IndexQ. No.Topic CoveredEx-1Ratio of exchange of stock, No. of shares, and market price per share using P/E method2Acquisition, Free cash flows, EBITDA analysis3Two-Tier offer vs one-tire offerProb-1Market value exchange ratio and effects on EPS2Calculation of EPS and cash price 3Analysis of market value exchange ratio and effects on EPS4Balance sheet formation using purchase and pooling of interest method5Acquisition and effects on EPS of the suviving company6Determination of the number of shares using majority & cummulative voting system7Invetment in company and control issues8Determination of market price and maximum price per share

Q1Q1-Yablonski Cordage Company is considering the acquisition of Yawitz Wire and Mesh Corporationwith stock. Relevant financial information is as follows:YablonskiYawitzPresent earnings (in thousands)4,0001,000Common shares (in thousands)2,000800Earnings per share21.25Price/ Earnings Ratio12X8XYablonski plans to offer a premium of 20 percent over the market price of Yawtiz stock.a-(1) What is the ratio of exchange of stock? (2) How many new shares will be issued?

b-What are the earnings per share for the surviving company immediately following the merger?

c-(1) If the price/ earnings ratio stays at 12 times what is the market price per share of thesurviving company? (2) What would happen if it went to 11 times?Ans1a-YablonskiYawitzEarnings per share21.25Price/ Earnings Ratio128Price (EPS X P/E)2410(1)Offer to Yawitz Stockholders in Yablonski stock (including the premium)10 X 1.2 =12per share.Exchange ratio = 12/24 = 0.50 or one-half share of Yablonski for every one share of Yawitz stock.(2)Number of new shares issued = 800,000 shares X 0.50 = 400,000SharesAns1b-Surviving company's earnings (in thousands)(4,000 +1,000)5,000Common shares (in thousands)(2,000 + 400)2,400Earnings per share2.0833

There is an increase in earnings per share by virtue of acquiring company with a lower price/ earnings ratio.Ans1c-Market price per share $2.0833 X 12 = 25.00

Market price per share $2.0833 X 11 = 22.92-In the first instance, the share price rises from $24, due to increase in earnings pershare. -In the second case, the share price falls owing to the decline in the price earnings ratio.-In efficient markets, we might expect some decline in price/ earnings ratio if therewas not likely to be synergy and/ or improved management.

Q2Q2-Wilson Service Corporation is engaged in electrical and fluid (mostly pumps) equipment maintenanceand sales for mid-market size companies. In this regard, it is relatively capital intensive. Its mostrecent year-end financial statements reflects revenue of $112 million, operating income of $28 million,depreciation of $7 million, net income after taxes of $12 million, total assets of $172 million, interest-bearing debt of $54 million, and shareholders' equity of $40 million. Its cash position is negligible. The 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 considering acquiring WilsonService. Keller Industries and its investment bankers believe that by offering a premium of 40 percent that Wilson can be acquired. Presently, Wilson's free cash flows (excluding interest on debt) is the following:Operating profits before taxes17Depreciation7Total24Less: capital expenditure8working-capital addition3Free cash flows13Keller believe that with synergy, it can grow EBITDA by 20 percent per annual for 3 years, and than by 12 percent for the next 3 years. At the same time, it believes it can hold capital expenditures and working capital additions to a combined increase (from the present $11 million) of only $2 million per year. At the end of 6 years, Keller assumes that free cash flows will grow at 5 percent per annum into perpetuity. It also assumes that the required discount rate for such an investment is 15 percent.Comparable recently acquired companies have had the following median valuation ratios:Equity value-to-book2.9xEnterprise value-to-sales1.4xEquity value-to-earnings15.3xEnterprise value-to-EBITDA7.8xYour are CFO of Keller industries. Does the acquisition of Wilson Service Corporation make sense to you?What is your recommendation?Ans2-Premium = 40%Current share price =16.25Offering share price (16.25 X 1.4) =22.75Market capitalization of equity = Shares outstanding X offering share price(5600000 X 22.75)127,400,000Add: Interest bearing debt =54,000,000Enterprise value181,400,000

