Mergers & Acquisition

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WACC

1. Following are the sources of finance of LLH Ltd.

Sources Values
(Rs.
Crs.)

Equity 100

R&S 600

14% Preference shares 100

11% Debentures 200

13% LT Loan 200

TOTAL 1200

• Face Value = Rs. 10/share and currently quoted at Rs.160/share

• The beta of the company is 1.21
• Preference shares are quoted at 5% premium
• Debentures are quoted at 15% discount
• Corporate Tax Rate @ 35%
• Risk free rate is 7.6% and Equity Risk Premium is 7.8%

A. Calculate Weights based on (1) Book Values and (2) Market Values
B. Calculate WACC based on MV weights
Time Value of Money

Following are the net cashflows of a project:

Year 1 – Rs. 100

Year 2 – Rs. 105
Year 3 – Rs. 112

The intermediate cashflows can be reinvested at 10%p.a

2..

Capital Budgeting – for understanding how to calculate cash

flow

Prakash Steel Ltd is planning to produce steel tubes at its existing steel complex.
Following is the plan:

 Installed capacity of the plant will be 20,000 TPA. Sales in the first
year of operations will be at 60% of capacity, increasing to 80%
and 100% in the second and the third and subsequent years.
 Total project cost is estimated at Rs. 3 crores. The equipment cost
will be Rs. 2.4 crores; half of it will be paid in the first year and the
other half on delivery by the middle of second year. Plant erection
will cost Rs. 0.2 crores and will take 6 months. Building and other
costs will be Rs. 0.3 crores. Interest during construction period will
be Rs. 0.1 crores.
 The selling price will be Rs. 10,000/tonne.
 H.R. Coils at 1.1 tonne/tonne of output are the raw materials, and
their cost is Rs. 5,600/tonne.
 Utilities and consumables are Rs. 700/tonne of output.
 Employee expenses would be Rs. 1.0 crores in the first year, Rs.
1.25 Cr in the second year and Rs 1.50 Cr in the third and
subsequent years.
 Selling & distribution expenses will be 5% of sales. Administrative
and other overheads will be Rs. 1 crores pr year
 Allocated rent for the project will be Rs 1 crore/year
 Depreciation is to be charged at 10% of capital cost on straight-line
basis.
 Working capital will consist of one month of raw material stock, half
a month of finished goods stock and one month of receivables.
 Creditors will be half a month of raw material stocks. The working
capital will be entirely financed through commercial banks at 11%.
 The company proposes to finance the capital cost of the project
with debt equity ratio of 1.5:1, same as the current capital structure.
Debt will be raised from financial institutions at 14%. It will be
repaid in six equal installments, with two-year moratorium.
 The corporate tax will be 35%
 The cost of capital of existing business, which has the same risk
class as the proposed project, is 12%.

Evaluate the project and interpret the significance of its NPV

3.

Geo Corporation, a privately held company, has developed a special weight –

loss programme called the Goan Diet. It has 1.5 million shares outstanding and
debt of Rs. 36 million. Comparable companies have a WACC of 9%. Balance
sheet and P & L account for the latest year (year 0) is given below:

Balance Sheet (Rs. Million)

Net Worth 41.1 GFA 95
Debt 36 Less: Depreciation 29 66
Net Current Assets 11.1
Total 77.1 Total 77.1

Profit & Loss Statement (Rs million)

1. Sales 83.6
2. Less: Cost of goods sold 63.1
3. EBITDA (1-2) 20.5
4. Depreciation 3.3
5. EBIT (3-4) 17.2
6. Tax @ 35% 6.0
7. Profit After Tax 11.2

Following assumptions can be made for the projection of financials:

1. Sales will grow at 7% per year for the next 3 years, and then slow at 4%
for years 4 to 6, and to 3% starting in year 7.
2. COGS will be 74% of sales in the first year. It will increase by 0.25% point
for each of the next 6 years. It will settle at 75.5% starting in year 7.
3. Data for Year 0 & projections for FA & NWC for next 7 year are given:
 0 1 2 3 4 5 6 7

Gross fixed assets 95.0 109.6 125.1 141.8 156.8 172.4 188.6 204.5
Less accumulated
depreciation 29.0 38.9 49.5 60.8 72.6 84.9 97.6 110.7
Net fixed assets 66.0 70.7 75.6 80.9 84.2 87.5 91.0 93.8
Net working capital 11.1 11.6 12.4 13.3 13.9 14.4 15.0 15.4

Based on the assumptions mentioned above, calculate the price per share.

