Q1-

Yablonski Cordage Company is considering the acquisition of Yawitz Wire and Me

with stock. Relevant financial information is as follows:

Present earnings (in thousands)

Common shares (in thousands)
Earnings per share
Price/ Earnings Ratio

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?

Ans1aEarnings per share

Price/ Earnings Ratio
Price (EPS X P/E)

Yablonski Yawitz
2
1.25
12
8
24
10

(1) Offer to Yawitz Stockholders in Yablonski stock (including the premium)

10 X 1.2 =

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 =

Ans1bSurviving company's earnings (in thousands)

Common shares (in thousands)
Earnings per share

(4,000 +1,000)
(2,000 + 400)

There is an increase in earnings per share by virtue of acquiring company with a

lower price/ earnings ratio.

Ans1cMarket 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 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.

of Yawitz Wire and Mesh Corporation

market price of Yawtiz stock.

new shares will be issued?

y immediately following the merger?

e market price per share of the

he premium)

ski for every one share of Yawitz stock.

400,000 Shares

000 +1,000)
000 + 400)

uiring company with a

5,000
2,400
2.0833

increase in earnings per

ne in the price earnings

e/ earnings ratio if there

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:

Operating profits before taxes

Depreciation
Total
Less: capital expenditure
working-capital addition
Free cash flows

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) =

Market capitalization of equity = Shares outstanding X offerin

(5600000 X 22.75)
Add: Interest bearing debt =
Enterprise value
EBITDA =
Depreciation =

With the situation mentioned above, the following ratios woul

Wilson
Equity value-to-book
Enterprise value-to-sales
Equity value-to-earnings
Enterprise value-to-EBITDA

3.2
1.6
10.6
5.2

As to discounted cash flows, we have the following (in millions):

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

For year 6 terminal value, we have:

35.3 X (1.05)
0.15 - 0.05

Year Free cash flow DF @ 15%

1
15.8
0.870
2
19.6
0.756
3
24.5
0.658
4
27.4
0.572
5
31.0
0.497
6
35.3
0.432
6
370.7
0.432
Present value of free cash flows
Conclusion:

- Even though the equity value-to-book and enterprise value-to

those for the comparable companies, the other two ratios are
earnings, or P/E ratio, is only 10.6x in comparison with 15.3x
value-to-EBITDA is only 5.2x, whereas the comparables have
attractive.

- With respect to DCF, a value of $251.23 million is comfortably

placed on the company of $181.4 million.

- Based on these financial considerations only, as a CFO we sho

Wilson Service Corporation at a share price of $22.75.

and fluid (mostly pumps) equipment maintenance

ard, it is relatively capital intensive. Its most
e of $112 million, operating income of $28 million,
$12 million, total assets of $172 million, interesty of $40 million. Its cash position is negligible. The
current share price is $16.25.

dustries, Inc., which is considering acquiring Wilson

s believe that by offering a premium of 40 percent
cash flows (excluding interest on debt) is the

17
7
24
8
3
13

by 20 percent per annual for 3 years, and than by 12

lieves it can hold capital expenditures and working
resent $11 million) of only $2 million per year. At the end
row at 5 percent per annum into perpetuity. It also
investment is 15 percent.

the following median valuation ratios:

n of Wilson Service Corporation make sense to you?

40%
16.25
22.75

Shares outstanding X offering share price

127,400,000
54,000,000
181,400,000
28,000,000
7,000,000
35,000,000

ve, the following ratios would prevail:

Comparables
2.9x
1.4x
15.3x
7.8x

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

book and enterprise value-to-sales ratios are moderately above

nies, the other two ratios are much better. The equity value-tox in comparison with 15.3x for comparables and enterprise
reas the comparables have the ratio of 7.8x. These are particularly

251.23 million is comfortably in excess of the enterprise value being

ations only, as a CFO we should recommend that acquisition of

hare price of $22.75.

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?

c- How can a company increase the probability of individual stockholders resisting

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 =

Total value of stock before

Increment to Passive Stockholders

3,250,065
2,499,950
5,750,015
5,500,000
250,015

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 the
economies, in contrast, aggressive stockholders receive a lager share.

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 =

Total value of stock before

Decrease in value to Passive Stakeholders

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.

the Passive company. Passive has 100,000

share. If it were combined with Aggressive,
y, the market price per share of Passive is
hare for the first 50,001 shares tendered and

assive? (2) How much inclemently will stock-

maximize his or her wealth? (2) What might

stockholders resisting too low a tender offer?

er and only $40 in the second tier?

therefore, Passive
otal value of the
lager share.

ndividual stockholders

olding out for a larger

only if they act as a

me incentives may
her offer. However,

$5,500,000. Clearly,
res the offer were

entive to offer more

nterbids. So that
0 in total, the present

Prob1The following data are pertinent for companies A and B:

A
Present earnings (in millions)
Shares (in million)
Price / earnings ratio

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?

Ans1aShares offered of company A = 1 million

Company A
EPS before the merger
Market price per share
before merger

Earnings (in millions)

Shares (in millions)
Earnings per share

2
36

Surviving company
24
11
2.18

Shareholders in Company A would experience an improvement in earnings per s

formal shareholders in Company B experience substantial reduction.

Market Value exchange ratio =

$36 X 1
40

Ans1b-

Earnings (in millions)

Surviving company
24

Shares (in millions)

Earnings per share

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.

Ans1cShares offered of company A = 1.5 million

Earnings (in millions)

Shares (in millions)
Earnings per share

Surmising company
24
11.5
2.087

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
=
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.

o were 1 share of company A

pact on earnings per share of the
If a merger likely to take place?

ch share of company B, what would

h share of company B, what would happen?