EBITDA =28,000,000Depreciation = 7,000,00035,000,000

With the situation mentioned above, the following ratios would prevail:WilsonComparablesEquity value-to-book3.2x2.9xEnterprise value-to-sales1.6x1.4xEquity value-to-earnings10.6x15.3xEnterprise value-to-EBITDA5.2x7.8xAs to discounted cash flows, we have the following (in millions):Present123456EBITDA24.028.834.641.546.452.058.3Cap. Exp &11131517192123w.c addn.Free cash flow13.015.819.624.527.431.035.3

For year 6 terminal value, we have:35.3 X (1.05)=37.0650.15 - 0.050.1=370.7YearFree cash flowDF @ 15%Present Value115.80.87013.74219.60.75614.79324.50.65816.09427.40.57215.69531.00.49715.42635.30.43215.256370.70.432160.24Present value of free cash flows251.23

Conclusion:-Even though the equity value-to-book and enterprise value-to-sales ratios are moderately abovethose for the comparable companies, the other two ratios are much better. The equity value-to-earnings, or P/E ratio, is only 10.6x in comparison with 15.3x for comparables and enterprise value-to-EBITDA is only 5.2x, whereas the comparables have the ratio of 7.8x. These are particularlyattractive.

-With respect to DCF, a value of $251.23 million is comfortably in excess of the enterprise value beingplaced on the company of $181.4 million.

-Based on these financial considerations only, as a CFO we should recommend that acquisition ofWilson Service Corporation at a share price of $22.75.

Q3Q3-Aggressive Incorporated wishes to make a tender offer for the Passive company. Passive has 100,000 shares of common stock outstanding and earns $5.50 per share. If it were combined with Aggressive, total economies of $1.5 million could be realized. Presently, the market price per share of Passive is$55. Aggressive make a two-tire tender offer (i) $65 per share for the first 50,001 shares tendered and(ii)$50 per share for the remaining shares.a-(1) If successful, what will Aggressive end up paying for Passive? (2) How much inclemently will stock-holders of Passive receive for the economies?

b-(1) Acting independently, what will each stockholder do to maximize his or her wealth? (2) What mightthey do if the could respond collectively as a cartel?c-How can a company increase the probability of individual stockholders resisting too low a tender offer?d-What might happen if Aggressive offered $65 in the first tier and only $40 in the second tier?Ans3a-Value to Passive:50,001 shares X 65 =3,250,06549,999 shares X 50 =2,499,9505,750,015Total value of stock before ($55 X 100,000)=5,500,000Increment to Passive Stockholders250,015

The total value of economies to be realized is $1,500,000. therefore, Passive stockholders would receive only a modest portion of the total value of theeconomies, in contrast, aggressive stockholders receive a lager share.Ans3b-(1) With a two-tier offer, there is a great incentive for the individual stockholdersto tender early, thereby ensuring success for the acquiring firm.(2) Collectively, Passive stockholders would be better off holding out for a largerfraction of the total value of economies. They can do this only if they act as a cartel in their response to the offer.Ans3c-By 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.Ans3d-Value to Passive:50,001 shares X 65 =3,250,06549,999 shares X 40 =1,999,9605,250,025Total value of stock before5,500,000Decrease in value to Passive Stakeholders(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 weresuccessful. However, the other potential acquirers would have an incentive to offer morethan 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 presentmarket value.

