Question

Europium plc is a large conglomerate which is seeking to acquire other companies. The Business Development division of Europium plc has recently identified an engineering company – Promithium plc – as a possible acquisition target.

Financial information relating to each company is given below:

Profit and Loss Account for the year ended 30 November 1997

	Europium plc			Promithium plc
Turnover	820			260
Profit on ordinary activities before tax	87			33
Taxation on profit on ordinary activities	(27)			(9)
Profit on ordinary activities after tax		60			24
Dividends	(15)			(5)
Retained profit for the year		45			19
Price:earnings ratio	16			10
Capital and reserves
£1 ordinary shares	80			30
Retained profits	195			124
	275			154

The Business Development division of Europium plc believes that shares of Promithium plc can be acquired by offering its shareholders a premium of 25 per cent above the existing share price. The purchase consideration will be in the form of shares in Europium plc.

Required

(a)Calculate the rate of exchange for the shares and the number of shares of Europium plc which must be issued at the anticipated price in order to acquire all the shares of Promithium plc.

(b)Suggest reasons why Europium plc may be prepared to pay a premium above the current market value to acquire the shares of Promithium plc.

(c)Calculate the market value per share of Europium plc following the successful takeover and assuming the P:E ratio of Europium plc stays at the pre-takeover level. Would you expect the P:E ratio of Europium plc to stay the same?

(d)State what investigations Europium plc should undertake before considering a takeover of Promithium plc.

Answer 1

Step 1 :- Key Data for calculating exchange ratio

Sr. No.	Particulars	Europium plc	Promithium plc
a	Net Profit After Taxes	$60.00	$24.00
b	No of Shares	80	30
c = a / b	Earning per share	$0.75	$0.80
d	Price earning ratio (Times)	16.00	10.00
e = c x d	Market price per share	$12.00	$8.00
f = b x e	Market Capitalization	$960.00	$240.00

.

Step 2 :- Calculation of Exchange Ratio for share acquisition of Promithium Plc

i) Exchange Ratio on the basis of Market price per share

= Negotiated Market price of share of Target company : Market Price of share of acquiring Company

= (8 x 1.25) : 12

= 10:12

= 5:6

Therefore, Exchange ratio is 5 shares of Europium Plc for every 6 shares of Promithium Plc

.

ii) Calculating Number of shares to be issued to Promithium Plc

= Number of Shares of Promithium Plc (Before Merger) x Exchange Ratio

= 30 x 5 / 6

= 25 Shares of Europium Plc

.

Answer b) Reasons for payment of premium on shares during Mergers and acquisition are as follows:-

Value of synergy through merger

Compensation value for acquiring controlling stake in company

Value of Intangible assets (i.e. Patents, Brands, Trade marks Etc.) and goodwill of Target Company.

.

Answer c) Calculating the market Price per share of Europium plc after the successful takeover and assuming the P:E ratio of Europium plc stays at the pre-takeover level.

Sr. No.	Particulars		Europium plc
a	Combined Net Profit After Taxes	(60+24)	$84.00
b	No of Shares (After Merger)	(80 + 25)	105
c = a / b	Earning per share (After Merger)		$0.80
d	Price earning ratio (Times)	Same	16.00
e = c x d	Market price per share (After) Merger		$12.80

iii) No, The P/E ratio for Emporium Inc. will not remain same. because,

Lower Price Earning ratio implies that company is under performing as compared to its peers. In this case the factor of "Quality Asset" is compromised

In the given case, Price earning ratio of Promithium plc. before merger was only 10 times as compared to the peers (i.e. Price earnings ratio for Europium Inc 16 Times, Thus the price earning ratio of Europium Inc. after merger may reduce from current ratio of 16 times.

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Answer d) Types of investigations to be done by Europium plc before considering a takeover of Promithium plc are

Financial and commercial Investigation - it includes tax matters also,

Legal Investigation,

Strategic and technical investigations, Etc