R Ltd. and S Ltd. are companies that operate in the same industry. The financial statements of both the companies for the current financial year are…

CA Final · Advanced Financial Management · RTP · May 2025
R Ltd. and S Ltd. are companies that operate in the same industry. The financial statements of both the companies for the current financial year are as follows: Balance Sheet Particulars R. Ltd. (₹) S. Ltd (₹) Equity & Liabilities Shareholders Fund Equity Capital (10 each) 20,00,000 16,00,000 Retained earnings 4,00,000 Non-current Liabilities 16% Long term Debt 10,00,000 6,00,000 Current Liabilities 14,00,000 8,00,000 Total 48,00,000 30,00,000 Assets Non-current Assets 20,00,000 10,00,000 Current Assets 28,00,000 20,00,000 Total 48,00,000 30,00,000 Income Statement Particulars R. Ltd. (₹) S. Ltd. (₹) A. Net Sales 69,00,000 34,00,000 B. Cost of Goods sold 55,20,000 27,20,000 C. Gross Profit (A-B) 13,80,000 6,80,000 D. Operating Expenses 4,00,000 2,00,000 E. Interest 1,60,000 96,000 F. Earnings before taxes [C-(D+E)] 8,20,000 3,84,000 G. Taxes @ 35% 2,87,000 1,34,400 H. Earnings After Tax (EAT) 5,33,000 2,49,600 Additional Information: No. of equity shares 2,00,000 1,60,000 Dividend payment Ratio (D/P) 20% 30% Market price per share - 5020 Assume that both companies are in the process of negotiating a merger through exchange of Equity shares: You are required to: (i) Decompose the share price of both the companies into EPS & P/E components. Also segregate their EPS figures into Return On Equity (ROE) and Book Value/Intrinsic Value per share components. (ii) Estimate future EPS growth rates for both the companies. (iii) Based on expected operating synergies, R Ltd. estimated that the intrinsic value of S Ltd. Equity share would be 25 per share on its acquisition. You are required to develop a range of justifiable Equity Share Exchange ratios that can be offered by R Ltd. to the shareholders of S Ltd. Based on your analysis on parts (i) and (ii), would you expect the negotiated terms to be closer to the upper or the lower exchange ratio limits and why?

Suggested Answer and Working Notes:

(a) (i) Determination of EPS, P/E Ratio, ROE and BVPS of R Ltd. & S Ltd. R Ltd. S Ltd. EAT (₹) 5,33,000 2,49,600 N 200000 160000 EPS (EAT÷N) 2.665 1.56 Market Price Per Share 50 20 PE Ratio (MPS/EPS) 18.76 12.82 Equity Fund (Equity Value) 2400000 1600000 BVPS (Equity Value ÷ N) 12 10 ROE (EAT÷ EF) or 0.2221 0.156 ROE (EAT ÷ EF) x 100 22.21% 15.60% (ii) Determination of Growth Rate of EPS of R Ltd.& S Ltd. R Ltd. S Ltd. Retention Ratio (1-D/P Ratio) 0.80 0.70 Growth Rate (ROE x Retention Ratio) or 0.1777 0.1092 Growth Rate (ROE x Retention Ratio) x 100 17.77% 10.92% (iii) Justifiable equity share exchange ratio (a) Market Price Based = MPSS/MPSR = 20/50 = 0.40:1 (lower I) (b) Intrinsic Value Based = 25/50 = 0.50:1 (max. limit) Since R Ltd. has higher EPS, PE, ROE and higher growth expectations the negotiated term would be expected to be closer to the lower limit, based on existing share price.

Topics: Mergers, Acquisitions and Corporate Restructuring

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