 1500 90
0.1 х 0.4 1200 48
1770 2298
Operating Costs (40%) (708) (35%) (804)

Interest 100 х 1 (10) (10)

Profit after Interest 1052 1484
Tax 316 445
Earnings/Cash flows 736 1039
Estimated Cash flows for 2007, 2008 & 2009:-
2007 - 1039 х 1.4 = 1455/-
2008 - 1455 х 1.4 = 2037/-
2009 - 2037 х 1.4 = 2852/-
Discounted Cash flows for the year 2005-2009
Year Cash flows Disc. Factor at 15% PV
2005 - 736 0.870 640
2006 - 1039 0.756 785
2007 - 1455 0.658 957
2008 - 2037 0.572 1165
2009 - 2852 0.497 1417
4964
Estimates of value of Cash flows from 2010 to infinity
Earnings in 2010 - 2852 х 1.1 = 3137
In today’s money - 3137 х 0.497 = 1559
Po = D1/(Ke – G)
= 1559/0.15- 0.10 = 31180/-
Present value of all future estimated cash flows:-
2005 - 2009 - 4964
2009 onwards - 31180
36144
 Company valuation is 36144/-
Note: Few printing errors have crept in this question viz 40% growth in earnings has
appeared as 405 likewise 10% growth in earnings has been wrongly printed as 105. The
answer provided above pertains to 40% and 10% growth.
Question 31
Yes Ltd. wants to acquire No Ltd. and the cash flows of Yes Ltd. and the merged entity are
given below:

(` 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.
(i) Compute the Value of Yes Ltd. before and after merger.
(ii) Value of Acquisition and
(iii) Gain to shareholders of Yes Ltd. (8 Marks) (November 2012)
Answer
(i) Working Notes:
Present Value of Cash Flows (CF) upto 5 years
Year CF of Yes Ltd. PVF PV of CF CF of Merged PV of CF of
End (` lakhs) @15% (` lakhs) Entity Merged 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
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
Question 32
AB Ltd. has recently approached the shareholders of CD Ltd. which is engaged in the same
line of business as that of AB Ltd. with a bid of 4 new shares in AB Ltd. for every 5 CD Ltd.
shares or a cash alternative of `360 per share. Past records of earnings of CD Ltd. had been
poor and the company’s shares have been out of favour with the stock market for some time.
Pre bid information for the year ended 31.3.2006 are as follows:
AB Ltd in lakhs CD Ltd. in lakhs
Equity share capital 60 170
Number of shares 24 17
Pre-tax profit 125 110
P/E Ratio 11 7
Estimated post tax cost of Equity Capital per Annum 12% 10%
Both AB Ltd. and CD Ltd. pay income tax at 30%. Current earnings growth forecast is 4% for
the foreseeable future of both the Companies.
Assuming no synergy exists, you are required to evaluate whether proposed share to share
offer is likely to be beneficial to the shareholders of both the companies using merger terms
available. AB Ltd.’s directors might expect their own pre bid P/E ratio to be applied to
combined earnings.
Also comment on the value of the two Companies from the constant growth form of dividend
valuation model assuming all earnings are paid out as dividends.(14 Marks) (November 2007)

Answer
Alternative 1 (when number of shares are 2.4 and 1.7 lakhs respectively)
Evaluation:-
Background calculations:-
(Figures in lakhs)
AB Ltd. CD Ltd. Total
PBT 125 110 235
PAT 87.5 77 164.5
Pre bid EPS 36.46 45.29
P/E ratio 11 7
Pre-bid Price Per Share 401.06 317.03
Market value of the company 962.54 538.95 1,501.49
No. of New Shares Post bid 2.4 1.36 3.76
% combined company owned by 63.83% 36.17%
Value to the original Shareholders 958.40 543.09 1,501.49
Post bid Price per share to original shareholders i.e., 399.33 319.46
2.40 lakhs and 1.70 lakhs shareholders respectively.
(Note: The Post bid Price per share to new shareholders as per terms of acquisition works
out to `399.33 for both the companies)
These figures suggest post bid acquisition share price of `399.33 for AB Ltd., and 319.46 for
CD Ltd.’s. Original shareholders. The price of CD Ltd share is likely to be influenced by the
value of cash alternative.
The post bid share price of the new firm can be estimated by applying the P/E ratio to the
combined earnings of the two old companies.
In that case,
Market Value would be = 164.5 х 11 = 1809.50
1,809.50
Price per share of the combined company would be =  ` 481.25
3.76
 Therefore share of AB Ltd., shareholders would raise by `481.25 – `401.06= `80.19 i.e.,
20%.
Share value of CD Ltd., shareholder expected to rise by
 4
 ` 481.25    317.03  ` 67.97 i.e. 21.44%
 5