4.

Compute the value of Target Ltd., with the help of comparable firms, using
following information of Target Ltd.:

(Rs. Crores)
Sales 100
Book Value 60
Profit After Tax 15

Details of comparable firms are as follows: (Rs. Crores)

XXX Ltd YYY Ltd ZZZ Ltd

Sales 80 120 150
Profit After Tax 12 18 25
Book value 40 90 100
Market Value 120 150 240

The valuer feels 50% weightage should be given to earnings in the valuation
process, and sales and book value may be given equal weightage.

5.Problems on Exchange ratio

1
Given Following details: -
 Company “A” Company “T”
EPS 4.53 3.49
No of Shares 1000 300

1. Determine Exchange Ratio based on Current EPS

2. EPS of Company “A” will grow by 6% pa while EPS of
“T” will grow at 4% pa. Determine Exchange Ratio based on next year
earnings.
3. Determine the Exchange Rate assuming that the above growth rate will
continue for five years.
4. Merger of both companies is likely to result in synergy of Rs 2000/=.
Determine the Boundaries of Negotiations.

Company ‘A’ Company ‘T’

Total Earnings 20,000 5,000
No of shares 5,000 2,000
Market Price 64 30
EPS 4.00 2.50

Case 1. Company “A” is prepared to Value Company “T” share at Rs 35.

Determine Exchange Rate using Market prices.
Case 2. Company “T” insists and gets Rs 45 per share. Determine the
Exchange Ratio.

6.Stock Market Reaction

(A) Company “A” has market value of Rs 20 lacs and company “T” has market
value of Rs 2 lacs. Merging both companies will have a cost saving with
PV = 1,20,000. Suppose, Co. “T” is bought by Co. “A” for cash for Rs
2,50,000, Find

(a) NPV of Project

 (b) What could be the reaction of stock market when merger is
announced.

(B)
Post-merger Co. A

Item Company ‘A’ Company ‘T’ St. Market St. Market

fooled Rational
EPS 2 2
Market Price 40 20
PE Ratio 20 10
No of shares 1,00,000 1,00,000
Total Earnings 2,00,000 2,00,000
Market Value 40,00,000 20,00,000

Company “A” acquires company “T” based on current Market Price exchange
ratios. How should stock market look at this acquisition?

7.Risk in Project/Company Valuation

ACC Ltd – one of the largest cement manufacturers in India - is
evaluating various projects to manufacture cement.

Its cost of equity is 20%, and pre tax cost of debt is 16%. Current
capital structure, which reflects targeted capital structure, is equal
share of debt and equity. Tax rate is 35%. Therefore, the WACC is
15.2%

Following are the projects under evaluation:

1. A debottlenecking project to increase capacity from 1 million

TPA to 1.2 million TPA. Project cost = Rs 200 crores. It will be
entirely financed thru internal generations.
2. A brown field 1 million TPA plant at an existing site. Project
cost= Rs 1300 crores. This will be financed thru 60% internal
generations and 40% debt
3. A green field 1 million TPA plant with a project cost of Rs 1600
crores. This will be financed thru 65% debt and 35% thru
internal generations.
What should be the discount rate for each of the above mentioned
three projects?

8.Merger Accounting

ITEM Company “A” Company “T” Company “T”

(Book Value) (Fair Mkt Value)
Current Assets 2,50,000 87,000 94,000
Fixed Assets 7,25,000 1,39,000 1,98,000
Total Assets 9,75,000 2,26,000 2,92,000
Other Liabilities 2,90,000 79,000 74,000
Share Capital (Face 4,00,000 96,000
Value Rs 10)
Reserves and Surplus 2,85,000 51,000
Total Liabilities 9,75,000 2,26,000

Current Market Price of Company “A” is Rs 35. Exchange Ratio is 1:1. Prepare
post-merger Balance Sheet of Company “A” under (a) Pooling of Interest Method
and (b) Purchase Method.

9.

GCL Industries is an industrial conglomerate undergoing restructuring. GCL is

considering the sale of its low-growth Fleet Jute Packing unit. Long – term growth
of sales value is projected at 3%. Operating and other pertinent data are
presented below for year 0 (Actual) and projections for next 5 years.

Estimate the price GCL may get for Fleet.

