Question

The board of Hanging Valley plc wishes to take over Rattling Creek Ltd. Shown below are

summarised financial data for the two companies:

Hanging Valley plc Rattling Creek Ltd

Profit before interest and tax GHS420,000 GHS200,000

Ordinary share dividends 6.9p 14.0p

Corporate tax rate 35% 35%

Financial position statement extracts:

Hanging Valley plc Rattling Creek Ltd

Non-current assets 1,750,000 800,000

Current assets 800,000 500,000

Total assets 2,550,000 1,300,000

Equity

Ordinary shares (GHS1) 1,500,000 500,000

Reserves 600,000 400,000

2,100,000 900,000

10% bonds 200,000

Current liabilities 450,000 200,000

Total liabilities 2,550,000 1,300,000

Hanging Valley’s earnings and dividends have been increasing at 15 per cent per year in recent times, while over the same period the earnings and dividends of Rattling Creek have remained static. The current market price of Hanging Valley’s ordinary shares is GHS1.60. The board of Hanging Valley believes that Rattling Creek shareholders will accept a share-for share offer of four shares in Hanging Valley for every five shares in Rattling Creek.

(a) Using the asset base and the market base valuation models, determine the effect on the wealth of Hanging Valley plc’s shareholders if Rattling Creek Ltd’s shareholders accept the proposed share-for-share offer.

(b) Critically discuss the economic reasons why one company may seek to take over

another.

(b)

i. Critically discuss which factors will influence a company to finance a takeover by either a share-for-share offer or a cash offer financed by an issue of bonds.

ii. Provide three explanations for the failure of acquisitions to enhance shareholder value.

Answer 1

Earning yield of HV = eps / price = 0.182/1.6 = 11.38%

RC Capital value = EAT / yield = 117000/ 11.38% = GHS 1028119.5

B The economic reasons for taking over another company is that shareholder wealth will be enhanced by the deal. This increase in wealth can arise from the following ways such as synergy, whereby the value of the combined entity exceeds its parts ,economies of scale, e.g. in distribution and production; the elimination of inefficient management; entry into new markets  ;to provide critical mass; to provide growth; to provide market share.

b i

The main difference is , In cash transactions, the expected synergy value present in the acquisition premium will not be materialized since the entire risk will be on  acquiring shareholders where as in the stock transactions, that synergy risk will be shared with selling shareholders in a proportion to the percentages the acquiring and selling shareholders own in the combined company .In case cash is being fiananced by bonds the acquiring comapny shareholders will not get the synergy gain preasent in the merger and there are the chances of rising the debt value to the company and which also effects the earnings to equity holders as interest expenses comes in.

b ii The reasons for failure of acquisitions to enhance shareholder value can be window dressing ( superficial or misleading presentation about the affairs of the company ),market irrationality , premptive action, hubris hypothesis