360  317.03
With the cash offer the premium is  13.55% only
317.03
Hence shareholders of CD Ltd are gaining more from the merger in a share exchange and cash
alternative is unlikely to be accepted.
Using constant growth model the value of both the individual companies would be:
36.46(1.04)
AB Ltd., share price =  ` 473.98
0.12  0.04
45.29 1.04
CD Ltd., share price =  ` 785.03
0.10  0.04
On this basis market slightly undervalues AB Ltd share but share of CD Ltd., are highly
undervalued possibly because of previous disappointments. However, if AB Ltd. forecast is
believed that the AB Ltd., is getting CD Ltd. shares, it will be a cheap proposal for AB Ltd. to
acquire the CD Ltd. on share exchange basis and especially if any of the shareholder of CD
Ltd. Accept the cash offer.
The shareholders of CD Ltd. would also be benefited post merger based on share exchange
ratio since the value of their share would be going up from `317.03 to `399.33. However,
their share price would still be undervalued as compared with the share price calculated by
using constant growth model.
Alternative 2 (when number of shares are 24 and 17 lakhs respectively)
If we take into consideration the number of shares being 24 lakhs and 17 lakhs the Pre-bid
share price works out to `40.15 and `31.71 respectively, which seems to be illogical against a
cash offer @ `360/- per share. However, since many students may have solved this question
based on the figures of 24 lakhs and 17 lakhs number of shares, an alternative solution is
provided below.
Evaluation: Figures in lakhs
Background calculations: AB Ltd. CD Ltd. Total
PBT 125 110 235
PAT 87.5 77 164.5
Pre bid EPS 3.65 4.53
P/E Ratio 11 7
Pre-bid Price per share 40.15 31.71
Market value of the company 963.60 539.07 1502.67
No. of new shares Post-bid 24 13.6 37.6
% of combined company owned by 63.83 36.17

Value to the original shareholders 959.15 543.52 1502.67

Post-bid Price to original shareholders i.e,, 24 39.96 31.97
lakhs and 17 lakhs shareholders respectively
(Note: The Post bid price per share works out to `39.96 for both the companies)
These figures suggest Post acquisition share price of `39.96 for AB Ltd and `31.97 for CD
Ltd’s original shareholders. The Price of CD Ltd. Share is likely to be influenced by the value
of cash alternative.
The Post bid share price of the new firm can be estimated by applying the P/E ratio to the
combined earnings of the two old companies.
In that case,
Market-value would be = 164.5 х 11 = 1809.50
Price per share of the combined company
1809.50
Would be =  48.13
37.6
 Shares of AB Ltd. shareholders would raise by `48.13 – 40.15 = 7.98 i.e., 19.87% or 20%.
 4
Share value of CD Ltd., shareholders expected to raise by `  48.13    31.71
 5
= `7.40 or 23.34%.
360  31.71
However, with the cash offer the premium is  1035.29%
31.71
Hence, the shareholders of CD Ltd., are substantially benefited by cash offer and they are
unlikely to accept the share swap ratio.
Using constant growth model the value of shares of both the individual companies would be
3.65(1.04) 3.80
AB Ltd. Share Price = = = `47.5
0.12- 0.04 0.08
4.53 (1.04) 4.71
CD Ltd. Share Price =  = `78.5
0.10  0.04 0.06
On this basis market slightly undervalues AB Ltd. Share but share of CD Ltd., is highly
undervalued possibly because of previous disappointments. However, if AB Ltd. forecast is
believed that the AB Ltd. is getting CD Ltd. share it will be a cheap proposal for AB Ltd., to
acquire CD Ltd., on share exchange basis.
The shareholders of CD Ltd., would however be more benefited by cash offer.

Question 33
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. (12 Marks) (May 2005)
Answer
Swap Ratio
Efficient Ltd. Healthy Ltd.
Market capitalisation 500 lakhs 750 lakhs
No. of shares 10 lakhs 7.5 lakhs
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
EPS Total profit 50 lakh  150 lakh 200
 
No. of shares 28.75 lakh 28.75
= ` 6.956
(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
Question 34
Abhiman Ltd. is a subsidiary of Janam Ltd. and is acquiring Swabhiman Ltd. which is also a
subsidiary of Janam Ltd.
The following information is given:
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
Janam Ltd., is interested in doing justice to both companies. The following parameters have been
assigned by the Board of Janam Ltd., for determining the swap ratio:

Book value 25%

Earning per share 50%
Market price 25%
You are required to compute
(i) The swap ratio.
(ii) The Book Value, Earning Per Share and Expected Market Price of Swabhiman Ltd.,
(assuming P/E Ratio of Abhiman ratio remains the same and all assets and liabilities of
Swabhiman Ltd. are taken over at book value.) (8 Marks) (May 2011)
Answer
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
Total Pr ofit ` 100 lac  ` 97.50 lac
EPS = = = ` 56.62
No. of shares 3.48825 lac
Expected market price = ` 56.62  PE Ratio= ` 56.62  10 = ` 566.20
Question 35
The following information relating to the acquiring Company Abhiman Ltd. and the target
Company Abhishek Ltd. are available. Both the Companies are promoted by Multinational
Company, Trident Ltd. The promoter’s holding is 50% and 60% respectively in Abhiman Ltd.
and Abhishek Ltd. :
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
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 :
(a) Issue Bonus shares in the ratio of 1 : 2; and
(b) Split the stock (share) as ` 5 each fully paid. (20 Marks) (June 2009) (S)
Answer
(a) Swap Ratio
Abhiman Ltd. Abhishek Ltd.
Share Capital 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) 80 -
(` 8 X 10) - 80
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 : 0.08 0.08 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

(b) Book Value , EPS & Market Price

Total No of Shares 2 Lakh + 1.5 Lakh = 3.5 Lakh
Total Capital ` 200 Lakh + ` 100 Lakh = ` 300 Lakh
Reserves ` 800 Lakh + ` 500 Lakh = ` 1,300 Lakh
Book Value ` 300 Lakh + ` 1,300 Lakh = ` 457.14 per share
3.5 Lakh
Total Profit ` 80 Lakh ` 80 Lakh ` 160 Lakh
EPS = =
No. of Share 3.5 Lakh 3.5
= ` 45.71
Expected Market Price EPS (` 45.71) x P/E Ratio (10) = ` 457.10
(c) (1) 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%
(2) Free Float Market Capitalisation
Free Float Market = (3.5 Lakh – 1.9 Lakh) x ` 457.10
Capitalisation = ` 731.36 Lakh
(3) (i) & (ii)
Revised Capital ` 350 Lakh + ` 175 Lakh = ` 525 Lakh
No. of shares before Split (F.V ` 100) 5.25 Lakh
No. of Shares after Split (F.V. Rs 5 ) 5.25 x 20 = 105 Lakh
EPS 160 Lakh / 105 Lakh = 1.523
Book Value Cap. ` 525 Lakh + ` 1125 Lakh
No. of Shares =105 Lakh
= ` 15.714 per share
Question 36
You have been provided the following Financial data of two companies:
Krishna Rama
Ltd. Ltd.
Earnings after taxes ` 7,00,000 ` 10,00,000

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.
Answer
(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
(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)
Question 37
T Ltd. and E Ltd. are in the same industry. The former is in negotiation for acquisition of the
latter. Important information about the two companies as per their latest financial statements is
given below:
T Ltd. E Ltd.
` 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) (` Lakhs) 400.86 115.71
Market Price/share (` ) 220.00 110.00
T Ltd. plans to offer a price for E Ltd., business as a whole which will be 7 times EBIDAT
reduced by outstanding debt, to be discharged by own shares at market price.
E Ltd. is planning to seek one share in T Ltd. for every 2 shares in E Ltd. based on the market
price. Tax rate for the two companies may be assumed as 30%.
Calculate and show the following under both alternatives - T Ltd.'s offer and E Ltd.'s plan:
(i) Net consideration payable.
(ii) No. of shares to be issued by T Ltd.
(iii) EPS of T Ltd. after acquisition.
(iv) Expected market price per share of T Ltd. after acquisition.
(v) State briefly the advantages to T Ltd. from the acquisition.
Calculations (except EPS) may be rounded off to 2 decimals in lakhs.
(16 Marks) (May 2010) (S)

Answer
As per T Ltd.’s Offer
` in lakhs
(i) Net Consideration Payable
7 times EBIDAT, i.e. 7 x ` 115.71 lakh 809.97
Less: Debt 240.00
569.97
(ii) No. of shares to be issued by T Ltd
` 569.97 lakh/` 220 (rounded off) (Nos.) 2,59,000
(iii) EPS of T Ltd after acquisition
Total EBIDT (` 400.86 lakh + ` 115.71 lakh) 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 (12 lakh + 2.59 lakh) 14.59 lakh
EPS (` 300 lakh/ 14.59 lakh) ` 20.56
(iv) Expected Market Price:
` in lakhs
Pre-acquisition P/E multiple:
EBIDAT 400.86
10
Less: Interest ( 580 X ) 58.00
100
342.86
Less: 30% Tax 102.86
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