Company B
4
40

ving company

ment in earnings per share

reduction.

ving company

0.9

are as before.
olders $2 X $2 = $4

1.8

B. Unless B has great

e/ earnings ratio would
merger to be attractive

sing company

n earnings per share.

olders = $1.5 X $2.087 =

1.35

to Company B stockom their standpoint.

ate benefit would depend

ding on whether they

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.

Ans2aPrice per Noor share = $20

Premium
= 25%
Value in Nimbus Share per Noor share = 20 X 1.25 =
Market value per Nimbus share (25/100) =
Noor Shares =
New Nimbus shares
Old Shares
Total shares of Nimbus

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

or Company. If the merger were effected

e willing to pay a 25 percent premium for the
have to be as favorable to the Noor Shareto sell its own stock in the market.

an exchange of stock?

their stock for more than 1 year, have a 20 percent

rage $14 for their shares, what cash price would have
part a? (assume that Noor shareholders equate value
value per share in Nimbus 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?

Ans3aMarket Value exchange ratio =

$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.

merger. Compare the earnings

better? Why?

gher P/E than Noor? What should

dustry and Noor made cement, would

d the increase in earnings resulting from

or shareholders would have approved the

1.25

fter Merger

selling at a P/E ratio of 20,

h the premium, the exchange

od growth prospects or very

ther hand may be charterized
dustry. Noor does not automatically
synergy and better management are

duction may provide justification for

he parts, a company can only capitalize
ore the market awakens to the decreasing

owth rate should not be included.

ter year. If we assume no internal
emonstrate continual growth in
mpanies every year. However,
e fooled, and the P/E multiple will

Since the Noor holders are already

ould settle for lower incomes as well.

emium, but it is likely that a higher

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)

Total Liabilities and Shareholders' equity

, and Screw it, Hardware Company (NGS)

in liabilities. The balance sheet of the two

after the merger under the purchase and

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-

Annual earnings (in millions)

No. of shares (in millions)
Earnings per share

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.

$10 million with, 4 million shares of

e of $30. In the absence of any merger,
a compound rate of 5 percent per annum.
seeking to acquire, has present annual
tanding, and a market price per share of
pound annual rate of 10 percent per annum.
are of Brass Fitting Company. No synergistic

arnings per share?

w attractive now, when will it be attractive

Surviving
Company
12
5.2
2.31

for Brass Fitting than its own, ($36/$2 = 18 times)

d significant drop in earnings per share.
treat the total earnings of the surviving company
percent compound annual rate of growth and

Prob6-

D. Sent, a disgruntled stockholder of the Zeboc Corporation, desires representat

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 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.

Ans6aMajority Voting System

D. Sent have to control minimum 500,001 shares to have control to be assured o

under the majority voting system.

Ans6bCumulative Voting System

1,000,000 +1
10 +1

= 1000001
11

Ans6cMajority Voting System

(1) Once again D. Sent have to control minimum 500,001 shares to have control to
directorship under the majority voting system.
(2) Cumulative Voting System
1,000,000 +1
5 +1

= 1000001
6

on, desires representation on the board.

ion shares outstanding.

ed of one directorship under a majority

rs reduced to 5.

control to be assured of the directorship

90,909

ares to have control to be assured of the

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)

1,000,000 shares with 2 votes per share = 2,000,000 shares because

keep 50 percent control in his hands.

(2)

Initial payment of 10 percent of 2,000,000 shares X $1 par value = $2

to class A stock holders, or 10 cents a share.
The residual earnings would be available for class B dividends.

(3)

Amount of class A shares

Dividend to class A stockholders (10 percent X 2 = 2
Joe's shares in shares (2 votes per share)
Class B Shares
10 percent dividend for class B stockholders
or 4 cents per share

Prob7b(1)

Equal payments to all shares (8 cents per share).

Amount of class A shares

Dividend to class A stockholders (10 percent X 2 = 2
Joe's shares in shares (1 votes per share)
Class B Shares
10 percent dividend for class B stockholders
or 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 cents

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.

ercent return after taxes, although no

llion in $1 par value stock for his
ock, and all earnings will be paid in

after he has acquired new financing. He

e, class B, with 2 votes per share, while
er, would require a dividend formula
ow many class A shares would be issued?
equirements? (3) What dividend payment

ld have just one class of common stock as

idend rate of return. (1) What would be
nswer with that obtained in part a, what is

uire a 9 percent dividend return. What happens

,000,000 shares because Joe wants to

hares X $1 par value = $200,000

class B dividends.

olders (10 percent X 2 = 20%)

tes per share)

ss B stockholders

1,000,000
200,000
800,000
2
400,000
40,000

olders (10 percent X 2 = 20%)

tes per share)

ss B stockholders

ckholders, $80,000 again

ble value of the firm. Therefore, Joe

. Assuming earnings and dividends

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-

Maximum Price per share

1,000,000 Shares X $24 per share =
Synergy gain
Salary and perks

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

Ans8bIndifferent price from Management's perspective

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

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.

share. Management together with their

standing. Roche Cement Company wishes
es. The estimated present value of these
ny feels that management of Friday Harbor
tter management motivation, lower salaries,
the disposition of two yachts, approximately
d add $3 million in value to the acquisition.

nt Company can afford to pay for Friday

Harbor Lime Company be indifferent to

benefits?

24,000,000
8,000,000
3,000,000
35,000,000
35.00

rspective
9,600,000
3,000,000
12,600,000

are, a tight range. Unless

private control benefits

ement to sell, but it leaves