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Yablonski Yawitz
4,000
1,000
2,000
800
2
1.25
12X
8X
Yablonski plans to offer a premium of 20 percent over the market price of Yawtiz
a- (1) What is the ratio of exchange of stock? (2) How many new shares will be issu
b- What are the earnings per share for the surviving company immediately followin
c- (1) If the price/ earnings ratio stays at 12 times what is the market price per sha
surviving company? (2) What would happen if it went to 11 times?
Yablonski Yawitz
2
1.25
12
8
24
10
12 per share.
Exchange ratio = 12/24 = 0.50 or one-half share of Yablonski for every one shar
(2) Number of new shares issued = 800,000 shares X 0.50 =
(4,000 +1,000)
(2,000 + 400)
25.00
22.92
- In the first instance, the share price rises from $24, due to increase in earnings p
share.
- In the second case, the share price falls owing to the decline in the price earning
ratio.
- In efficient markets, we might expect some decline in price/ earnings ratio if the
was not likely to be synergy and/ or improved management.
he premium)
000 +1,000)
000 + 400)
5,000
2,400
2.0833
Q2-
Wilson Service Corporation is engaged in electrical and fluid (mostly pumps) equ
and sales for mid-market size companies. In this regard, it is relatively capital in
recent year-end financial statements reflects revenue of $112 million, operating
depreciation of $7 million, net income after taxes of $12 million, total assets of $
bearing debt of $54 million, and shareholders' equity of $40 million. Its cash pos
company has 5.6 million shares outstanding and its current share price is $16.25
The company has attracted the attention of Keller Industries, Inc., which is consi
Service. Keller Industries and its investment bankers believe that by offering a p
that Wilson can be acquired. Presently, Wilson's free cash flows (excluding intere
following:
Keller believe that with synergy, it can grow EBITDA by 20 percent per annual fo
percent for the next 3 years. At the same time, it believes it can hold capital exp
capital additions to a combined increase (from the present $11 million) of only $
of 6 years, Keller assumes that free cash flows will grow at 5 percent per annum
assumes that the required discount rate for such an investment is 15 percent.
Comparable recently acquired companies have had the following median valuat
Equity value-to-book
Enterprise value-to-sales
Equity value-to-earnings
Enterprise value-to-EBITDA
2.9x
1.4x
15.3x
7.8x
Your are CFO of Keller industries. Does the acquisition of Wilson Service Corpora
What is your recommendation?
Ans2Premium =
Current share price =
Offering share price (16.25 X 1.4) =
3.2
1.6
10.6
5.2
EBITDA
Cap. Exp &
w.c addn.
Free cash flow
Present
24.0
11
13.0
1
28.8
13
2
34.6
15
15.8
19.6
17
7
24
8
3
13
40%
16.25
22.75
x
x
x
x
in millions):
3
41.5
17
4
46.4
19
5
52.0
21
6
58.3
23
24.5
27.4
31.0
35.3
=
Present Value
13.74
14.79
16.09
15.69
15.42
15.25
160.24
251.23
37.065
0.1
370.7
Q3-
Aggressive Incorporated wishes to make a tender offer for the Passive company.
shares of common stock outstanding and earns $5.50 per share. If it were comb
total economies of $1.5 million could be realized. Presently, the market price pe
$55. Aggressive make a two-tire tender offer (i) $65 per share for the first 50,00
(ii)$50 per share for the remaining shares.
a- (1) If successful, what will Aggressive end up paying for Passive? (2) How much
holders of Passive receive for the economies?
b- (1) Acting independently, what will each stockholder do to maximize his or her w
they do if the could respond collectively as a cartel?
d- What might happen if Aggressive offered $65 in the first tier and only $40 in the
Ans3aValue to Passive:
50,001 shares X 65 =
49,999 shares X 50 =
3,250,065
2,499,950
5,750,015
5,500,000
250,015
Ans3b-
(1) With a two-tier offer, there is a great incentive for the individual stockholders
to tender early, thereby ensuring success for the acquiring firm.
(2) Collectively, Passive stockholders would be better off holding out for a larger
fraction of the total value of economies. They can do this only if they act as a
cartel in their response to the offer.
Ans3cBy instigating antitakeover amendments and devices, some incentives may
be created for individual stockholders to hold out for a higher offer. However,
in practice, it is impossible to achieve a complete cartel response.
Ans3dValue to Passive:
50,001 shares X 65 =
49,999 shares X 40 =
3,250,065
1,999,960
5,250,025
5,500,000
(249,975)
This value is lower than the previous total market value of $5,500,000. Clearly,
stockholders would fare poorly if in the rush to tender shares the offer were
successful.
However, the other potential acquirers would have an incentive to offer more
than Aggressive, even with no economies to be realized.