Fleet Jute Packing Co.- Actual & Projections (Rs. in Millions)

Actual Projection
s
Year 0 1 2 3 4 5
Sales 2223.2 2245.6 2284.2 2308 2550 2616.7
EBIDTA 2.55% 2.57% 2.65% 2.71% 2.71% 2.71%
margin
Deprn 29 32.6 34.2 32.9 32 31.5
Increase in 0.5 1.6 2.2 2.9 2.5 2.5
def.taxes
Capex+NWC 38.7 41.8 42.2 33.4 32.5 32.5
increase

Miscellaneous data:

1. Corporate tax rate: 35%

2. GCL estimates that the buyer can finance the acquisition with 50% debt
that can be raised at 9%
3. The beta of companies in Fleet’s industry with similar capital structure is
0.92. The yield on 10-year government bond is 7.1% and equity risk
premium is 7.3%
4. An examination of comparable companies yielded an average current
EBIDTA multiple of 5.

10.

the value of Target Ltd., with the help of comparable firms, using following
information of Target Ltd.:

Sales (Rs. Crores) 200

Reserves & Surplus (Rs. Crores) 90
EPS (Rs/Share) 10
Number of share (Crores) 3

Details of comparable firms are as follows:

Alpha Ltd Beta Ltd Gama Ltd

Sales (Rs. Crores) 160 240 300
Reserves & Surplus (Rs. Crores) 56 160 170
EPS (Rs/Share) 10 18 16.66
Market Price (Rs/Share) 100 150 160
Number of share (Crores) 2.4 2 3

The valuer feels 50% weightage should be given to earnings in the valuation
process, and sales and book value may be given equal weightage. Shares of
both the companies have face value of Rs. 10

11.

The current financials (Year 0) of Exotica Corp is given below:

(Rs million)

 Revenues 4000
 EBIT (12.5% of revenues) 500
 Capital Expenditure 300
 Depreciation 200
  Net Working Capital as a % of revenues 30 percent
 Corporate tax rate (for all time) 40 percent
 Paid up equity capital (FV=Rs 10) 300
 Market value of debt 1250

The Company is expected to grow at a higher rate for 5 years; thereafter the
growth rate is likely to stabilize at a lower rate.

Inputs for first 5 years are given below:

 Growth rate in Rev, Dep, EBIT and Capex 10%

 Net Working capital as % of revenues 30%
 Pretax cost of debt 15%
 Debt Equity ratio 1:1
 Risk free rate 13%
 Market risk premium 6%
 Equity beta 1.333

Inputs for the stable growth period are given below:

 Growth rate in revenues and EBIT 6%
 Capex is offset by depreciation
 Net working capital as a % of revenues 30%
 Pretax cost of debt 15%
 Debt equity ratio 2:3
 Risk free rate 12%
 Market risk premium 7%
 Equity beta 1

Calculate the value of firm and value per share.

12.

You are considering the acquisition of XYZ Enterprises. XYZ’s Balance Sheet as
at today (year 0) is as follows:
(Rs Crores)
Assets Liabilities
Current assets 50 Current Liabilities 20
Plant 50 Debt 30
Net worth 50
Total 100 Total 100

Following are the projections for the next 5 years

Year1 Year 2 Year 3 Year 4 Year 5

Sales 200 217 239 270 293
EBIT 20 22 25 26 30
NWC 33 37 41 44 48
Depreciation 5 5 6 7 8
Capex 10 10 15 6 20

Tax rate t = 34% and WACC = 13%. Sales Growth after 5 years will be 5%

Calculate the value of XYZ Enterprises. Provide two alternative valuations based
on two alternative scenarios with reference to the continuity value. In one of the
alternatives you may consider the concept of steady – state cash flow.

13.

Following are the details of firms that are comparable to Target Company Ltd.:

Alpha Ltd Beta Ltd Gama Ltd

Sales (Rs. Crores) 160 240 300
Reserves & Surplus (Rs. Crores) 56 160 170
Net Debt (Rs. Crores) 35 80 85
EPS (Rs/Share) 10 18 16.66
Market Price (Rs/Share) 100 150 160
Number of share (Crores) 2.4 2 3

Following are the details of Target Company Ltd.:

Sales (Rs. Crores) 200

Reserves & Surplus (Rs. Crores) 90
Net Debt (Rs. Crores) 45
EPS (Rs/Share) 10
Number of share (Crores) 3

The valuer feels 50% weightage should be given to an EV-based multiple in the
valuation process, and MV-based multiples in relation to book value and earnings
may be given equal weightage. Shares of all the companies have face value of
Rs. 10.

Compute the market value/share of Target Company Ltd.