Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

Mr. Upendo, a director of Yote Limited met Mr. Mapenzi, a director of Toa Limited during a conference in Mombasa. They had some discussion about their various companies. After flying back to Nairobi, Mr. Upendo proposed to his board of directors acquisition of Toa Limited.

During his presentation to the board he stated that: “As a result of this takeover we will diversify our operations and our earnings per share will rise 13%, bringing great benefits to our shareholders”.

No bid has yet been made and Yote Limited currently owns only 2% of Toa Limited.
A bid would be based on an exchange of shares between the two companies which would be one Yote share for every six Toa shares. Financial data for the two companies include the following:


Required:
a) Explain whether you agree with Mr. Upendo when he says that the takeover would bring „great benefits to our shareholders‟. Support your explanation with relevant calculations. State clearly any assumptions made.

b) On the basis of information provided, calculate the likely post acquisition price of a share of Yote Limited if the bid is successful.
c) What alternative forms of payment are available in a bid?
ANSWER
a) The great benefits to shareholders can only be evaluated from the perspective of post-merger EPS.

Yote Ltd already own 2% of shares of Toa Ltd.
Therefore it can only acquire the remaining 98% i.e 98% x 150M shares = 147M shares.


• Apart from increase in EPS, other benefit of diversification would be increased borrowing capacity which increases the interest tax shield to the shareholders of Yote Ltd.
• However, as long as shareholders are holding well-diversified portfolios, diversification through mergers and acquisitions will not be beneficial to them.
• The assumption made is that there are no synergistic effects.

b) Post-merger MPS
Pre-merger M.V of Yote Ltd = 40M shares @ Sh.3.20 = Sh.128M
Pre-merger M.V of Toa Ltd = 150M shares @ Sh.0.45 = Sh. 67.5
Sh.195.5

The market value of Yote Ltd will not change and it is simple equal to the combined market values. There is no synergistic effects.

(c) Other forms of financing the merger are: Cash
Issue of preference shares
Issue of debentures including mezzanine financial (convertible debentures) An offer which comprises a combination of the above 3 methods.

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