Question

Suppose you work as a strategic financial manager at Nadia Inc., a large telecommunications firm which is considering making an offer to purchase Shaan Inc. a smaller network company. You have collected the following information for this important financial decision: Nadia Shaan Price-earnings ratio 8 6 Shares outstanding 500,000 220,000 Earnings $1,500,000 $440,000 Securities analysts expect the earnings and dividends (currently $1 per share) of Shaan to grow at a constant rate of 4% each year. Nadia management believes that its acquisition of Shaan will generate some economies of scale increasing Shaan's dividend per share growth rate to 6% per year. Based on this belief, Nadia is considering the following two alternative ways of acquiring Shaan:

Alternative 1

Acquire Shaan by paying $15 cash per share for Shaan’s stock.

Alternative 2

Acquire Shaan by share exchange ratio of l:4 (i.e. one share of Nadia for 4 shares of Shaan).

1. Which of the above two alternatives Should Nadia choose? Support your answer with calculations.

2. At what exchange ratio of Nadia's shares to Shaan's shares would the shareholders of Shaan be indifferent between Nadia's cash or stock offer for their stock? Show calculations to support your answer.

Answer 1

Particulars Shaan ($) a) 220 000 3 12 per Nadia (6) Earnings. 1500 000 44000 b) Shaus outstanding 5oooo EPS (a/b). 2. 6. d) 8 PE ratio (given) Market Price share (cxd) zu f) Market capitalization (bxe) 12000 000 2640000 Alternative if takeover in funded by cash? - 220000 15 6 26 40 000 Cost of take over for Nadia 66000o. Alternative @ If take over is funded by stock 220000 x - sooo shares be paid @ per share. Total market value of merged entity = 120 00 00 + 2640000 = 14640000 = u 2u will Shares alloted Assuming Soooo shares X100 Percentage holding of Shaan in merged entity: 55000 500000+ 55000 9.909941 True cost of megen =14640000 X 9.909.4 (-) con SSC00 x 24. = Iu So 824 6 13 20 00 O 130824 $ . since True Cost of Merger is low in stock; Stock funding should be prefered Lie) Alternative ②. Note :- * If exchange Ratio is based on Earnings per share (ie) 0.666 then; earnings will be same before & after merger. & will be in different between two (43) alternatives mentioned above.