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Hi, I have been working through Qn 45 Kaplan Kit; Doubler Inc (June 2007). The model answer states;
” … when this (redundancy costs) is included the combined value of the company is still expected to substantially increase.”
However, my calculation of the combined company value when redundancy cost is included using the P/E valuation method comes to $168,459. Comparing this with pre-acquisition value of $170,000 shows a reduction in value by $1,541. Please advise.
Facts of the question (only relevant figures are included):
Doubler Inc is considering a takeover bid for Fader Inc. The Board of Directors have issued the following statement; “Our superior P/E ratio and synergistic effect of the acquisition will lead to post acquisition increase in earnings per share and in the combined market value of the companies”.
Doubler Inc Fader Inc
$’000 $’000
Profit before tax 6,300 4,100
Tax (1,890) (1,230)
Profit after tax 4,410 2,870
Ordinary Shares (10 cent par value) 4,000 3,000
Notes:
i. After tax saving in operating costs of $750,000 per year indefinitely are expected as a result of the acquisition
ii. Initial redundancy costs will be $1 million before tax;
iii. Doubler’s cost of capital is 12%
iv. Current share prices are: Doubler 290 cents, Fader 180 cents;
v. The proposed terms of takeover are payment of 2 Doubler shares for every 3 Fader shares.
REQUIRED
c) Estimate the effect on combined market value as a result of the takeover using:
i. P/E based valuation
ii. Cash flow based valuation
State clearly any assumption that you make. (5 marks)I don’t know how you arrived at $168,459.
The combined earnings will be 4410 + 2870 + 750 = 8030
You could either use Doublers PE of 26.30 ( on the basis of what the board say) or, more sensibly, the weighted average PE of 23.35.
These would give total market values of either 211189 or 187,500.
Subtract the redundancy costs of 700 (after tax) and both result in values higher than the current 170,000.
Many thanks John.
I realised where the mistake was, I made error in copying combined earning (including net redundancy cost) as 7,230 instead of 7,330
With the weighted average P/E ratio of 23.3 and
combined earnings of 4,410 + 2,870 + 750 – 1,000(1-0.3) = 7,330The market value is 23.3 x 7,330 = 170,789 which is just over the pre-acquisition value.
Tax rate = 1890/6300 x 100 = 30%
Hi.i was attempting this question and it got me confused.i thought when adjusting post tax earnings we remove one off items but it seems the value of redundancy costs was not factored.may u help me understand.is it a wrong answer if i had considered my EPS value as 7.33/60 & got 12,22 cents
Because the redundancy is a ‘one-off’ it should really be ignored when calculating the EPS, therefore getting 8.03/60 as per the examiners answer. The question does refer to increasing the post-acquisition earnings per share, and the redundancy costs will not affect the post-acquisition earnings.
Including them as you have done is not a major error and you would still get most of the marks.
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