Question

(a)       Company XX has a market value of GH¢50 million. Company YY has a market value of GH¢200 million. YY has determined that if it combines resources with XX, cost savings will be worth GH¢25 million today. On this basis YY makes an offer to buy XX.

(i) If YY makes a cash offer of GH¢65 million for all the shares of XX, what is the cost of this purchase to YY?   

(ii) What are the gains of this transaction?          

(iii) Suppose YY has issued 100 of its shares to its shareholders, and is considering issuing 30 shares to the shareholders of XX, what is the cost of the share offer?
   

(iv) What is the net present value of the transaction under the cash offer to YY?
   

(v) What is the net present value under the share offer?   

(b) Explain clearly but briefly, three (3) ways by which synergies might be realized in business combinations.

Answer 1

a)

Given information,

Market value of Company XX = GHc 50 million

Market value of Company YY = GHc 200 million

Cost savings after combining resources with company XX = GHc 25 million

YY makes an offer to buy XX.

i)

Now, YY makes cash offer to XX for purchase of it's all shares and offers XX GHc 65 million in exchange of it's shares.

So now we have to calculate Cost of merger i.e. cost to company YY after considering merger of Company XX.

Therefore, Cost of purchase to YY= (Cash paid by YY to company XX for purchase of shares) - (Value of company XX before acquisition)

Cost of purchase to YY = GHc 65 million - GHc 50 million

Cost of purchase to YY = GHc 15 million

Therefore if YY makes cash offer to XX for purchase of it's shares then it will have to bear cost of GHc 15 million.

ii)

Cost of purchase as calculated above= GHc 15 million

As we know, if YY combines it's resources with XX, it will have cost savings of GHc 25 million.

So Gain from this transaction will be (Cost savings - Cost of purchase)

= GHc 25 million - GHc 15 million

= GHc 10 million

Hence, Company YY will gain GHc 10 million from this transaction.

iii)

Company YY is offering 100 shares to it's shareholders and issuing 30 shares to company XX.

Therefore total number of shares issued by Company YY = 100 shares out of which 30 shares to company XX and remaining 70 shares to other shareholders.

Market value of company YY after combination = Market value of company XX before combination + Market value of company

YY before combination

= GHc 50 million + GHc 200 million

= GHc 250 million

Therefore now we have to calculate price paid per share after combination

Therefore price paid per share after combination = Market value after combination  

Total no. of shares after combination

= GHc 250 million

100 shares

= GHc 2.5 per share.

Therefore price paid for combining resources of XX = shares offered by YY company to XX * Price paid per share

= 30 shares * GHc 2.5 per share

= GHc 75 million.

Therefore, if YY issued 30 shares to XX company then cost of this stock offer to YY company will be

(GHc 75 million - GHc 50 million) = GHc 25 million.

iv)

Therefore as we have calculated all the values so net present value of the transaction is as of now what is the net gain from the transaction. Hence, Net present value of the transaction from cash offer is GHc 10 million.

v)

Simmilarly Net present value from stock offer transaction is calculated as

Gain from combination as GHc 25 million - Cost of stock offer as GHc 25 million = GHc 0 million.

Hence net present value from stock offer is zero.

vi)

Following are different ways from which synergies might be realised in business combination:

• Due to business combination, there will be reduction in competition as if both the companies which are getting combines are competitors of each other then competition will be reduced due to this.
• Revenue of business will get increased if both the companies gets merged into each other as well as costs of both the companies will be decreased as both the companies will bear the total costs after combination.
• Due to stock offer, companies cash position will not get affected much and due to cash offer there is change in control position as both shareholders will get mixed.
• Both the offers have it's advantages and disadvantages.