Competition among potential acquirers should ensure counterbids. So that
Aggressive would be forced to bid no less than $5,500,000 in total, the present
market value.
therefore, Passive
otal value of the
lager share.
ndividual stockholders
me incentives may
her offer. However,
$5,500,000. Clearly,
res the offer were
nterbids. So that
0 in total, the present
B
20
10
18x
4
1
10x
a- If the two companies were to merge and the exchange ratio were 1 share of com
for each share of company B, what should be the initial impact on earnings per s
two companies? What is the market value exchange ratio? If a merger likely to t
b- If the exchange ratio were two shares of company A for each share of company
happen with respect to part a?
c- If the exchange ratio were 1.5 shares of company A for each share of company B
d- What exchange ratio would you suggest?
2
36
Surviving company
24
11
2.18
$36 X 1
40
Ans1b-
Surviving company
24
12
2.00
Company A's stock holders have the same earnings per share as before.
Effective earnings per share for former Company B stockholders $2 X $2 = $4
Same as before.
Market Value exchange ratio =
$36 X 2
40
This represents a substantial premium to pay for Company B. Unless B has great
growth potential and / or synergistic prospects, and its price/ earnings ratio wou
suggest it does not, Company A would not likely to find the merger to be attract
on these terms.
Surmising company
24
11.5
2.087
$36 X 1.5
=
40
The merger provides a significant premium in market price to Company B stockholders. It would seem that merger would be worthwhile from their standpoint.
While EPS improves for Company A stockholders, the ultimate benefit would dep
on the future earnings and likely synergistic effects. Depending on whether they
exist, a merger might take place on these terms.
Ans1d-
No Solution recommended.
Company B
4
40
ving company
ving company
0.9
are as before.
olders $2 X $2 = $4
1.8
sing company
1.35
Prob2-
Nimbus Company
Noor Company
Net
Income
5,000,000
1,000,000
Number of
Shares
1000000
500000
The Nimbus Company wishes to acquire the Noor Company. If the merger were e
through an exchange of stock, Nimbus would be willing to pay a 25 percent prem
Noor shares. If done for cash, the terms would have to be as favorable to the No
holders. To obtain the cash, Nimbus would have to sell its own stock in the mark
a- Compute the combined earnings per share for an exchange of stock?
b- If we assume that Noor shareholders have held their stock for more than 1 year,
marginal capital gains tax rate, and paid an average $14 for their shares, what c
to be offered to be as attractive as the terms in part a? (assume that Noor share
per share in cash after capital gains taxes with value per share in Nimbus stock.
Net Income =
No. of shares =
Earnings per share =
Ear. per org. shr.
Old Nimbus
5,000,000
1,000,000
5.00
5.33
Ans2b$25 =
X - 0.2(X - 1.4)
Noor
1,000,000
500,000
2.00
1.33
$25 =
X - 0.2X - 2.8
$25 =
0.8X - 2.8
0.8X =
25 - 2.80
0.8X =
22.2
X=
22.2
0.8
X=
27.75
Market price
Per share
100
20
Tax rate
50%
50
an exchange of stock?
25
0.25
500,000
125,000
1,000,000
1,125,000
New Nimbus
6,000,000
1,125,000
5.33
Prob3-
Assume the exchange of Nimbus shares for Noor shares as outlined in problem 2
a- What is the ratio of exchange?
b- Compare the earnings per Noor share before and after the merger. Compare the
per Nimbus share. One this basis alone, which group fared better? Why?
c- Why do you imagine that the old Nimbus commanded a higher P/E than Noor? W
be the change in P/E ratio resulting from the merger?
d- if the Nimbus company were in high-technology growth industry and Noor made
you revise your answer?
e- In determining the appropriate P/E ratio for Nimbus, should the increase in earni
this merger be added as a growth factor?
f- In light of the foregoing discussion, do you feel that the Noor shareholders would
merger if Noor paid a $1 dividend and Nimbus paid $3? Why?
$100 X 0.25
$20
Ans3bEarnings
Per Noor Share
Per Nimbus Share
Before Merger
2.00
5.00
After Merger
1.33
5.33
Nimbus appeared to have fared better. Nimbus stock was selling at a P/E ratio of
while Noor was only selling at 10 times earnings. Even with the premium, the ex
price only represents 12.5 times moor's earnings.
Ans3c-
Nimbus would have a P/E ratio of 20 by virtue of either good growth prospects o
high quality or moderate growth prospects. Noor, on the other hand may be cha
by the mediocre management, or may be in a declining industry. Noor does not
deserve a P/E ratio of 20 just because Nimbus bought it. If synergy and better m
not forthcoming, the P/E ratio of Nimbus should decline.
Ans3d-
the real point to be made is that while synergy and risk reduction may provide ju
the market value of whole being greater than the sum of the parts, a company c
cement earnings at an electronics multiple for so long before the market awaken
growth rate and reacts accordingly.
Ans3e-
If the merger is one-shot proposition, it is clear that the growth rate should not b
the problem arises if Nimbus does this sort of thing year after year. If we assume
growth at all, it is possible for a 20 P/E ratio company to demonstrate continual g
earnings per share by merging with enough 12 multiple companies every year. H
this growth is an illusion. The market, if efficient, will not be fooled, and the P/E
decline.