Prob1Prob1-The following data are pertinent for companies A and B:ABPresent earnings (in millions)204Shares (in million)101Price / earnings ratio18x10xa-If the two companies were to merge and the exchange ratio were 1 share of company Afor each share of company B, what should be the initial impact on earnings per share of thetwo companies? What is the market value exchange ratio? If a merger likely to take place?

b-If the exchange ratio were two shares of company A for each share of company B, what wouldhappen with respect to part a?c-If the exchange ratio were 1.5 shares of company A for each share of company B, what would happen?d-What exchange ratio would you suggest?Ans1a-Shares offered of company A = 1 millionCompany ACompany BEPS before the merger24Market price per share 3640before mergerSurviving companyEarnings (in millions)24Shares (in millions)11Earnings per share2.18

Shareholders in Company A would experience an improvement in earnings per shareformal shareholders in Company B experience substantial reduction.Effective Earnings per share for company B =$2.18 X 1 = $2.18Market Value exchange ratio = $36 X 1=0.940Ans1b-Surviving companyEarnings (in millions)24Shares (in millions)12Earnings per share2.00

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 = $4Same as before. Market Value exchange ratio = $36 X 2=1.840This represents a substantial premium to pay for Company B. Unless B has greatgrowth potential and / or synergistic prospects, and its price/ earnings ratio wouldsuggest it does not, Company A would not likely to find the merger to be attractiveon these terms.Ans1c-Shares offered of company A = 1.5 millionSurmising companyEarnings (in millions)24Shares (in millions)11.5Earnings per share2.087

Company A's stockholders experience a modest increase in earnings per share.Effective earnings per share for former Company B stockholders = $1.5 X $2.087 =3.13. This is significantly less than the $4.00 EPS before. Market Value exchange ratio = $36 X 1.5=1.3540The merger provides a significant premium in market price to Company B stock-holders. It would seem that merger would be worthwhile from their standpoint.While EPS improves for Company A stockholders, the ultimate benefit would dependon the future earnings and likely synergistic effects. Depending on whether they exist, a merger might take place on these terms.Ans1d-No Solution recommended.

Prob2Prob2-NetNumber of Market priceTax rateIncomeSharesPer shareNimbus Company5,000,000100000010050%Noor Company1,000,0005000002050

The Nimbus Company wishes to acquire the Noor Company. If the merger were effectedthrough an exchange of stock, Nimbus would be willing to pay a 25 percent premium for theNoor shares. If done for cash, the terms would have to be as favorable to the Noor Share-holders. To obtain the cash, Nimbus would have to sell its own stock in the market.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, have a 20 percentmarginal capital gains tax rate, and paid an average $14 for their shares, what cash price would haveto be offered to be as attractive as the terms in part a? (assume that Noor shareholders equate valueper share in cash after capital gains taxes with value per share in Nimbus stock.)Ans2a-Price per Noor share = $20Premium = 25%Value in Nimbus Share per Noor share = 20 X 1.25 =25Market value per Nimbus share (25/100) =0.25Noor Shares =500,000New Nimbus shares125,000Old Shares1,000,000Total shares of Nimbus1,125,000

Old NimbusNoorNew NimbusNet Income = 5,000,0001,000,0006,000,000No. of shares =1,000,000500,0001,125,000Earnings per share =5.002.005.33Ear. per org. shr.5.331.33

Ans2b-$25 = X - 0.2(X - 14)$25 = X - 0.2X - 2.8$25 = 0.8X - 2.80.8X =25 - 2.800.8X =22.2X =22.20.8X =27.75

