Question

BLUERAIL LTD, a large social networking firm, is considering acquiring BLUE LOG LTD, a relatively new app development firm.

Assume the following details for the current year are relevant:

BLUERAIL BLUE LOG

Price-earnings ratio                                                          10                                           12                 

Total earnings                                                                  R21 600 000                         R6 720 000

Number of shares in issue                                            9 000 000                              4 200 000

Dividend per share                                                              R1.60                                     R0.96

BLUELOG earnings and dividends are expected to grow by 18% over the next three years, after which the earnings and dividends are expected to grow at a sustainable growth rate of 8% per annum.

BLUE LOG ordinary shareholders’ required rate of return is 15%.

The industry average price-earnings (PE) ratio is 9.

BLUERAIL estimates that the acquisition of BLUELOGwill increase the earnings of the combined firm by R3.6 million.

WHAT EXCHANGE RATIO SHOULD BE ACCEPTED FOR MERGER

Answer 1

Year	0	1	2	3
1.Dividends (0.96*1.18) & so on	0.96	1.1328	1.3367	1.5773
2.Terminal value (1.5773*1.08)/(15%-8%)				24.33549
3.Total cash flows (1+2)		1.1328	1.3367	25.9128
4.PV F at 15%(1/1.15^Yr.n)		0.86957	0.75614	0.65752
5.PV at 15% (3*4)		0.98504	1.01074	17.03808
NPV/intrinsic Value of BlueLog' s share	19.0339
Taking the
Price-earnings (P/E) ratio of Bluelog= 12
BLUERAIL's estimate that the acquisition of BLUELOG will increase the earnings of the combined firm by R3.6 million.
P/E=12
ie. P/3.6 mln.=12
so,offer price by Bluerail=3.6*12=43.2 mlns.
for 4.2 mln shares of Bluelog
ie. 43.2/4.2=
10.29
per share of BlueLog
Divided by
per share value of Blue Log calculated above
19.0339
Exchange ratio will be
10.29/19.03=
0.54
Ie. 0.54 share per every share in merged firm