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.
Question 38
The following information is relating to Fortune India Ltd. having two division, viz. Pharma
Division and Fast Moving Consumer Goods Division (FMCG Division). Paid up share capital of
Fortune India Ltd. is consisting of 3,000 Lakhs equity shares of Re. 1 each. Fortune India Ltd.
decided to de-merge Pharma Division as Fortune Pharma Ltd. w.e.f. 1.4.2009. Details of
Fortune India Ltd. as on 31.3.2009 and of Fortune Pharma Ltd. as on 1.4.2009 are given
below:
Particulars Fortune Pharma Ltd. Fortune India Ltd.
` `
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
Board of Directors of the Company have decided to issue necessary equity shares of Fortune
Pharma Ltd. of Re. 1 each, without any consideration to the shareholders of Fortune India Ltd.
For that purpose following points are to be considered:
1. Transfer of Liabilities & Assets at Book value.
2. Estimated Profit for the year 2009-10 is ` 11,400 Lakh for Fortune India Ltd. & ` 1,470
lakhs for Fortune Pharma Ltd.
3. Estimated Market Price of Fortune Pharma Ltd. is ` 24.50 per share.
4. Average P/E Ratio of FMCG sector is 42 & Pharma sector is 25, which is to be expected
for both the companies.
Calculate:
1. The Ratio in which shares of Fortune Pharma are to be issued to the shareholders of
Fortune India Ltd.
2. Expected Market price of Fortune India Ltd.
3. Book Value per share of both the Companies immediately after Demerger.
Answer
Share holders’ funds (` Lakhs)
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.

2. Expected market price of Fortune India 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
Question 39
H Ltd. agrees to buy over the business of B Ltd. effective 1st April, 2012.The summarized
Balance Sheets of H Ltd. and B Ltd. as on 31st March 2012 are as follows:
Balance sheet as at 31st March, 2012 (In Crores of Rupees)
Liabilities: H. Ltd B. Ltd.
Paid up Share Capital
-Equity Shares of `100 each 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:
(1) The weighted average post tax maintainable profits of H Ltd. and B Ltd. for the last 4
years are ` 300 crores and ` 10 crores respectively.
(2) Both the companies envisage a capitalization rate of 8%.

(3) H Ltd. has a contingent liability of ` 300 crores as on 31st March, 2012.
(4) H Ltd. to issue shares of `100 each to the shareholders of B Ltd. in terms of the
exchange ratio as arrived on a Fair Value basis. (Please consider weights of 1 and 3 for
the value of shares arrived on Net Asset basis and Earnings capitalization method
respectively for both H Ltd. and B Ltd.)
You are required to arrive at the value of the shares of both H Ltd. and B Ltd. under:
(i) Net Asset Value Method
(ii) Earnings Capitalisation Method
(iii) Exchange ratio of shares of H Ltd. to be issued to the shareholders of B Ltd. on a Fair
value basis (taking into consideration the assumption mentioned in point 4 above.)
Answer
(i) Net asset value
H Ltd. ` 1300 Crores  ` 300 Crores
= ` 285.71
3.50 Crores
B Ltd. ` 31.50 Crores
= ` 48.46
0.65 Crores
(ii) Earning capitalization value
H Ltd. ` 300 Crores / 0.08
= ` 1071.43
3.50 Crores
B Ltd. ` 10 Crores / 0.08
= ` 192.31
0.65 Crores
(iii) Fair value
H Ltd. ` 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

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.

Question 40
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? (8 Marks) (May 2006)
Answer
(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
Thus, the shareholders of both the companies (RIL + SIL) are better off than before
(iii) Post-Merger Earnings:
Increase in Earnings by 20%
New Earnings: `30,00,000 x (1+0.20) `36,00,000
No. of equity shares outstanding: 12,50,000
EPS (` 36,00,000/12,50,000) `2.88
PE Ratio 10
Market Price Per Share:
= `2.88 x 10 = `28.80
 Shareholders will be better-off than before the merger situation.
Question 41
AFC Ltd. wishes to acquire BCD Ltd. The shares issued by the two companies are 10,00,000
and 5,00,000 respectively:
(i) Calculate the increase in the total value of BCD Ltd. resulting from the acquisition on the
basis of the following conditions:
Current expected growth rate of BCD Ltd. 7%
Expected growth rate under control of AFC Ltd., (without any additional 8%

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
Current Dividend per share of BCD Ltd. Re. 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%. (8 Marks) (May 2007)
Answer
(i) For BCD Ltd., before acquisition
The cost of capital of BCD Ltd. may be calculated by using the following formula:
Dividend
 Growth %
Pr ice
Cost of Capital i.e., Ke = (0.60/20) + 0.07 = 0.10
After acquisition g (i.e. growth) becomes 0.08
Therefore, price per share after acquisition = 0.60/(0.10-0.08) = `30
The increase in value therefore is = `(30-20) x 5,00,000 = `50,00,000/-
(ii) To share holders of BCD Ltd. the immediate gain is `100 – `20x4 = `20 per share
The gain can be higher if price of shares of AFC Ltd. rise following merger which they
should undertake.
To AFC Ltd. shareholders (` (In lakhs)
Value of Company now 1,000
Value of BCD Ltd. 150
1,150
No. of shares 11.25
 Value per share 1150/11.25= `102.22
Gain to shareholders of BCD Ltd. = `102.22 – `(4 x 20) = `22.22
Gain to shareholders of AFC Ltd. = `102.22 – `100.00 = `2.22

