Unit III: Deal Valuation and Evaluation

 Factors affecting valuation basics

 Methods of valuation
 Cash flow approaches
 Economic value added (EVA)
 Sensitivity analysis
 Valuation for slump sale
 Valuation of synergy
 Cost-benefit analysis and swap ratio determination

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 Situation requiring Valuation
2
Following are some of the usual circumstances when valuation of
shares or enterprise becomes essential:
1. When issuing shares to public either through an initial public offer or
by offer for sale of shares of promoters or for further issue of shares
to public.
2. When promoters want to invite strategic investors or for pricing a
first issue or a further issue, whether a preferential allotment or
rights issue.
3. In making investment in a joint venture by subscription or
acquisition of shares or other securities convertible into shares.
4. For making an ‘open offer’ for acquisition of shares.
5. When company intends to introduce a ‘buy back’ or ‘delisting of
shares’.
6. In schemes involving mergers/demergers, share valuation is
resorted to in order to determine the consideration for the purpose
of issue of shares or any other consideration to shareholders of
transferor or demerged companies.
7. On directions of Tribunal or Authority or Arbitration Tribunals.
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 Situation requiring Valuation
3
Following are some of the usual circumstances when valuation of
shares or enterprise becomes essential:
8. For determining fair price for effecting sale or transfer of shares as
per Articles of Association of the company.
9. As required by the agreements between two parties.
10. To determine purchase price of a ‘block of shares’, which may or
may not give the holder thereof a controlling interest in the
company.
11. To value the interest of dissenting shareholders under a scheme of
amalgamation, merger or reconstruction.
12. Conversion of debt instruments into shares.
13. Advancing a loan against the security of shares of the company by
the Bank/Financial Institution.
14. As required by provisions of law such as the Companies Act, 2013
or Foreign Exchange Management Act, 1999 or Income Tax Act,
1961 or the SEBI (Substantial Acquisition of Shares and Takeovers)
Regulations, 2011 [the Takeover Code] or SEBI (Share Based
Employee Benefits) Regulations, 2014 or SEBI (Buy Back of
Securities) Regulations, 2018 or Delisting Guidelines.

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 Factors Affecting Valuation Basics
4

 The key to valuation is finding a common ground

between all of the companies for the purpose of a fair
evaluation.
 Determining the value of a business is a complicated and
intricate process. Valuing a business requires the
determination of its future earnings potential, the risks
inherent in those future earnings. A company’s fair
market value is the price at which the business would
change hands between a willing buyer and a willing seller
when neither are under any compulsion to buy or sell,
and both parties have knowledge or relevant facts.

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 Factors Influencing Valuation
5

The process of arriving at this value includes a detailed

analysis of its mix of physical and intangible assets, and the
general economic and industry conditions.

The other salient factors include:

1) The stock exchange price of the shares of the two
companies before the commencement of negotiations or
the announcement of the bid.
2) Dividends paid on the shares.
3) Relative growth prospects of the two companies.

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 Factors Influencing Valuation contd.
6

The other salient factors include:

4) In case of equity shares, the relative gearing of the
shares of the two companies. (‘gearing’ means ratio of
the amount of issued preference share capital and
debenture stock to the amount of issued ordinary share
capital.)
5) Net assets of the two companies.
6) Voting strength in the merged (amalgamated) enterprise
of the shareholders of the two companies.
7) Past history of the prices of shares of the two
companies.
8) Merger and amalgamation deals can take a number of
months to complete during which time valuations can
fluctuate substantially. Hence provisions must be made
to protect against such swings.
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 Preliminary steps in Valuation
7
A business valuation involves analytical and logical application/analysis
of historical/future tangible and intangible attributes of business. The
preliminary study to valuation involves the following aspects:
1) Purpose of valuation.
2) Goodwill/Brand name in the market.
3) Business environment of the entity to be valued.
4) Estimation/forecast of future cash flows as accurately as possible.
5) Is company listed on any stock exchange?
6) If listed, whether shares of the company are traded frequently?
7) The industry in which the entity is part of
8) The industry P/E ratio, past and future growth rate.
9) Who are the competitors locally, internationally?
10) Whether any similar valuation has been done recently?
11) The technology concerning the enterprise and its probability of
obsolescence.
12) The accepted discounting rate.
13) Study of market capitalization aspects.
14) Identification of hidden liabilities through analysis of material
contracts.

