The directors of E. Ltd. are considering the acquisition of the entire capital of a private limited company, A (P) Ltd. Both companies being…

CA Final · Advanced Financial Management · RTP · November 2026
The directors of E. Ltd. are considering the acquisition of the entire capital of a private limited company, A (P) Ltd. Both companies being financed by equity. The acquisition would take place on 1st April 2027. E Ltd. has deputed a person to collect sufficient relevant information. This person has discovered that a public limited company, named T Ltd. most closely resembling A(P) Ltd. It has equity cost of capital of 19.30% and has a PE Ratio of 7.9. T Ltd. is engaged in the same line of business as A (P) Ltd. and possess similar business and financial risk. The following details relating to E Ltd. and A (P) Ltd. have been compiled by the same person: (i) The cost of capital of E Ltd. is 15.85%. As per his estimates, if A (P) Ltd. is acquired, the cash flow of E Ltd. for the year 2027-28 will be increased by an amount equal to 105% of the net profit of the year 2026-27 of A(P) Ltd. before deducting director's emoluments. (ii) In addition to that post acquisition cash flow generated by A (P) Ltd. shall constitute 30% of total cash generated of the combined firm. Further it is predicted that the cash flows of E Ltd. will increase by 5% per annuam in 2028-29 and subsequent years whether A(P) Ltd. is acquired or not. (iii) Following is the net profit figures of A(P) Ltd. (after deduction of director's emoluments). Year Net Profit 2021-22 ₹ 6.19 Crore 2022-23 ₹ 6.00 Crore 2023-24 ₹ 5.24 Crore 2024-25 ₹ 6.04 Crore 2025-26 ₹ 6.28 Crore 2026-27 (Estimated) ₹ 7.90 Crore The draft annual statements of the year 2026-27 also show that the net assets of A (P) Ltd. are 36.18 crore on historic cost basis and 63.75 crore on replacement cost basis. He also estimated that the net assets of A (P) Ltd. would realise ₹ 40 Crore on liquidation. (iv) The two directors and only shareholders are Mr. and Mrs. A, whose emoluments appear to average 10% of the net profits figures, after deducting those emoluments. Required: You as CFO of E Ltd. has been asked to suggest the maximum amount the directors of E Ltd. would be willing to pay for the acquisition of A (P) Ltd. Note: Carry out calculation in ₹ Crore and round off figures upto four decimal points.

Suggested Answer and Working Notes:

9. The maximum amount which the directors of E Ltd. should pay for the acquisition of A (P) Ltd. is equal to the increase in wealth of E Ltd.'s shareholders as a result of the acquisition. This increase will come from extra cash flows generated for the shareholders of E Ltd. either as an income-producing going concern or by sale of its assets, on by combination of the two. Since from the fact given there is no hint that the directors of E Ltd. have any intention to liquidate the A (P) Ltd. the present value of additional cash generated will be used to calculate the addition in the wealth (equivalent to the value of A (P) Ltd.) of shareholders of E Ltd. consequent upon acquisition. Using analyst's estimate first we shall Calculate additional cash flow to be generated due to acquisition is as follows. ₹ Crore Profit of A (P) Ltd. for the year 2026-27 7.90 Add: Director's Remuneration 0.79 8.69 Addition of Cash in the year 2027-28 @105%. 9.1245 Now the addition to the shareholder's wealth can be calculated using following two approaches: Approach I Assuming 5%. (as used above) growth rate be continued the PV of additional Cash generated Shall be: ₹ 9.1245 crore/(0.193 - 0.05) = ₹ 63.8077 crores Approach II Alternatively, 30%. of additional cash flow generated for combined can also be used to compute the same value as follows: However, in such situation the discount rate to be used shall be weighted average cost of capital i.e. 0.70 x 15.85% + 0.30 x 19.30% = 16.89% ₹ Crore Cash Flow of A(P) Ltd. for the year 2027-28 9.1245 Thus, combined cash flow of E Ltd. (100/30) x 9.1245 30.4150 The Combined Value of Firm = 30.4150/(0.1689-0.05) (A) 255.8032 Portion of Cash flow pertain to E Ltd. 0.70 x 30.4150 Value of E Ltd. alone = 21.2905/(0.1585 – 0.05) (B) Increase in Value & Firm due to acquisition (A) – (B) 21.2905 196.2258 59.5774 Decision: - Though any of Value ₹ 63.8077 crore or ₹ 59.5774 crore can be offered to acquire A (P) Ltd. but the amount of ₹ 59.5774 is more appropriate to offer as it accounts for direct impact on cash flow of E Ltd. due to acquisition of A (P) Ltd.

Topics: Mergers, Acquisitions and Corporate Restructuring

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