(iii) Gain to shareholders of AFC Ltd:-

Earnings of BCD Ltd. (5,00,000 x 2.50) `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
Question 42
AB Ltd., is planning to acquire and absorb the running business of XY Ltd. The valuation is to
be based on the recommendation of merchant bankers and the consideration is to be
discharged in the form of equity shares to be issued by AB Ltd. As on 31.3.2006, the paid up
capital of AB Ltd. consists of 80 lakhs shares of `10 each. The highest and the lowest market
quotation during the last 6 months were `570 and `430. For the purpose of the exchange, the
price per share is to be reckoned as the average of the highest and lowest market price during
the last 6 months ended on 31.3.06.
XY Ltd.’s Balance Sheet as at 31.3.2006 is summarised below:
` lakhs
Sources
Share Capital
20 lakhs equity shares of `10 each fully paid 200
10 lakhs equity shares of `10 each, `5 paid 50
Loans 100
Total 350
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
(i) Calculate the total value of the business of XY Ltd.
(ii) The number of shares to be issued by AB Ltd.; and
(iii) The basis of allocation of the shares among the shareholders of XY Ltd.
Answer
Price/share of AB Ltd. for determination of number of shares to be issued:
(`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
Question 43
BA Ltd. and DA Ltd. both the companies operate in the same industry. The Financial
statements of both the companies for the current financial year are as follows:

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:
(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. (12 Marks) (November 2008) (M)
Answer
Market price per share (MPS) = EPS X P/E ratio or P/E ratio = MPS/EPS
(i) Determination of EPS, P/E ratio, ROE and BVPS of BA Ltd. and DA Ltd.
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%
(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) (`) 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 + (.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
Question 44
A valuation done of an established company by a well-known analyst has estimated a value of
` 500 lakhs, based on the expected free cash flow for next year of ` 20 lakhs and an
expected growth rate of 5%.
While going through the valuation procedure, you found that the analyst has made the mistake
of using the book values of debt and equity in his calculation. While you do not know the book
value weights he used, you have been provided with the following information:
(i) Company has a cost of equity of 12%,
(ii) After tax cost of debt is 6%,
(iii) The market value of equity is three times the book value of equity, while the market value
of debt is equal to the book value of debt.
You are required to estimate the correct value of the company. (8 Marks) (November 2010) (S)

Answer
Cost of capital by applying Free Cash Flow to Firm (FCFF) Model is as follows:-
FCFF1
Value of Firm = V0 =
K c  gn
Where –
FCFF1 = Expected FCFF in the year 1
Kc = Cost of capital
gn = Growth rate forever
Thus, ` 500 lakhs = ` 20 lakhs /(Kc-g)
Since g = 5%, then Kc = 9%
Now, let X be the weight of debt and given cost of equity = 12% and cost of debt = 6%,
then 12% (1 – X) + 6% X = 9%
Hence, X = 0.50, so book value weight for debt was 50%
 Correct weight should be 75% of equity and 25% of debt.
 Cost of capital = Kc = 12% (0.75) + 6% (0.25) = 10.50%
and correct firm’s value = ` 20 lakhs/(0.105 – 0.05) = ` 363.64 lakhs.
Question 45
The valuation of Hansel Limited has been done by an investment analyst. Based on an
expected free cash flow of ` 54 lakhs for the following year and an expected growth rate of 9
percent, the analyst has estimated the value of Hansel Limited to be ` 1800 lakhs. However,
he committed a mistake of using the book values of debt and equity.
The book value weights employed by the analyst are not known, but you know that Hansel
Limited has a cost of equity of 20 percent and post tax cost of debt of 10 percent. The value of
equity is thrice its book value, whereas the market value of its debt is nine-tenths of its book
value. What is the correct value of Hansel Ltd? (6 Marks) (November 2014)
Answer
Cost of capital by applying Free Cash Flow to Firm (FCFF) Model is as follows:-
FCFF1
Value of Firm = V0 =
K c  gn
Where –
FCFF1 = Expected FCFF in the year 1
Kc = Cost of capital