Prob3Prob3-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 earnings per Nimbus share. On this basis alone, which group fared better? Why?c-Why do you imagine that the old Nimbus commanded a higher P/E than Noor? What shouldbe the change in P/E ratio resulting from the merger?d-if the Nimbus company were in high-technology growth industry and Noor made cement, wouldyou revise your answer?e-In determining the appropriate P/E ratio for Nimbus, should the increase in earnings resulting fromthis merger be added as a growth factor?f-In light of the foregoing discussion, do you feel that the Noor shareholders would have approved themerger if Noor paid a $1 dividend and Nimbus paid $3? Why?Ans3a-Market Value exchange ratio = $100 X 0.25=1.25$20Ans3b-EarningsBefore MergerAfter MergerPer Noor Share2.001.33Per Nimbus Share5.005.33Nimbus appeared to have fared better. Nimbus stock was selling at a P/E ratio of 20,while Noor was only selling at 10 times earnings. Even with the premium, the exchangeprice only represents 12.5 times moor's earnings. (As shown below):NetNumber of Market priceTax rateIncomeSharesPer shareNimbus Company5,000,000100000010050%Noor Company1,000,0005000002050EPS5.002.0025.0012.5timesP/E2010Ans3c-Nimbus would have a P/E ratio of 20 by virtue of either good growth prospects or veryhigh quality or moderate growth prospects. Noor, on the other hand may be charterized by the mediocre management, or may be in a declining industry. Noor does not automaticallydeserve a P/E ratio of 20 just because Nimbus bought it. If synergy and better management are 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 justification forthe market value of whole being greater than the sum of the parts, a company can only capitalizecement earnings at an electronics multiple for so long before the market awakens to the decreasing growth rate and reacts accordingly.Ans3e-If the merger is one-shot proposition, it is clear that the growth rate should not be included.the problem arises if Nimbus does this sort of thing year after year. If we assume no internalgrowth at all, it is possible for a 20 P/E ratio company to demonstrate continual growth in earnings per share by merging with enough 12 multiple companies every year. However,this growth is an illusion. The market, if efficient, will not be fooled, and the P/E multiple willdecline.Ans3f-The return per Noor share would drop from $1.00 to $0.75. Since the Noor holders are alreadygiving up earnings per share, it seems unlikely that they would settle for lower incomes as well.This situation could be altered by the size of the market premium, but it is likely that a higheryielding convertible preferred would be a better vehicle.

Prob4Prob4-Biggo Stores, Inc. (BSI), has acquired the Nail it, Glue it, and Screw it, Hardware Company (NGS)for $4 million in stock and the assumption of $2 million in liabilities. The balance sheet of the twocompanies before the merger were (in millions):BSINGSTangible and total assets105Liabilities42Shareholders' equity63

Determine the balance sheet of the combined company after the merger under the purchase andpooling-of-interest methods of accounting.Ans4-(in millions)Pooling ofPurchaseinterestsTangible and total assets(10 +5)1515GoodwillBal. Fig10.0

Total Assets1615

Liabilities( 4 + 2)6( 4 + 2)6Shareholders' equity(Increase)109

Total Liabilities and Shareholders' equity1615

Prob5Prob5-Copper Tube Company currently has annual earnings of $10 million with, 4 million shares ofcommon stock outstanding and a market price per share of $30. In the absence of any merger, Copper Tube's annual earnings are expected to grow at a compound rate of 5 percent per annum. Brass Fitting Company, which Copper Tube Company is seeking to acquire, has present annualearnings of $2 million, 1 million shares of common outstanding, and a market price per share of$36. Its annual earnings are expected to grow at a compound annual rate of 10 percent per annum.Copper Tube will offer 1.2 shares of its stock for each share of Brass Fitting Company. No synergisticeffects 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 will it be attractivefrom the standpoint of earnings per share?Ans5a-CopperSurviving TubeCompanyAnnual earnings (in millions)1012No. of shares (in millions)45.2Earnings per share2.52.31

Market priceEPSP/ECopper Tube302.512Brass Fittings36218

Ans5b-Because Copper Tube Company pays a higher P/E ratio for Brass Fitting than its own, ($36/$2 = 18 times)versus ($30/$2.5 = 12 times), there is an immediate and significant drop in earnings per share. However, the expected growth rates are different. If we treat the total earnings of the surviving companyas a weighted average of those of Copper Tube with a 5 percent compound annual rate of growth and those of Brass Fitting with a 10 percent rate of growth.