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 Valuation for M&A
8

The value of a business is a function of the business logic

driving the M&A and is based on bargaining powers of
buyers and sellers. Thorough due diligence has to be
exercised in deciding the valuation parameters since these
parameters would differ from sector to sector and company
to company.
Some most popular methods of valuation amongst other
are:
A. Assets based valuation
B. Earnings based valuation
C. Market based valuation
D. Discounted cash flow method
E. Liquidation value method

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 Sensitivity Analysis
9

 The profitability of an enterprise may be sensitive to

different factors. If we take these factors as independent
variables, then given a change in one or more of the
variables, how the profitability will change? This
technique is known as “Sensitivity Analysis”.
 In business valuation, there are variables such as
discount rate, future growth rate, market share, beta
value, required rate of return, etc. Each of these factors
can be varied to test the business valuation model.

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 Sensitivity Analysis contd.
10

Eg 1:
The variables are Sales and EBT%. How sensitive is the EBT% to
decrease or increase in sales.
Current 10% decline 10% 20% decline 32%
in sales increase in in sales increase in
sales sales
Sales 100000 90000 110000 88000 132000

Cost of Sales 70% 70000 63000 77000 61600 92400

Gross Profit 30000 27000 33000 26400 39600

Fixed Cost 15000 15000 15000 15000 15000

Interest 10% 5000 5000 5000 5000 5000

Earnings before 10000 7000 13000 6400 19600

tax
EBT % 10% 8% 12% 7% 15%
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 Sensitivity Analysis contd.
11

As can be seen the sensitivity analysis is:

Variable = Sales Variable = EBT%

0% change from current 10%

10% decrease Decrease by 8%

10% increase increase to 12%

20% decrease decrease to 7%

32% increase increase to 15%

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 Sensitivity Analysis contd.
12

Example 2:
 Business valuation of an enterprise which has 2 crore
shares issued and paid-up, has current earnings of Rs.10
per share.
Current Earnings Earnings P/E ratio P/E ratio
decrease increase by increase by decrease
by 10% 10% 20% by 20%
P/E ratio of industry 25 25 25 30 20
Earnings per share 10 9 11 10 10
(Rs.)
Market price of share 250 225 275 300 200
(Rs.)
Value of the 500 450 550 600 400
enterprise (Rs. in cr.)

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 Swap Ratio
13

 A swap ratio is an exchange rate of the shares of the

companies that would undergo a merger. This is calculated by
the valuation of various assets and liabilities of the merging
companies.

 The swap ratio determines the control that each group

of shareholders of the companies shall have over the
combined firm. It is an indicator of relative values of financial
and strategic results of the company.

 In a merger or acquisition between two companies, the

ratio at which the acquiring company offers its own
shares in exchange for the target company’s shares, is
known as the swap ratio.

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 Exchange Ratio / Swap Ratio
14

 Exchange ratio is defined as the number of shares the

acquiring firm is willing to give in exchange for one share
of the target firm.

 An exchange ratio of 0.5 means that the acquiring firm is

willing to give half a share for every share of the target
firm.

 Swap Ratio : Parameter of the target company

Parameter of the acquiring company

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 Exchange Ratio / Swap Ratio
15

Example:
 In October 2017, Indusind Bank acquired a micro finance
company Bharat Financial Inclusion Ltd. The swap ratio
had been decided at 639 shares of IndusInd Bank for
every 1,000 shares of Bharat Financial. This means that
the value of one share of Bharat Financial is equal to
0.639 share of Indusind Bank, swap ratio of 1:0.639.