gn = Growth rate forever

Thus, `1800 lakhs = `54 lakhs /(Kc-g)
Since g = 9%, then Kc = 12%
Now, let X be the weight of debt and given cost of equity = 20% and cost of debt = 10%, then
20% (1 – X) + 10% X = 12%
Hence, X = 0.80, so book value weight for debt was 80%
 Correct weight should be 60 of equity and 72 of debt.
 Cost of capital = Kc = 20% (60/132) + 10% (72/132) = 14.5455%
and correct firm’s value = ` 54 lakhs/(0.1454 – 0.09) = ` 974.73 lakhs.
Question 46
Following informations are available in respect of XYZ Ltd. which is expected to grow at a higher rate
for 4 years after which growth rate will stabilize at a lower level:
Base year information:
Revenue - ` 2,000 crores
EBIT - ` 300 crores
Capital expenditure - ` 280 crores
Depreciation - `200 crores
Information for high growth and stable growth period are as follows:
High Growth Stable Growth
Growth in Revenue & EBIT 20% 10%
Growth in capital expenditure and 20% Capital expenditure are
depreciation offset by depreciation
Risk free rate 10% 9%
Equity beta 1.15 1
Market risk premium 6% 5%
Pre tax cost of debt 13% 12.86%
Debt equity ratio 1:1 2:3
For all time, working capital is 25% of revenue and corporate tax rate is 30%.
What is the value of the firm? (10 Marks) (May 2010) (M)

Answer
High growth phase :
ke = 0.10 + 1.15 x 0.06 = 0.169 or 16.9%.
kd = 0.13 x (1-0.3) = 0.091 or 9.1%.
Cost of capital = 0.5 x 0.169 + 0.5 x 0.091 = 0.13 or 13%.
Stable growth phase :
ke = 0.09 + 1.0 x 0.05 = 0.14 or 14%.
kd = 0.1286 x (1 - 0.3) = 0.09 or 9%.
Cost of capital = 0.6 x 0.14 + 0.4 x 0.09 = 0.12 or 12%.
Determination of forecasted Free Cash Flow of the Firm (FCFF)
(` in crores)
Yr. 1 Yr. 2 Yr 3 Yr. 4 Terminal Year
Revenue 2,400 2,880 3,456 4,147.20 4,561.92
EBIT 360 432 518.40 622.08 684.29
EAT 252 302.40 362.88 435.46 479.00
Capital Expenditure 96 115.20 138.24 165.89 -
Less Depreciation
∆ Working Capital 100.00 120.00 144.00 172.80 103.68
Free Cash Flow (FCF) 56.00 67.20 80.64 96.77 375.32
Alternatively it can also be computed as follows:
(` in crores)
Yr. 1 Yr. 2 Yr 3 Yr. 4 Terminal Year
Revenue 2,400 2,880 3,456 4,147.20 4,561.92
EBIT 360 432 518.40 622.08 684.29
EAT 252 302.40 362.88 435.46 479.00
Add: Depreciation 240 288 345.60 414.72 456.19
492 590.40 708.48 850.18 935.19
Less: Capital Exp. 336 403.20 483.84 580.61 456.19
 WC 100.00 120.00 144.00 172.80 103.68
56.00 67.20 80.64 96.77 375.32
Present Value (PV) of FCFF during the explicit forecast period is:

FCFF PVF @ 13% PV

(` in crores) (` in crores)
56.00 0.885 49.56
67.20 0.783 52.62
80.64 0.693 55.88
96.77 0.613 59.32
` 217.38
Terminal Value of Cash Flow
375.32
= ` 18,766 Crores
0.12 - 0.10
PV of the terminal, value is:
1
` 18,766 Crores x = ` 18,766 Crores x 0.613 = ` 11,503.56 Crores
(1.13) 4
The value of the firm is :
` 217.38 Crores + ` 11,503.56 Crores = ` 11,720.94 Crores
Question 47
ABC, a large business house is planning to sell its wholly owned subsidiary KLM. Another
large business entity XYZ has expressed its interest in making a bid for KLM. XYZ expects
that after acquisition the annual earning of KLM will increase by 10%.
Following information, ignoring any potential synergistic benefits arising out of possible
acquisitions, are available:
(i) Profit after tax for KLM for the financial year which has just ended is estimated to be ` 10
crore.
(ii) KLM's after tax profit has an increasing trend of 7% each year and the same is expected
to continue.
(iii) Estimated post tax market return is 10% and risk free rate is 4%. These rates are
expected to continue.
(iv) Corporate tax rate is 30%.
XYZ ABC Proxy entity for KLM in
the same line of business
No. of shares 100 lakhs 80 lakhs --
Current share price ` 287 ` 375 --
Dividend pay out 40% 50% 50%
Debt : Equity at market values 1:2 1:3 1:4