Ans3f-
The return per Noor share would drop from $1.00 to $0.75. Since the Noor holde
giving up earnings per share, it seems unlikely that they would settle for lower in
This situation could be altered by the size of the market premium, but it is likely
yielding convertible preferred would be a better vehicle.
outlined in problem 2.
1.25
fter Merger
Prob4-
Biggo Stores, Inc. (BSI), has acquired the Nail it, Glue it, and Screw it, Hardware
for $4 million in stock and the assumption of $2 million in liabilities. The balance
companies before the merger were (in millions):
BSI
Tangible and total assets
Liabilities
Shareholders' equity
NGS
10
4
6
5
2
3
Determine the balance sheet of the combined company after the merger under
pooling-of-interest methods of accounting.
Ans4(in millions)
Tangible and total assets
Goodwill
(10 +5)
Bal. Fig
Total Assets
Liabilities
Shareholders' equity
(Increase)
Purchase
15
1
Pooling of
interests
15
-
16
15
6
10
6
9
16
15
Prob5-
Copper Tube Company currently has annual earnings of $10 million with, 4 millio
common stock outstanding and a market price per share of $30. In the absence
Copper Tube's annual earnings are expected to grow at a compound rate of 5 pe
Brass Fitting Company, which Copper Tube Company is seeking to acquire, has p
earnings of $2 million, 1 million shares of common outstanding, and a market pr
$36. Its annual earnings are expected to grow at a compound annual rate of 10
Copper Tube will offer 1.2 shares of its stock for each share of Brass Fitting Comp
effects are expected from the merger.
a- What is the immediate effect on surviving company's earnings per share?
b- Would you want to acquire Brass Fitting Company? If now attractive now, when w
from the standpoint of earnings per share?
Ans5a-
Copper
Tube
10
4
2.5
Surviving
Ans5b-
Because Copper Tube Company pays a higher P/E ratio for Brass Fitting than its
versus ($30/$2.5 = 12 times), there is an immediate and significant drop in earn
However, the expected growth rates are different. If we treat the total earnings o
as a weighted average of those of Copper Tube with a 5 percent compound annu
those of Brass Fitting with a 10 percent rate of growth.
Surviving
Company
12
5.2
2.31
Prob6-
a- How many shares would Sent have to control to be assured of one directorship u
voting system?
b- Recompute part a, assuming a cumulative voting system.
c- Recompute part a and b, assuming the number of directors reduced to 5.
= 1000001
11
= 1000001
6
rs reduced to 5.
90,909
166,667
Prob7-
Joe Million has formed a company that can earn a 12 percent return after taxes,
investment has yet been made, Joe plans to take $1 million in $1 par value stock
promotion efforts. All financing for the firm will be in stock, and all earnings will
dividends.
a- Joe desires to keep 50 percent control of the company after he has acquired new
can do so by taking his stock in the form of $1 par value, class B, with 2 votes pe
selling $1 par value class A stock. The investors however, would require a divide
that would give them 10 percent dividend return. (1) How many class A shares w
(2) What dividend formula would meet the investors' requirements? (3) What div
would be left for Joe's class B shares?
b- If Joe were willing to accept one share-one vote, he could have just one class of
in part a. The investor would require only 8 percent dividend rate of return. (1) W
dividend distribution in this case? (2) Comparing this answer with that obtained
Joe paying to retain control?
c- Rework part b under assumption that the investors require a 9 percent dividend
to Joe?
Prob7a(1)
(2)
(3)
Prob7b(1)
(3)
Prob7c-
$240,000/0.9 =
266,667 = sustainable value of the firm. Ther
can only take $666,667 in promotional stock. Assuming earnings and
are 9 cents a share, Joe receives $60,000 per year.
class B dividends.
ss B stockholders
1,000,000
200,000
800,000
2
400,000
40,000
ss B stockholders
1,000,000
200,000
800,000
1
800,000
80,000
Prob8-
Friday Harbor Lime Company presently sells for $24 per share. Management tog
families, controls 40 percent of the 1 million shares outstanding. Roche Cement
to acquire Friday Harbor Lime because of likely synergies. The estimated presen
synergies is 8 million. Moreover, Roche Cement Company feels that managemen
Lime is overpaid and "over perked". It feels that with better management motiva
and fewer perks for controlling management, including the disposition of two ya
$400,000 per year in expenses can be saved. This would add $3 million in value
a- What is the maximum price per share that Roche Cement Company can afford to
Harbor Lime Company?
b- At what price per share will the management of Friday Harbor Lime Company be
giving up the present value of their privately controlled benefits?
c- What price per share would you offer?
Ans8a-
Ans8c-
- The boundaries for bidding are $31.50 to $35.00 per share, a tight range. Unless
management of Friday Harbor Lime is unmindful of the private control benefits
they give up, the bid needs to be at least $31.50 per share.
- Perhaps a bid of $32 or $33 would be a sufficient inducement to sell, but it leave
little in value creation for Roche Cement Company.
24,000,000
8,000,000
3,000,000
35,000,000
35.00
rspective
9,600,000
3,000,000
12,600,000