Business valuations

FM – L2 – Q123 – Mergers and acquisitions

Calculate NPV of Kofi Ltd's acquisition of Ama Ltd and advise on proceeding with a cash offer

Question

The Directors of Kofi Ltd (Kofi), a large listed company, are considering an opportunity to acquire all the shares of Ama Ltd (Ama), a small listed company with a highly efficient production technology.

Kofi has 10 million shares of common stock in issue that are currently trading at GH¢6.00 each. Ama Ltd has 5 million shares of common stock in issue, each of which is trading at GH¢4.50.

If Ama is acquired and integrated into the business of Kofi, the production efficiency of the combined entity would increase and save the combined business GH¢600,000 in operating costs each year to perpetuity.

Though Kofi operates in the same industry as Ama, its financial leverage is higher than that of Ama. Kofi’s total debt stock is valued at GH¢40 million, and its after-tax cost of debt is 22%. The beta of Kofi’s common stock is 1.2. The return on the risk-free asset is 20% and the market risk premium is 5%.

Required:

Suppose Kofi offers a cash consideration of GH¢25 million from its existing funds to the shareholders of Ama for all of their shares.

(a) Calculate the NPV of the acquisition, and advise the directors of Kofi on whether to proceed with the acquisition or not.

(b) Calculate the value of the combined entity immediately after the acquisition.

Answer

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Tags: Acquisitions, Business valuations, ergers, Market price, Share exchange ratio
Level: Level 2

Topic: Mergers and acquisitions

FM – L2 – Q119 – Business valuations

Calculate offer price for SmallCorp using a forward P/E multiple of 8.0 based on expected earnings

Question

LargeCorp is considering a takeover bid for SmallCorp, another company in the same industry. SmallCorp is expected to have earnings next year of GH₵86,000. If LargeCorp acquires SmallCorp, the expected results from SmallCorp will be as follows:

	Year after the acquisition
	Year 1	Year 2	Year 3
Sales	GH₵200,000	GH₵280,000	GH₵320,000
Cash costs/expenses	120,000	160,000	180,000
Capital allowances	20,000	30,000	40,000
Interest charges	10,000	10,000	10,000
Cash flows to replace assets and finance growth	25,000	30,000	35,000

From Year 4 onwards, it is expected that the annual cash flows from SmallCorp will increase by 4% each year in perpetuity. Tax is payable at the rate of 30%, and the tax is paid in the same year as the profits to which the tax relates. If LargeCorp acquires SmallCorp, it estimates that its gearing after the acquisition will be 35% (measured as the value of its debt capital as a proportion of its total equity plus debt). Its cost of debt is 7.4% before tax. LargeCorp has an equity beta of 1.60. The risk-free rate of return is 6% and the return on the market portfolio is 11%.
Required:

(a) Suggest what the offer price for SmallCorp should be if LargeCorp chooses to value SmallCorp on a forward P/E multiple of 8.0 times.

(b) Calculate a cost of capital for LargeCorp.

Answer

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Tags: Acquisition, Business valuations, Cash Flows, DCF, Perpetuity, WACC
Level: Level 2

Topic: Business valuations

FM – L2 – Q15 – Business valuations

Estimate market value of irredeemable 7.5% bonds with 9% required return.

Question

Assume that bond investors in Ama Industries require a return of 9% per year on their investments.

Required:

(A) Estimate the market value of irredeemable 7.5% bonds that pay interest annually.

(B) Estimate the market value of bonds paying coupon interest of 6% per year annually, that are redeemable at par in four years’ time.

(C) Estimate the market value of bonds paying coupon interest of 10%, redeemable at par after three years, where interest is payable every six months.

(D) Estimate the market value of a convertible bond with a coupon of 5% and interest payable annually; these bonds are convertible after three years into equity shares at the rate of 20 shares for every GH₵100 nominal value of bonds. The expected share price in three years’ time is GH₵7.

Answer

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Tags: Bond valuation, Business valuations, Interest rate, Irredeemable bonds
Level: Level 2

Topic: Business valuations

FM – L2 – Q14 – Business valuations

Calculate expected share price using dividend valuation model with constant dividends of GH₵0.24 in perpetuity.

Question

Kofi Enterprises has shareholders expecting an 8% annual return. The company paid dividends of GH₵0.24 per share in the year just ended.

Required:

(A). Assume that Kofi Enterprises pays out all of its annual profits as dividends, and the annual dividend per share is expected to be GH₵0.24 in perpetuity. Using the dividend valuation model, suggest what the expected share price of the company should be.

(B). Assume that the expected annual rate of growth in dividends is expected to be 3%. Using the dividend growth valuation model, suggest what the expected share price of the company should be.

(C). Assume that Kofi Enterprises is expected to retain 60% of its profits and reinvest the money to earn an annual return of 9%. Using the dividend growth valuation model (the Gordon growth model), suggest what the expected share price of the company should be.

Answer

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Tags: Business valuations, dividend valuation, Perpetuity, share price
Level: Level 2

Topic: Business valuations

Tag (SQ): Business valuations

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FM – L2 – Q123 – Mergers and acquisitions

Calculate NPV of Kofi Ltd's acquisition of Ama Ltd and advise on proceeding with a cash offer

FM – L2 – Q119 – Business valuations

Calculate offer price for SmallCorp using a forward P/E multiple of 8.0 based on expected earnings

FM – L2 – Q15 – Business valuations

Estimate market value of irredeemable 7.5% bonds with 9% required return.

FM – L2 – Q14 – Business valuations

Calculate expected share price using dividend valuation model with constant dividends of GH₵0.24 in perpetuity.

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FM – L2 – Q123 – Mergers and acquisitions

Calculate NPV of Kofi Ltd's acquisition of Ama Ltd and advise on proceeding with a cash offer

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FM – L2 – Q119 – Business valuations

Calculate offer price for SmallCorp using a forward P/E multiple of 8.0 based on expected earnings

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FM – L2 – Q15 – Business valuations

Estimate market value of irredeemable 7.5% bonds with 9% required return.

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FM – L2 – Q14 – Business valuations

Calculate expected share price using dividend valuation model with constant dividends of GH₵0.24 in perpetuity.

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