P/E ratio 10 13 12
Equity beta 1 1. 1 1.1
Assume gearing level of KLM to be the same as for ABC and a debt beta of zero.
You are required to calculate:
(a) Appropriate cost of equity for KLM based on the data available for the proxy entity.
(b) A range of values for KLM both before and after any potential synergistic benefits to XYZ
of the acquisition. (8 Marks) (May 2010) (M)
Answer
a.  ungreared for the proxy company = 1.1 X 4 / [ 4 + (1 – 0.3) ] = 0.9362
0.9362 =  equity greared X 3/ [ 3 + (1 - 0.3)]
 equity geared = 1.1546
Cost of equity = 0.04 + 1.1546 X (0.1 – 0.04) = 10.93%
b. P/E valuation
(Based on earning of ` 10 Crore)
Using proxy Using XYZ’s
Entity’s P/E P/E
Pre synergistic value 12 X ` 10 Crore 10 X ` 10 Crore
= ` 120 Crore = ` 100 Crore
Post synergistic value 12 X ` 10 Crore X 1.1 10 X ` 10 Crore X 1.1
= ` 132 Crore = ` 110 Crore
Dividend valuation model
Based on 50% payout Based on 40% payout
Pre synergistic value 0.5 X 10 X 1.07 0.4X10X1.07
0.1093 - 0.07 0.1093 - 0.07
= ` 136.13 Crore =` 108.91 Crore
Post synergistic value 0.5 X 10 X 1.1 X 1.07 0.4 X 10 X 1.1 X 1.07
0.1093 - 0.07 0.1093 - 0.07
= ` 149.75 Crore = ` 119.79 Crore
Market Price
Although no information is available about the value of KLM, it may be possible to
calculate a market value based on proportion of earnings of ABC that is generated by
KLM.

Market value of ABC = 80 Lakh Shares X ` 375 = ` 300 Crore

Post Tax earnings of ABC = ` 300/13 = ` 23.08 Crore
If market value of ABC is allocated to KLM in the proportion of relative earning of KLM to
that of ABC, KLM would have a market value of ` 300 crore X [ 10/23.08] = ` 130 Crore.
KLM’s Post Tax earning = ` 10 Crore.
If ABC’s P/E ratio is applied to it, the market value of KLM becomes ` 10 Crore X 13 = `
130 Crore.
Therefore, it assumes that KLM has the same P/E ratio as that of ABC.
Range of valuation
Pre synergistic ` 100 Crore ` 136.13 Crore
Post synergistic ` 110 Crore ` 149.75 Crore
Question 48
Using the chop-shop approach (or Break-up value approach), assign a value for Cranberry
Ltd. whose stock is currently trading at a total market price of €4 million. For Cranberry Ltd,
the accounting data set forth three business segments: consumer wholesale, retail and
general centers. Data for the firm’s three segments are as follows:
Business Segment Segment Segment Segment Operating
Sales Assets Income
Wholesale €225,000 €600,000 €75,000
Retail €720,000 €500,000 €150,000
General € 2,500,000 €4,000,000 €700,000
Industry data for “pure-play” firms have been compiled and are summarized as follows:
Business Capitalization/Sales Capitalization/Assets Capitalization/Operating
Segment Income
Wholesale 0.85 0.7 9
Retail 1.2 0.7 8
General 0.8 0.7 4
Answer
Business Segment Capital-to-Sales Segment Sales Theoretical Values
Wholesale 0.85 €225000 €191250

Retail 1.2 €720000 €864000

General 0.8 €2500000 €2000000
Total value €3055250
Business Segment Capital-to-Assets Segment Assets Theoretical Values

Wholesale 0.7 €600000 €420000
Retail 0.7 €500000 €350000
General 0.7 €4000000 €2800000
Business Segment Capital-to- Operating Income Theoretical Values

Operating Income
Wholesale 9 €75000 €675000
Retail 8 €150000 €1200000
General 4 €700000 €2800000
3055250  3570000  4675000

Average theoretical value   3766750
3
Average theoretical value of Cranberry Ltd. = €3766750
Question 49
The following is the Balance-sheet of Grape Fruit Company Ltd as at March 31st ,2011.
Liabilities (` in lakhs) Assets (` in lakhs)
Equity shares of ` 100 each 600 Land and Building 200
14% preference shares of ` 100/- 200 Plant and Machinery 300
each
13% Debentures 200 Furniture and Fixtures 50
Debenture interest accrued and 26 Inventory 150
payable
Loan from bank 74 Sundry debtors 70
Trade creditors 340 Cash at bank 130
Preliminary expenses 10
Cost of issue of 5
debentures