Prob6disgruntled = dissatisfiedProb6-D. Sent, a disgruntled stockholder of the Zeboc Corporation, desires representation on the board.The Zeboc Corporation, which has 10 directors, has 1 million shares outstanding.a-How many shares would Sent have to control to be assured of one directorship under a majorityvoting system?

b-Recompute part a, assuming a cumulative voting system.c-Recompute part a and b, assuming the number of directors reduced to 5.Ans6a-Majority Voting System

D. Sent have to control minimum 500,001 shares to have control to be assured of the directorshipunder the majority voting system.Ans6b-Cumulative Voting System1,000,000 +1=1000001=90,90910 +111Ans6c-Majority Voting System(1)Once again D. Sent have to control minimum 500,001 shares to have control to be assured of the directorship under the majority voting system.(2)Cumulative Voting System

1,000,000 +1=1000001=166,6675 +16

Prob7Prob7-Joe Million has formed a company that can earn a 12 percent return after taxes, although noinvestment has yet been made, Joe plans to take $1 million in $1 par value stock for his promotion efforts. All financing for the firm will be in stock, and all earnings will be paid in dividends.a-Joe desires to keep 50 percent control of the company after he has acquired new financing. Hecan do so by taking his stock in the form of $1 par value, class B, with 2 votes per share, while selling $1 par value class A stock. The investors however, would require a dividend formulathat would give them 10 percent dividend return. (1) How many class A shares would be issued?(2) What dividend formula would meet the investors' requirements? (3) What dividend paymentwould 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 common stock asin part a. The investor would require only 8 percent dividend rate of return. (1) What would be dividend distribution in this case? (2) Comparing this answer with that obtained in part a, what isJoe paying to retain control?c-Rework part b under assumption that the investors require a 9 percent dividend return. What happens to Joe?Prob7a-(1)1,000,000 shares with 2 votes per share = 2,000,000 shares because Joe wants tokeep 50 percent control in his hands.(2)Initial payment of 10 percent of 2,000,000 shares X $1 par value = $200,000to class A stock holders, or 10 cents a share.The residual earnings would be available for class B dividends.(3)Amount of class A shares1,000,000Dividend to class A stockholders (10 percent X 2 = 20%)200,000800,000Joe's shares in shares (2 votes per share)2Class B Shares400,00010 percent dividend for class B stockholders40,000or 4 cents per shareProb7b-(1)Equal payments to all shares (8 cents per share).Amount of class A shares1,000,000Dividend to class A stockholders (10 percent X 2 = 20%)200,000800,000Joe's shares in shares (1 votes per share)1Class B Shares800,00010 percent dividend for class B stockholders80,000or 8 cents per share(2)$160,000 or 8 cents per share to class A stockholders, $80,000 again 8 cents a share, to Joe.(3)For control Joe is giving up $40,000 or 4 centsProb7c-$240,000/0.09 = 2,666,667 = sustainable value of the firm. Therefore, Joecan only take $666,667 in promotional stock. Assuming earnings and dividends are 9 cents a share, Joe receives $60,000 per year.$240,000$2,666,6670.092,000,000$666,667X 0.09$60,000

Prob8Prob8-Friday Harbor Lime Company presently sells for $24 per share. Management together with their families, controls 40 percent of the 1 million shares outstanding. Roche Cement Company wishesto acquire Friday Harbor Lime because of likely synergies. The estimated present value of these synergies is 8 million. Moreover, Roche Cement Company feels that management of Friday Harbor Lime is overpaid and "over perked". It feels that with better management motivation, lower salaries, and fewer perks for controlling management, including the disposition of two yachts, approximately$400,000 per year in expenses can be saved. This would add $3 million in value to the acquisition.a-What is the maximum price per share that Roche Cement Company can afford to pay for FridayHarbor Lime Company?

b-At what price per share will the management of Friday Harbor Lime Company be indifferent to giving up the present value of their privately controlled benefits?c-What price per share would you offer?Ans8a-Maximum Price per share

1,000,000 Shares X $24 per share =24,000,000Synergy gain8,000,000Salary and perks3,000,00035,000,000

Maximum price $35,000,000/1,000,000 shares =35.00

Ans8b-Indifferent price from Management's perspective

Total share value for controlling management is 9,600,000(400,000 shares X $24)Value give up for salaries and perks3,000,00012,600,000

Ans8c--The boundaries for bidding are $31.50 to $35.00 per share, a tight range. Unlessmanagement 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 leaveslittle in value creation for Roche Cement Company.