Following are the financial statements for A Ltd and T Ltd for the current financial year. Both firms operate in the same industry.
BALANCE SHEETS
Particulars Firm A Firm B
Total current assets
Total fixed assets (net) Rs 14,00,000
10,00,000 Rs 10,00,000
5,00,000
Total assets 24,00,000 15,00,000
Equity capital (of Rs 10 each) 10,00,000 8,00,000
Retained earnings 2,00,000 _
14% Long-term debt 5,00,000 3,00,000
Total current liabilities 7,00,000 4,00,000
24,00,000 15,00,000
INCOME STATEMENTS
Net sales
Cost of goods sold Rs 34,50,000
27,60,000 Rs 17,00,000
13,60,000
Gross profit 6,90,000 3,40,000
Operating expenses 2,96,923 1,45,692
Interest 70,000 42,000
Earnings before taxes (EBT) 3,23,077 1,52,308
Taxes (0.35) 1,13,077 53,308
Earnings after taxes (EAT) 2,10,000 99,000
Additional information:
Number of equity shares
1,00,000
80,000
Dividend payment (D/P) ratio
Market price per share (MPS) 0.40
Rs 40 0.60
Rs 15
Assume that the two firms 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 prices of both the companies into EPS and P/E components, and also segregate
their EPS figures into return on equity (ROE) and book value of intrinsic value per share (BVPS)
components.
(ii) Estimate future EPS growth rates for each firm.
(iii) Based on expected operating synergies, A Ltd estimates that the intrinsic value of T’s equity share would be Rs 20 per share on its acquisition. You are required to develop a range of justifiable equity
share exchange ratios that can be offered by A Ltd’s shareholders. Based on your analysis in parts (i)
and (ii), would you expect the negotiated terms to be closer to the upper, or the lower exchange ratio limits? Why?
(iv) Calculate the post-merger EPS based on an exchange ratio of 0.4 : 1 being offered by A Ltd. Indicate
the immediate EPS accretion or dilution, if any, that will occur for each group of shareholders.
(v) Based on a 0.4 :1 exchange ratio, and assuming that A’s pre-merger P/E ratio will continue after the merger, estimate the post-merger market price. Show the resulting accretion or dilution in pre-merger market prices.
Very VEry High Priority!!!!!
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To address the given questions, we will go through a step-by-step analysis of the information provided. Let's start with part (i) by decomposing the share prices of both companies into EPS and P/E components, as well as segregating their EPS figures into return on equity (ROE) and book value of intrinsic value per share (BVPS) components.
To calculate EPS, we need to divide the earnings after tax (EAT) by the number of equity shares.
For Firm A:
EPS_A = EAT_A / Number of equity shares_A
= 2,10,000 / 1,00,000
= Rs 2.10
For Firm B:
EPS_B = EAT_B / Number of equity shares_B
= 99,000 / 80,000
= Rs 1.24
To calculate the P/E ratio, we divide the market price per share (MPS) by the EPS.
For Firm A:
P/E ratio_A = MPS_A / EPS_A
= Rs 40 / Rs 2.10
= 19.05
For Firm B:
P/E ratio_B = MPS_B / EPS_B
= Rs 15 / Rs 1.24
= 12.10
Next, let's calculate the return on equity (ROE) and the book value of intrinsic value per share (BVPS) for each firm.
ROE can be calculated by dividing the earnings after tax (EAT) by the equity capital.
For Firm A:
ROE_A = EAT_A / Equity capital_A
= 2,10,000 / 10,00,000
= 0.21 or 21%
For Firm B:
ROE_B = EAT_B / Equity capital_B
= 99,000 / 8,00,000
= 0.12375 or 12.38%
BVPS can be calculated by dividing the equity capital by the number of equity shares.
For Firm A:
BVPS_A = Equity capital_A / Number of equity shares_A
= 10,00,000 / 1,00,000
= Rs 10
For Firm B:
BVPS_B = Equity capital_B / Number of equity shares_B
= 8,00,000 / 80,000
= Rs 10
Moving on to part (ii), where we need to estimate the future EPS growth rates for each firm. Unfortunately, the information provided does not directly give us the required details to calculate the growth rates. We would need additional information, such as historical EPS figures from previous years, to project future growth rates accurately.
Now, let's proceed to part (iii), where we estimate the intrinsic value of T Ltd's equity share and develop a range of justifiable equity share exchange ratios that can be offered by A Ltd's shareholders.
Given that A Ltd estimates the intrinsic value of T Ltd's equity share to be Rs 20 per share on its acquisition, we can use this information to determine the exchange ratio.
Exchange ratio = Intrinsic Value of T Ltd's equity share / MPS of A Ltd
= Rs 20 / Rs 40
= 0.5
Therefore, the exchange ratio offered by A Ltd's shareholders would be 0.5 equity shares of A Ltd for each equity share of T Ltd.
Based on the analysis in parts (i) and (ii), we can see that Firm A has a higher EPS, P/E ratio, ROE, and BVPS compared to Firm B. This suggests that Firm A is a more profitable and efficient company. Therefore, we would expect the negotiated terms to be closer to the upper exchange ratio limits. A Ltd shareholders would likely offer a higher exchange ratio to T Ltd shareholders to compensate for the difference in the value of the two companies.
Moving on to part (iv), let's calculate the post-merger EPS based on an exchange ratio of 0.4:1 offered by A Ltd.
Post-merger EPS = (EAT_A + EAT_B) / (Number of shares_A + (Exchange ratio * Number of shares_B))
= (2,10,000 + 99,000) / (1,00,000 + (0.4 * 80,000))
= Rs 2,52,000 / 1,32,000
= 1.91
To determine whether there is an immediate EPS accretion or dilution, we need to compare the post-merger EPS with the EPS of each firm individually.
For Firm A:
EPS accretion_A = Post-merger EPS - EPS_A
= 1.91 - 2.10
= -0.19 or -19% (dilution)
For Firm B:
EPS accretion_B = Post-merger EPS - EPS_B
= 1.91 - 1.24
= 0.67 or 54% (accretion)
From the calculations, we can see that the merger would result in immediate EPS dilution for Firm A and accretion for Firm B.
Lastly, for part (v), assuming the pre-merger P/E ratio of A Ltd continues after the merger and using the exchange ratio of 0.4:1, we can estimate the post-merger market price.
Post-merger market price = P/E ratio_A * Post-merger EPS
= 19.05 * 1.91
= Rs 36.36
To calculate the resulting accretion or dilution in pre-merger market prices, we compare the post-merger market price with the pre-merger market price of each firm.
For Firm A:
Accretion or Dilution_A = (Post-merger market price - MPS_A) / MPS_A
= (36.36 - 40) / 40
= -0.09 or -9% (dilution)
For Firm B:
Accretion or Dilution_B = (Post-merger market price - MPS_B) / MPS_B
= (36.36 - 15) / 15
= 1.42 or 142% (accretion)
Therefore, the post-merger market price would result in a 9% dilution for Firm A and a 142% accretion for Firm B.
Please note that to provide a more accurate analysis, additional information such as historical data, growth projections, and market conditions should be considered.