Profit and Loss 525

account
1440 1440
The Company did not perform well and has suffered sizable losses during the last few years.
However, it is felt that the company could be nursed back to health by proper financial
restructuring. Consequently the following scheme of reconstruction has been drawn up :
(i) Equity shares are to be reduced to ` 25/- per share, fully paid up;
(ii) Preference shares are to be reduced (with coupon rate of 10%) to equal number of
shares of ` 50 each, fully paid up.
(iii) Debenture holders have agreed to forgo the accrued interest due to them. In the future,
the rate of interest on debentures is to be reduced to 9 percent.
(iv) Trade creditors will forego 25 percent of the amount due to them.
(v) The company issues 6 lakh of equity shares at ` 25 each and the entire sum was to be
paid on application. The entire amount was fully subscribed by promoters.
(vi) Land and Building was to be revalued at ` 450 lakhs, Plant and Machinery was to be
written down by ` 120 lakhs and a provision of `15 lakhs had to be made for bad and
doubtful debts.
Required:
(i) Show the impact of financial restructuring on the company’s activities.
(ii) Prepare the fresh balance sheet after the reconstructions is completed on the basis of
the above proposals. (6+4 Marks) (November 2011)
Answer
Impact of Financial Restructuring
(i) Benefits to Grape Fruit Ltd.
(a) Reduction of liabilities payable
` in lakhs
Reduction in equity share capital (6 lakh shares x `75 per share) 450
Reduction in preference share capital (2 lakh shares x `50 per 100
share)
Waiver of outstanding debenture Interest 26
Waiver from trade creditors (`340 lakhs x 0.25) 85
661

(b) Revaluation of Assets

Appreciation of Land and Building (`450 lakhs - `200 lakhs) 250
Total (A) 911
(ii) Amount of `911 lakhs utilized to write off losses, fictious assets and over- valued assets.
Writing off profit and loss account 525
Cost of issue of debentures 5
Preliminary expenses 10
Provision for bad and doubtful debts 15
Revaluation of Plant and Machinery 120
(`300 lakhs – `104 lakhs)
Total (B) 675
Capital Reserve (A) – (B) 236
(ii) Balance sheet of Grape Fruit Ltd as at 31st March 2011 (after re-construction)
(` in lakhs)
Liabilities Amoun Assets Amoun
t t
12 lakhs equity shares of `25/- 300 Land & Building 450
each
10% Preference shares of `50/- 100 Plant & Machinery 180
each
Capital Reserve 236 Furnitures & Fixtures 50
9% debentures 200 Inventory 150
Loan from Bank 74 Sundry debtors 70
Trade Creditors 255 -15 55
Cash-at-Bank 280
(Balancing figure)*
1165 1165
*Opening Balance of `130/- lakhs + Sale proceeds from issue of new equity shares
`150/- lakhs.
Question 50
M/s Tiger Ltd. wants to acquire M/s. Leopard Ltd. The balance sheet of Leopard Ltd. as on
31st March, 2012 is as follows:

Liabilities ` Assets `
Equity Capital (70,000 shares) 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. Debentureholders will get 13% convertible
debentures in the purchasing company for the same amount. Debtors and inventories are
expected to realize ` 2,00,000.
(ii) Tiger Ltd. has decided to operate the business of Leopard Ltd. as a separate division.
The division is likely to give cash flows (after tax) to the extent of
` 5,00,000 per year for 6 years. Tiger Ltd. has planned that, after 6 years, this division
would be demerged and disposed of for ` 2,00,000.
(iii) The 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 .862 .743 .641 .552 .476 .410
Answer
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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13

Merger, Acquisition & Restructuring

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

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The EPS of the new firm is = (` 3,52,941+`1,50,000)/6,25,000

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(ii) Determination of Market Price of Equity Share

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For the year ended

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PV of the terminal, value is:

The value of the firm is :

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Residual Value - 2419.20/0.15 = 16,128

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Projected Balance Sheet

Projected Cash Flows

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EPS after the merger 5.00 x 3/5 3.00

(ii) Merger effect on EPS with share exchange ratio of 1 : 2

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Total number of shares to be issued = 4/5  3,00,000 = 2,40,000 Shares.

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ABC Ltd. XYZ Ltd.

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Earnings after tax (`) 50,00,000 18,00,000

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Present Earnings Per share for company N. Ltd.

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Total no. of shares in M Co. Ltd. after acquisition of N Co. Ltd.

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Appropriation of gains from the merger among shareholders:

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Equity 0.20 360 0.60 90 0.20 0 126

You are required to determine:

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Pre Merger PAT of Longitude Ltd. ` 120 Lakhs

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(iv) Determine the market value of the merged Co.

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announcement are as follows:

(i) Market Value of company

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Interest 100 х 1 (10) (10)

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Value of Yes Ltd.

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Value to the original shareholders 959.15 543.52 1502.67

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(i) Calculation of Swap Ratio

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Book value 1 : 0.8 i.e. 0.8  25% 0.2

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Book value 25%

Calculation of SWAP Ratio

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