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Good Evening!
following is an introductory level question in the bpp text #26. there are 3 parts to the question and will ask them one by one so i am clear. here goes….Atlas is considering to bid for Global. following info is given :
—————————————–Atlas——————————–Global
EPS———————————–$4—————————————$0.9
share price————————–$70————————————-$22
Number of shares—————–1m————————————0.5mthe consensus view is that global will grow at 5%. the mgmt of Atlas thinks that without any investments, it make global grow at 7%
(a) – calculate the gain from the acquisition.
the working uses:
P=EPS/(k-g) …. by using 5% growth, it calculates the Ke
then it plugs Ke in the same formula to compute Pso, 22=.9/(Ke – ..05) ——–> which gives Ke=.0909
then P = .9/(.0909-.07)——–> P = 43
my question on this part is
1. given the growth rate and the precise formula, which is
P0=D0(1+g)/(Ke-g)
i did 22=0.9x(1.05)/(Ke-g) ——-> Ke=.0929
and thus i got the P = 42question: am i wrong in having done this? — pls shed light
question: the methods of valuations are different for different types of acquisitions. in a very bookish way. i was trying to classify which type of acquistion this is so i can apply the correct method. in this case, i just took a shot in the dark to use the div growth model simply because growth rates were given.pls enlighten me..:) .. and apologies again for dumb questions!!!!
What you have done is fine.
The difference is simply due to rounding – it you use Ke to more decimal places you will end up with exactly the same answer doing it either way.
In the exam you do not lose marks because of this – you get the marks if the marker can follow your workings OK 🙂
mmmm.. thank u…..now to part (b)
(b) calculate the cost of acquisition if atlas pays $30/share in cash and recommend if acquisition should be made
now, in order to value the acquisition, i need to know if business/financial risks are being disturbed…based on these, i can use the appropriate methods to value the co.
since its a cash offer, am sure there is some/all debt associated…depending on how much retained earnings they already have. so can we assume since debt will go up the financial risk is being disturbed?
and as for the business risk, we dont know if the target is in the same sector. what sort of assumptions shd be made ?
It is impossible for me to answer properly without seeing the whole question.
However from what you have typed it seems that from part (a) you will have the gain from the acquisition (and therefore don’t need any more about the risk) and simply have to compare it with the $30 per share being paid.
However, again, without seeing the whole question I cannot really say more.
Do BPP not provide an answer to the question?what i wrote is the whole question …. for part (b) they do exactly what u wrote… they compare the gain to the 30 price. but the issues of risks are not explained- am pretty sure thats because this stuff must be obvious but not to me..:)
that is why i keep apologizing that i ask rather basic questions…:)
so, it asks whether the acquisition shd be done.
and it calculates the NPV:
NPV = additional revenue – cost of acquisition
the additional revenues = gain — i understand this now
but for the cost of acquisition it only takes the amount of premium (30-22)x500000.=4mbut the cost is 30 x 500,000=15,000,000….
why just take the premium as cost?Firstly, since the question makes no mention of any changes in risk, the risks involved are ignored.
Secondly, if they were to pay just $22 per share (the current value) then they would make a gain of $43. (So they could afford to pay more than $22 and still end up with a gain).
They are paying $30 per share, which is $8 more than the current value. So the shareholders of Global are gaining $8, and the gain to Atlas is reduced by $8 (so 43 – 8).
wow… thanks!
so, can i say the following:
since the share price is 22 and the value calculated, which is 43, means that global’s share is undervalued?
Not really – it really means that Global’s existing management are maybe not doing as well as they should. Currently they are only achieving growth of 5% a year, and the reason that there is a gain if they are acquired is that Atlas’s management think that they can increase the rate to 7%.
right! we get 43 because of the 7% growth rate…thank u!!!!
thats it for this question… 🙂
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