1. Vijay Company plans to acquire Ajay Company.

The following are the relevant

financials of the two companies.

Vijay Company Ajay Company

Total earnings, E Rs.200 million Rs.100 million
Number of outstanding shares 20 million 10 million
Market price per share Rs.200 Rs.120
 (i) What is the maximum exchange ratio acceptable to the shareholders of
Vijay Company if the PE ratio of the combined company is 18 and there is
no synergy gain?

Solution:

- S1 PE12 (E12)
ER1 = +
S2 P1 S2

20 18 (300)
= - + = 0.7
10 200 x 10

(ii) What is the minimum exchange ratio acceptable to the shareholders of Ajay
Company if the PE ratio of the combined company is 18 and there is a
synergy gain of 6 percent?
Solution:

P2S1
ER2 = (PE12) (E1 + E2) (1+S) – P2S2

120 x 20
= = 0.53
(18) (200 + 100) (1.06) -120 x 10

(iii) If there is no synergy gain, at what level of PE multiple will the lines ER 1
and ER2 intersect?

Solution:

The lines ER1 and ER2 will intersect at a point corresponding to the weighted average of
the two PE multiples wherein the weights correspond to the respective earnings of the
two firms.

200 100
PE12=x 20+x 12
300300

= 13.333 + 4 = 17.33
 (iv) If the expected synergy gain is 8 percent, what exchange ratio will result in a
post-merger earnings per share of Rs.11?

Solution:

(E1 + E2) (1 + S) (200 + 100) (1.08)

N1 + N2 x ER = = 11
20 + 10 x ER

ER = 0.945

(v) Assume that the merger is expected to generate gains which have a present
value of Rs. 400 million and the exchange ratio agreed to is 0.6. What is
the true cost of the merger from the point of view of Vijay Company?

Solution:

Cost =  PV (Vijay and Ajay) – PV ( Ajay)

0.60 x 10
 = = 0.231
20 + 0.6 x 10

PV (Vijay & Ajay) = 4000 + 1200 + 400 = 5600 million

Cost = 0.231 x 5600 - 1200 = Rs.93.6 million

2. Jeet Company plans to acquire Ajeet Company. The following are the relevant
financials of the two companies.

Jeet Company Ajeet Company

Total earnings, E Rs.1600 million Rs.600 million
Number of outstanding shares 40 million 30 million
Market price per share Rs .900 Rs.360

(i) What is the maximum exchange ratio acceptable to the shareholders of Jeet
Company if the PE ratio of the combined company is 21 and there is no
synergy gain?

Solution:
 - S1+PE12(E12)
ER1 =-----------------------
- S2P1S2

- 40+21 x 2200
= -----------------------
30900 X 30

= 0.378

(ii) What is the minimum exchange ratio acceptable to the shareholders of Ajeet
Company if the PE ratio of the combined company is 20 and there is a
synergy benefit of 8 percent?

Solution:

P2S1
ER2 =--------------------------------------------
(PE12) (E1 + E2) ( 1 + S) – P2S2
360 x 40
=-------------------------------------------- 20 x
(2200) (1.08) - 360 x 30

= 0.392

(iii) If there is no synergy gain, at what level of PE multiple will the lines ER 1
and ER2 intersect?

Solution:

The lines ER1 and ER2 will intersect at a point corresponding to the weighted average of
the two PE multiples wherein the weights correspond to the respective earnings of the two
firms.

1600600
PE12= ---------- x 22.5+---------- X 18
22002200

= 16.36 + 4.91
= 21.27
 (iv) If the expected synergy gain is 10 percent, what exchange ratio will result in
a post-merger earnings per share of Rs.30 ?

Solution:

(E1 + E2 ) ( 1 + ( 1600 + 600 ) ( 1.10 )

S) = --------------------------- =
--------------------- 30
--
N12420
+ N2 x ER 40 + 30 x ER
------------------- = 30
40 + 30ER

ER = 1.355

(v) Assume that the merger is expected to generate gains which have a present
value of Rs. 5000 million and the exchange ratio agreed to is 0.45. What is
the true cost of the merger from the point of view of Jeet Company?

