Merger and Aquisitions

Learning Week 5 Seminar Questions

Question 1 (G. Arnold, Corporate Financial Management, Third edition, Financial Times Prentice Hall, 2005, Chapter 23, Questions and Problems: Question 1)

Large plc is considering the takeover of Small plc. Large is currently valued at £60m on the stock market while Small is valued at £30m. The economies of scale and other benefits of the merger are expected to produce a market value for the combined firm of £110m. A bid premium of £20m is expected to be needed to secure Small. Transaction costs (advisers’ fees, etc.) are estimated at £3m. Large has 30 million shares in issue and Small has 45 million. Assume the managers are shareholder-wealth maximisers.

Required

1. Does this merger create value for Large plc?

E (value of combined) = 110
Value of L (60)
Value of S (30)
Synergistic bought = 20
Less Transaction costs = (3) < Often investment banks
total 17
Less Bid overpayment = 20
synergistic benefit = (3) << its not worth it as it is a loss

2. If the purchase is made with cash what will be the price offered for each of Small’s shares?

Value = £30m
+ bid premium = £20m
Total = £50m

No g share to acquire £45m

Price g each = £50m / £45m = £1.11

3. What would be the value of each of Large’s shares after this merger?

Large acquires S for Cash
L has 30m shares outstanding
Value – £110 -3 – (130+20) = £57m of L alone
=£57m /30m shares = £1.90 per shares vs previous £2 per share

Question 2 (G. Arnold, Corporate Financial Management, Third edition, Financial Times Prentice Hall, 2005, Chapter 23, Questions and Problems: Question 3).

Box plc is considering the acquisition of Circle plc. The former is valued at £100m and the latter at £50m by the market. Economies of scale will result in savings of £2.5m annually in perpetuity. The required rate of return on both firms and the combination is 11 per cent. The transaction costs will amount to £1m.

Required:

1. What is the present value of the gain from the merger?

Combined value of firm:

100m B
50m C
150m
Plus synergy = 22.727
Less bid-pref = 0
Less transfer costs (1)
Value of combined firm = 150 + 21.727 = 171.727

2. If a cash offer of £70m is accepted by Circle’s shareholders what is the value created for Box’s shareholders

Cash offer accped for C = 70m

Bid = 70-50 = £20m premium
Value G = 150m + 21.7272m

3. If shares are offered in such a way that Circle’s shareholders would posses one-third of the merged entity, what is the value created for Box’s shareholders?

Cirle shares hold 1/3 of F B

Value B = 2/3 (100+50+21.7272) = 114

Question 3 (D. Watson and A. Head, Corporate Finance – Principles & Practice, Fourth edition, Financial Times Prentice Hall, 2007, Chapter 11, Questions for discussion: Question 1 / (a)).

The board of Hanging Valley plc wishes to take over Rattling Creek Ltd. Shown below are summarised financial data for the two companies.

Hanging Valley

Rattling Creek

Profit before interest and tax

£420,000

£200,000

Ordinary share dividends

6.9p

14.0p

Corporation tax rate

35%

35%

Balance sheet extracts:

Hanging Valley

Rattling Creek

Net fixed assets

1,750,000

800,000

Current assets

800,000

500,000

Current liabilities

(450,000)

(200,000)

Total assets less current liabilities

2,100,000

1,100,000

Long term debt at 10% per year
Long term liabilities

(200,000)

2,100,000

900,000

Financed by:
Ordinary shares, £1

1,500,000

500,000

reserves

600,000

400,000

2,100,000

900,000

Hanging Valley’s earnings and dividends have been increasing at approximately 15 per cent per year in recent times, while over the same period the earnings and dividends of Rattling Creek have remained static. The current market price of Hanging Valley’s ordinary shares is £1.60. The board of Hanging Valley considers that the shareholders of Rattling Creek will accept a share-for-share offer in the proportion of four shares in Hanging Valley for every five shares in Rattling Creek.

Required:

(a) Using three different valuation models[1], determine the effect on the wealth of Hanging Valley plc’s shareholders if Rattling Creek Ltd’s shareholders accept the proposed share exchange.

Net Assets Value = Fixed + current + sort term liability + long term liabilities
NAV based on book value

Value HV
Net assets 2.1m

Value RC
Net Assets 1.5m

Question 4 (D. Watson and A. Head, Corporate Finance – Principles & Practice, Fourth edition, Financial Times Prentice Hall, 2007, Chapter 11, Questions for discussion: Question 5).

It is 1 January 2012 and Magnet plc is in the process of divesting part of its operations via a proposed management buyout (MBO) The buyout team is currently looking for venture capital to finance the MBO. They have agreed a price of £25m with Magnet and have proposed that the financing will involve their putting up £5m of their personal funds to purchase an equity stake in the business with the remaining funds (£20m) coming from the venture capitalist in the form of long-term unsecured mezzanine debt finance.

The venture capitalist has indicated that it will require an interest rate on its debt investment of 11 per cent given that its finance will be unsecured. The four members of the MBO team have indicated that they intend to draw an annual salary of £150,000 each. The MBO team has just presented the venture capitalist company with the following five-year cash flow predictions (excluding directors’ salaries) which they consider to be on the pessimistic side:

Year ending

2012

2013

2014

2015

2016

Predicted sales

£6.78m

£6.82m

£7.23m

£7.51m

£8.02m

Cash outflows

£3.39m

£3.34m

£3.47m

£3.53m

£3.84m

Reinvestment

£1.5m

The new entity will pay corporation tax at a rate of 20 per cent in the year that profits arise. The reinvestment of £1.5m in 2014 will not qualify for capital allowances.

Required.

On the basis of this information, critically evaluate whether the proposed MBO is viable from a cash flow perspective in light of the two parties’ financial requirements and the predicted sales and costs. Support your answer with appropriate calculations.


[1] net asset valuation based on book values, capitalisation of earnings valuation (i.e. earnings yield valuation), and dividend yield method of share valuation

20120213-142627.jpg

0 replies

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *