VALUATION OF MERGER PROPOSAL

INTRODUCTION An acquiring firm should pursue a merger only if it

creates some real economic values which may arise from any source such as better and ensured supply of raw materials, better access to capital market, better and intensive distribution network, greater market share, tax benefits etc.

The financial evaluation of a target candidate, therefore, includes the determination of the total consideration as well as the form of payment, i.e., in cash or securities of the acquiring firm.

METHODS OF VALUATION

Valuation based on assets. Valuation based on earnings. Market value approach. Earnings per share. Share exchange ratio. Other methods of valuation.

VALUATION BASED ON ASSETS

The worth of the target firm, no doubt, depends upon the tangible and intangible assets of the firm.

The value of a firm may be defined as:-

Value of all assets – External Liabilities = Net Assets

The assets of firm may be valued on the basis of the book values or realizable values

BOOK VALUE OF THE ASSETSIn this case, the values of various assets given in the

latest balance sheet of the firm are taken as worth of the assets.

From the total of the book values of all the assets, the amount of external liabilities is deducted to find out the net worth of the firm.

The net worth may be divided by the number of equity shares to find out the value per share of the target firm.

REALISABLE VALUE OF THE ASSETS

In this case, the current market prices or the realizable

values of all the tangible and intangible assets of the

target firm are estimated and from this the expected

external liabilities are deducted to find out the net

worth of the target firm.

VALUATION BASED ON EARNINGS

In the earnings based valuation, the PAT (Profit after taxes) is

multiplied by the Price – Earnings ratio to find out the value.

MARKET PRICE PER SHARE = EPS * PE RATIO

The earnings based valuation can also be made in terms of

earnings yield as follows:-

EARNINGS YIELD = EPS/MPS *100

Earnings valuation may also be found by capitalizing the total

earnings of the firm as follows:-

VALUE = EARNINGS/ CAPITALIZATION RATE * 100

MARKET VALUE APPROACH This approach is based on the actual market price of

securities settled between the buyer and seller.

The price of a security in the free market will be its most appropriate value.

Market price is affected by the factors like demand and supply and position of money market.

Market value is a device which can be readily applied at any time.

EARNINGS PER SHARE

According to this approach, the value of a prospective merger or acquisition is a function of the impact of merger/acquisition on the earnings per share.

As the market price per share is a function (product) of EPS and Price- Earnings Ratio, the future EPS will have an impact on the market value of the firm.

SHARE EXCHANGE RATIOThe share exchange ratio is the number of shares that

the acquiring firm is willing to issue for each share of the target firm.

The exchange ratio determines the way the synergy is distributed between the shareholders of the merged and the merging company.

The swap ratio also determines the control that each group of shareholders will have over the combined firm.

METHODS OF CALCULATIONBASED ON EARNINGS PER SHARE (EPS)

Share Exchange Ratio = EPS of the target firm / EPS of the Acquiring firm

BASED ON MARKET PRICE (MP)

Share Exchange Ratio = MP of the target firm’s share / MP of the Acquiring firm’s share

BASED ON BOOK VALUE (BV)

Share Exchange Ratio = BV of share of the target firm / BV of share of the Acquiring firm

OTHER METHODS OF VALUATION

ECONOMIC VALUE ADDED

EVA is based upon the concept of economic return which refers to excess of after tax return on capital employed over the cost of capital employed.

MARKET VALUE ADDED

MVA is another concept used to measure the performance and as a measure of value of a firm. MVA is determined by measuring the total amount of funds that have been invested in the company (based on cash flows) and comparing with the current market value of the securities of the company.

FORMS OF FINANCING A MERGER

Cash offerEquity share financing or exchange of sharesDebt and preference share financingDeferred payment or earn – out planLeveraged buy-outTender offer

BENEFITS AND COSTS OF MERGERThe advantages of synergy of merger and the

resultant expectation of risk reduction may affect both the acquiring firm and the target firm.

If synergy is perceived to exist in a takeover, the value of a combines firm would be greater than the sum of the values of the target firm and the acquiring firm.

V (AT) > V (A) + V (B)