Solution:

Cost=  PV (J&eet
) &- A jeet) - PV
()Ajeet)
0.45 x 30
    
   x
30
PV ( Jeet & Ajeet ) = 36000 + 10800 + 5000 = 51800

PV ( Ajeet ) = 10800

Cost = 0.252 ( 51800 ) – 10800 = 2253.6

3. Shaan Company plans to acquire Aan Company. The following are the relevant
financials of the two companies.
Shaan Company Aan Company
Total earnings, E Rs.750 million Rs.240 million
Number of outstanding shares 50 million 20 million
Market price per share Rs.250 Rs.150
(i) What is the maximum exchange ratio acceptable to the shareholders of
Shaan Company if the PE ratio of the combined company is 15 and there is
no synergy gain?
Solution:

- S1 PE12 ( E 12)
ER1= +
S2 P1 S2

50 15 x 990
= -+= 0.47
20250 x 20

(ii) What is the minimum exchange ratio acceptable to the shareholders of Aan
Company if the PE ratio of the combined entity is 15 and there is a synergy
benefit of 6 percent?

Solution:

P2S1
ER2 =
(PE12) (E1 + E2) (1+S) – P2S2
150 x 50
== 0.589
15 x 990 x 1.06 – 150 x 20

(iii) If there is no synergy gain, at what level of PE multiple will the lines ER 1
and ER2 intersect?

Solution:

The lines ER1 and ER2 will intersect at a point corresponding to the weighted average of
the two PE multiples wherein the weights correspond to the respective earnings of the
two firms.

750 240
PE12=x 16.67+x 12.5
990990

= 15.66
 (iv) If the expected synergy gain is 6 percent, what exchange ratio will result in a
post-merger earnings per share of Rs.16?

Solution:

(E1 + E2) (1 + S) ( 750 + 240) (1.06)

== 16
N1 + N2 x ER50 + 20 x ER

ER = 0.779

(v) Assume that the merger is expected to generate gains which have a present
value of Rs. 600 million and the exchange ratio agreed to is 0.60. What is
the true cost of the merger from the point of view of Shaan Company?

Solution:

Cost = α PV (Shaan & Aan) – PV ( Aan)

0.60 x 20 12
α = = = 0.194
50 + 20 x 0.60 62

PV (Shaan & Aan) = 12500 + 3000 + 600 = 16100

PV (Aan) = 3000

Cost = 0.194 x 16100 – 3000 = Rs.123.4 million.

4. Arun Company has a value of Rs.40 million and Varun Company has a value of
Rs.20 million. If the two companies merge, cost savings with a present value of
Rs.5 million would occur. Arun proposes to offer Rs.22 million cash
compensation to acquire Varun. What is the net present value of the merger to the
two firms?

Solution:

PVA = Rs.40 million, PVV = Rs.20 million

Benefit = Rs.5 million, Cash compensation = Rs.22 million Cost =
Cash compensation – PVV = Rs.2 million
NPV to Arun = Benefit – Cost = Rs.3 million
NPV to Varun = Cash Compensation – PVV = Rs.2 million
5. Kamal Company has a value of Rs.80 million and Jamal Company has a value of
Rs.30 million. If the two companies merge, cost savings with a present value of
Rs.10 million would occur. Kamal proposes to offer Rs.35 million cash
compensation to acquire Jamal. What is the net present value of the merger to the
two firms?

Solution:

PVK = Rs.80 million, PVJ = Rs.30 million

Benefit = Rs.10 million, Cash compensation = Rs 35 million Cost =
Cash compensation – PVJ = Rs.5 million
NPV to Alpha = Benefit – Cost = Rs.5 million
NPV to Beta = Cash Compensation – PVJ = Rs.5 million

6. America Limited plans to acquire Japan Limited. The relevant financial details of the
two firms, prior to merger announcement, are given below:

America Japan
Market price per share Limited Limited
Rs. 100 Rs.40
Number of shares 800,000 300,000

The merger is expected to bring gains which have a present value of Rs.12
million. America Limited offers two share in exchange for every three shares of
Japan Limited.
Required : (a) What is the true cost of America Limited for acquiring Japan
Limited ?
(b) What is the net present value of the merger to America Limited ?
(c) What is the net present value of the merger to Japan Limited ?

