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E V A L U A T I O N O F M E R G E R P R O P O S A L
SWAP RATIO
The ratio in which an acquiring company will offer its
own shares in exchange for the target company's shares
during a merger or acquisition. To calculate the swap
ratio, companies analyze financial ratios such as book
value, earnings per share, profits after tax and dividends
paid, as well as other factors, such as the reasons for the
merger or acquisition.
The swap ratio determines the control that each group
of shareholders of the companies shall have over the
combined firm. It is an indicator of relative values of
financial and strategic results of the company.
CONT.
In finance, a swap ratio is an exchange rate of
the shares of the companies that would undergo
a merger.
For Example
If a company offers a swap ratio of 1:1.5, it will
provide one share of its own company for every 1.5
shares of the company being acquired.
DETERMINATION OF SWAP
RATIO
The commonly used bases for establishing the
exchange ratio are:
1. Earnings Per Share
2. Market Price Per Share
3. Book Value Per Share
1. EARNING PER SHARE
Earning per share is one of the important factor to
determine the exchange ratio.
Suppose the earnings per share of the acquiring
firm are Rs 5.00 and the earnings per share of the
target firm Rs 2.00. An exchange ratio based on
earnings per share will be 0.4 that is (2/5).
This means 2 shares of the acquiring firms will be
exchanged for 5 shares of the target firm.
While earnings per share reflect prime facie the earnings power, there
are some problems in an exchange ratio based solely on current
earnings per share of the merging companies because it fails to take
into account the following:
* The difference in the growth rates of earnings of the two companies
* The gains in earnings arising out of merger
* The differential risks associated with the earnings of the two
companies
2. MARKET PRICE PER
SHARE
The exchange ratio may be based on the relative market prices of
the shares of the acquiring firm and the target firm.
For example, if the acquiring firm’s equity share sells for Rs 50 and
the target firm’s equity share sells for Rs 10 the exchange ratio based
on the market price is 0.2 that is (10/50).
This means that 1 share of the acquiring firm will be exchanged for
5 shares of the target firm.
3. BOOK VALUE PER
SHARE
The relative book values of the two firms may be used to
determine the exchange rate.
For example, if the book value per share of the acquiring company
is Rs 25 and the book value per share of the target company is Rs 15,
the book value based exchange ratio is 0.6 =(15/25).
This means that 3 share of the acquiring firm will be exchanged for
5 shares of the target firm.
The proponents of book value contend that it provides a very
objectives basis. This however is not convincing argument because
book values are influenced by accounting policies which reflect
subjective judgments. There are still serious objections against the
use of the book value.
1. Book values do not reflect changes in purchasing power of
money.
2. Book values often are highly different from true economic
values.
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.
1. VALUATION BASED ON
The worth of the target firm,ASSETS
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 ASSETS
In 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