Solution:

Let A stand for America Limited and J for Japan Limited and AJ for the combined
entity.

PVA = Rs.100 x 800,000 = Rs.80 million

PVJ = Rs.40 x 300,000 = Rs.12 million
Benefit = Rs.12 million
PVAJ = 80 + 12 + 12 = Rs.104 million
Exchange ratio = 2:3
The share of Japan Limited in the combined entity will be :
200,000
α = = 0.2
800,000 + 200,000
 (b) True cost to America Limited for acquiring
Japan Limited Cost =  PVAJ - PVJ
= 0.2 x 104 - 12 = Rs.8.8 million

(c) NPV to America Limited

= Benefit - Cost
= 12 - 8.8 = Rs.3.2 million

(d) NPV to Japan Limited

= Cost = Rs.8.8 million

7. Amir Limited plans to acquire Jamir Limited. The relevant financial details of the
two firms, prior to merger announcement, are given below:

Amir Jamir
Market price per share Limited Limited
Rs. 500 Rs.100
Number of shares 600,000 200,000

The merger is expected to bring gains which have a present value of Rs.20
million. Amir Limited offers one share in exchange for every four shares of Jamir
Limited.
Required: (a) What is the true cost of Amir Limited for acquiring Jamir Limited?
(b) What is the net present value of the merger to Amir Limited ?
(c) What is the net present value of the merger to Jamir Limited ?

Solution:

Let A stand for Amir Limited and J for Jamir Limited and AJ for the combined
entity.

PVA = Rs.500 x 600,000 = Rs.300 million

PVJ = Rs.100 x 200,000 = Rs.20 million
Benefit = Rs.20 million
PVAJ = 300 + 20 + 20 = Rs.340 million
Exchange ratio = 1:4

The share of Jamir Limited in the combined entity will be:

50,000
α = = 0.0769
600,000 + 50,000

a) True cost to Amir Limited for acquiring Jamir Limited

Cost = α PVAJ - PVJ
= 0.0769 x 340 - 20 = Rs.6.146 million
 b)NPV to Amir Limited

= Benefit - Cost
= 20- 6.146 = Rs.13.854 million

c)NPV to Jamir Limited

= Cost = Rs.6.146 million

8. As the financial manager of National Company you are investigating the acquisition
of Regional Company. The following facts are given:

National Company Regional

Company
Earning per share Rs.8.00 Rs.3.00
Dividend per share Rs.5.00 Rs.2.50
Price per share Rs.86.00 Rs.24.00
Number of shares 8,000,000 3,000,000

Investors currently expect the dividends and earnings of Regional to grow at a

steady rate of 6 percent. After acquisition this growth rate would increase to 12
percent without any additional investment.

Required : (a) What is the benefit of this acquisition ?

(b) What is the cost of this acquisition to National Company if it (i)
pays Rs.30 per share cash compensation to Regional Company
and (ii) offers two shares for every five shares of Regional
Company?
Solution:

Let the suffixes A stand for National Company, B for Regional Company and AB for the
combined company.

a) PVB = Rs.24 x 3,000,000 = Rs.72 million

The required return on the equity of Regional Company is the value of k in the
equation.
Rs.2.50 (1.06)
Rs.24 =
k - .06

k = 0.1704 or 17.04 per cent.

If the growth rate of Regional rises to 12 per cent as a sequel to merger, the intrinsic
value per share would become:
2.50 (1.12)
= Rs.55.56
0.1704 - .12
 Thus the value per share increases by Rs.31.56 (55.56 – 17.04). Hence the benefit of
the acquisition is:
3 million x Rs.31.56 = Rs.94.68 million

(b) (i) If National pays Rs.30 per share cash compensation, the cost of the
merger is 3 million x (Rs.30 – Rs.24) = Rs.18 million.

(ii) If National offers 2 shares for every 5 shares it has to issue 1.2 million
shares to shareholders of Regional.
So shareholders of Regional will end up with

1.2

α = = 0.1304 or 13.04 per cent

8+ 1.2

shareholding of the combined entity,

The present value of the combined entity will be

PVAB = PVA + PVB + Benefit
= Rs.86x8 million + Rs.24x3 million + Rs.94.68 million
= Rs.854.68 million

So the cost of the merger is :

Cost = α PVAB - PVB
= .1304 x 854.68 - 72 = Rs.39.45 million

9. As the financial manager of Satya Limited you are investigating the acquisition of
Devaraj Limited. The following facts are given:

Satya Limited Devaraj

Limited
Earning per share Rs.12.00 Rs.4.00
Dividend per share Rs.10.00 Rs.3.00
Price per share Rs.110.00 Rs.38 .
00
Number of shares 5,800,000 1,400,00
0
Investors currently expect the dividends and earnings of Devaraj to grow at a
steady rate of 4 percent. After acquisition this growth rate would increase to 10
percent without any additional investment.
Required: (a) What is the benefit of this acquisition ?
(b) What is the cost of this acquisition to Satya Limited if it (i) pays
Rs.100 per share cash compensation to Devaraj Limited and (ii)
offers three shares for every seven shares of Devaraj Limited ?
Solution:

Let the suffixes A stand for Satya Limited, B for Devaraj Limited and AB for the
combined company

a) PVB = Rs.38 x 1,400,000 = Rs.53.2 million

The required return on the equity of Devaraj Limited is the value of k in the
equation.

Rs.3 (1.04)
Rs.38 =
k - .04

k = 0.1221 or 12.21 per cent.

If the growth rate of Devaraj Limited rises to 10 per cent as a sequel to merger, the
intrinsic value per share would become :

3(1.10)
= Rs.149.32
0.1221- .10

Thus the value per share increases by Rs.111.32 Hence the benefit of the
acquisition is
1.4million x Rs.111.32 = Rs.155.85 million

(b) (i) If Satya Limited pays Rs.100 per share cash compensation, the cost of the
merger is 1.4 million x (Rs.100 – Rs.38) = Rs.86.8 million.

(iii) If Satya Limited offers 3 shares for every 7 shares it has to issue0 .6 million shares

to shareholders of Devaraj Limited.

So shareholders of Devaraj Limited will end up with

0.6
  = 0.09375 or 9.375 per cent
5.8 + 0.6

shareholding of the combined entity,

The present value of the combined entity will be

PVAB = PVA + PVB + Benefit
= Rs.110x5.8 million + Rs.38x1.4 million + Rs.155.85 million
= Rs.847.05 million
 So the cost of the merger is :
Cost = α PVAB - PVB
= .09375 x 847.05 - 53.2 = Rs.26.21 million

10. Companies P and Q are valued as follows:

P Q
Earnings per share Rs. 12.00 Rs.4.00
Price per share Rs.110.00 Rs.28.00
Number of shares 60,000 21,000

P acquires Q by offering one shares of P for every three shares of Q. If there is no

economic gain from the merger, what is the price-earnings ratio of P's stock after
the merger?

Solution:

The expected profile of the combined entity after the merger is shown in the last column
below.

P Q Combined
entity
Number of shares 60,000 21,000 81,000
Aggregate earnings Rs.720,000 Rs.84,000 Rs.804,000
Market value Rs.6,600,00 Rs.588,00 Rs. 7,188,000
0 0
P/E 9.17 7.0 8.
94
11. Companies M and N are valued as follows:
M N
Earnings per share Rs.45.00 Rs.12.
00
Price per share Rs.360.00 Rs.53.0
0
Number of shares 100,000 32,000

M acquires N by offering one shares of M for every three shares of N. If there is

no economic gain from the merger, what is the price-earnings ratio of M's stock
after the merger?

Solution:

The expected profile of the combined entity after the merger is shown in the last column
below.

M N Combined entity
Number of shares 100,000 32,000 132,000
Aggregate earnings Rs.4,500,000 Rs.384,000 Rs.4,884,000
Market value Rs.36,000,000 Rs.1,696,000 Rs. 37,696,000
P/E 8 4.42 7.72
(340.62/44.13
)
EPS= Total earnings/ No. of shares = 4,884,000/1,00,000+10,666
= 44.13
Shares of M = 1,00,000
Shares of N = (32000/3)*1= 10,666
Price per share of merged entity = 37,696,000/1,00,000+10,666 = 340.62
12. X Limited is planning to acquire Y Limited. The management of X Limited
estimates its equity-related post tax cash flows, without the merger, to be as
follows:
Year 1 2 3 4 5
Cash flow (Rs. in million) 60 80 100 150 120
Beyond year 5, the cash flow is expected to grow at a compound rate of 8 percent
per year for ever.

If Y Limited is acquired, the equity-related cash flows of the combined firm are
expected to be as follows:
Year 1 2 3 4 5
Cash flow (Rs. in million) 10 12 1 25 2
0 0 5 0 0
0 0
Beyond year 5, the cash flow is expected to grow at a compound rate of 10
percent per year. The number of outstanding shares of X Limited and Y Limited
prior to the merger are 20 million and 12 million respectively. If the management
wants to ensure that the net present value of equity-related cash flows increase by
at least 50 percent, as a sequel to the merger, what is the upper limit on the
exchange ratio acceptable to it ? Assume cost of capital to be 15 percent.
Solution:
Value of X Limited’s equity as a stand-alone company.
60 80 100 150 120 120 x 1.08 1
+ + + + + x
2 3 4 5 5
(1.15) (1.15) (1.15) (1.15) (1.15) 0.15 – 0.08 (1.15)
= Rs. 1244.33 million
Value of the equity of the combined company
100 120 150 250 200 200 (1.10) 1
+ + + + + x
2 3 4 5 5
(1.15) (1.15) (1.15) (1.15) (1.15) 0.15 – 0.10 (1.15)
= Rs. 2706.27million
Let abe the maximum exchange ratio acceptable to the shareholders of X Limited.
Since the management of X Limited wants to ensure that the net present value of
equity-related cash flows increases by at least 50 percent, the value of a is
obtained as follows.
20
x 2706.27= 1.50 x 1244.33
20 + a 12
Solving this for a we get
a = 0.75
 13. P Limited is planning to acquire Q Limited. The management of P Limited
estimates its equity-related post tax cash flows, without the merger, to be as
follows:
Year 1 2 3 4 5
Cash flow (Rs. in million) 20 30 40 40 30

Beyond year 5, the cash flow is expected to grow at a compound rate of 4 percent
per year for ever.

If Q Limited is acquired, the equity-related cash flows of the combined firm are expected
to be as follows :
Year 1 2 3 4 5
Cash flow (Rs. in million) 30 50 60 50 40

Beyond year 5, the cash flow is expected to grow at a compound rate of 8 percent per year.
The number of outstanding shares of P Limited and Q Limited prior to the merger are 10
million and 8 million respectively. If the management wants to ensure that the net present
value of equity-related cash flows increase by at least 20 percent, as a sequel to the merger,
what is the upper limit on the exchange ratio acceptable to it ? Assume cost of capital to be
13 percent.

Solution:
Value of P Limited’s equity as a stand-alone company.
203040403030 x 1.04 1
+++++x
(1.13)(1.13)2(1.13)3(1.13)4(1.13)5 0.13 – 0.04 (1.13)5
= Rs. 297.89 million
Value of the equity of the combined company
305060504040 (1.08)1
+++++x
(1.13)(1.13)2(1.13)3(1.13)4(1.13)5 0.13 – 0.08 (1.13)5
= Rs. 628.61 million
Let a be the maximum exchange ratio acceptable to the shareholders of P Limited.
Since the management of P Limited wants to ensure that the net present value of
equity-related cash flows increases by at least 20 percent, the value of a is
obtained as follows.
10
x 628.61 = 1.20 x 297.89
10 + a 8
Solving this for a we get
a = 0.95
14. Rajagiri Mills Limited is interested in acquiring the textile division of Pricom
Industries Limited. The planning group of Rajagiri Mills Limited has developed
the following forecast for the textile division of Pricom Industries Limited.

Rs.in millions
Yea 1 2 3 4 5 6
r
Asset value 100 12 138 151. 163. 177.1
0 8 9
(at the beginning)
NOP 20 23 27.6 30.4 32.8 35.4
AT
Net investment 30 32 32.5 30.4 32.8 25.3
.5
Growth rate (%) 20 15 1 8 8 6
0

The growth rate from year 7 onward will be 6 percent. The discount rate to be used
for this acquisition is 20 percent. What is the value of this acquisition?

Solution:

1 2 3 4 5 6 7
FCF (10) (8.5 (4.9) 0 0 10.1 10.7
)
PVIF 0.83 0.69 0.579 0.482 0.402 0.33
3 4 5
PV (8.33 (5.9 (2.837 0 0 3.383
) 0) )
PV (FCF) during the explicit forecast period = -

13.68 FCF7 10.706

VH = = = 76.471
r-g 0.20 – 0.06

76.471
PV(VH) = =
25.60 (1.20)6

V0 = - 13.68 + 25.60 = Rs. 11.92 million.

15. CMX Limited is interested in acquiring the cement division of B&T Limited. The
planning group of CMX Limited has developed the following forecast for the
cement division of B & T Limited.
 Rs.in millions

Year 1 2 3 4 5 6

Asset value 1 140 1 21 241 277.7

0 7 0 .5
0 5
(at the beginning)
NOPAT 2 25 3 34. 39. 43.7
0 0 5 7
Net investment 3 36 3 37. 43. 42.0
5 .5 7 4 0
Growth rate (%) 4 25 2 15 15 10
0 0

The growth rate from year 7 onward will be 10 percent. The discount rate to be used for
acquisition is 12 percent. What is the value of this acquisition?

Solution:

1 2 3 4 5 6 7
FCF (15) (11.5) (7) (2.9) (3.3) 1.7
PVIF 0.893 0.797 0.71 0.63 0.567 0.507
2 6
PV (13.40) (9.17) (4.98 (1.84 (1.87) (0.86)
PV (FCF) during the explicit forecast) period=-3.4
)
FCF7 1.87
VH = = =93.5
r–g 0.12 – 0.10
PV (VH) =93.5 / (1.12)6 = 47.37
V0 = - 30.40 + 47.37 =Rs. 16.97 million

16. Rex Limited is interested in acquiring the cement division of Flex Limited. The
planning group of Rex Limited has developed the following forecast for the
cement division of Flex Limited

Year 1 2 3 4 5 6

Asset value 100 125 150 172 193 212.5

.5 .2 0
NOPAT 14 17.5 21 24. 27. 29.80
2 1
Net investment 20 22.5 22 24. 24. 25.3
.5 2 1
Growth rate(%) 25 20 15 12 10 8

The growth rate from year 7 onward will be 8 percent. The discount rate to be
used for this acquisition is 15 percent.
What is the value of this acquisition?
 Solution:

1 2 3 4 5 6 7
FCF (6 (5) (1.5) 0 3 4. 4
) 5 .
9
PV 0.870 0.7 0.658 0.49 0.432
PV (FCF) during the implicit
56 forecast period7
FCF74.9 (5.2 (3.7 (0.99 – 1.94
VH === 70 r -2)
g0.15 – 0.08
8) )
1.50
1
PV(VH) = 70 x= 30.26
(1.15)6
V0 = – 6.55 + 30.26
= Rs.23.71

Rupee per dollar

75 Rs. per dollar direct = 75/dollar rate
1 dollar = Rs 0.75