 In 2018, IDFC Bank and Capital First announced merger

between the two to form a combined entity with assets
under management of `88,000 crore, branch network of
194 and customer base of over 5 million. As per the
agreement, IDFC Bank will issue 139 shares for every 10
shares of Capital First. So the swap ratio here is 1:13.9.

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 Bases for Determining the Exchange ratio
16

 Book value per share

 Earnings per share
 Market price per share
 Dividend discount value per share
 Discounted cash flow value per share

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 Bases for Determining the Exchange ratio
17

 Book value per share

Do not reflect changes in purchasing power of money.
Often different from true economic values.

 Earnings per share

Difference in the growth rate of earnings of the two
companies.
Gains in earnings arising out of merger.
Differential risks associated with the earnings of the
two companies.
Negative earning per share.
Wind fall profit, large tax relief.

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 Bases for Determining the Exchange ratio
18

 Market price per share

Less reliable for stocks which are less traded
Does not exists for stocks which are less traded
Can be manipulated
 Dividend discount value per share
The dividend discounted value per share is the
present value of the expected stream of dividends.
Can be used when dividends can be predicted
 Discounted cash flow value per share
DCF value per share = Firm value using the DCF method – Debt value
Number of equity shares
Cash flow projections are available for a long period.

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 Bases for Determining the Exchange ratio
19

 Book value per share

 Earnings per share
 Market price per share
 Dividend discount value per share
 Discounted cash flow value per share

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 Boundaries for exchange rate determination
20

Larson & Gonedes

Conn & Nielson
 ER = Exchange Ratio
 P1 = Price per share for acquiring company
 P12 = Price per share for combined company
 PE12 = Price earnings multiple for combined company
 EPS12 = Earnings per share for combined company
 E1 = Earnings for acquiring company
 E2 = Earnings for acquired company
 S1 = Number of outstanding equity shares for acquiring
company
 S2 = Number of outstanding equity shares for acquired
company

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 Boundaries for exchange rate determination
21 contd.
P12 ≥ P1
P12 = P1
P12=(PE12) (EPS12) = P1

𝐸1+𝐸2
EPS12=
𝑆1+𝑆2 (𝐸𝑅1)

(𝑃𝐸12) (𝐸1+𝐸2)
P1 =
𝑆1+𝑆2 (𝐸𝑅1)

−𝐒𝟏 𝑬𝟏+𝑬𝟐 𝑷𝑬𝟏𝟐

ER1 = +
𝑺𝟐 𝑷𝟏𝑺𝟐

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 Boundaries for exchange rate determination
22 contd.
P12 (ER2) ≥ P2

(PE12) (EPS12) ER2 = P2

𝐸1+𝐸2
PE12 𝑥 𝑥 𝐸𝑅2 = 𝑃2
𝑆1+𝑆2 (𝐸𝑅2)

𝐸1 + 𝐸2 𝑃2
𝑥 𝐸𝑅2 =
𝑆1 + 𝑆2 (𝐸𝑅2) 𝑃𝐸12
𝑃2
𝐸1 + 𝐸2 𝑥 𝐸𝑅2 = 𝑥 (𝑆1 + 𝑆2 𝑥 𝐸𝑅2)
𝑃𝐸12
𝑃2𝑆1 𝑃2𝑆2 𝑥 𝐸𝑅2
𝐸1 + 𝐸2 𝑥 𝐸𝑅2 = +
𝑃𝐸12 𝑃𝐸12

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 Boundaries for exchange rate determination
23 contd.
𝑃2𝑆1 𝑃2𝑆2 𝑥 𝐸𝑅2
𝐸1 + 𝐸2 𝑥 𝐸𝑅2 = +
𝑃𝐸12 𝑃𝐸12

𝑃2𝑆2 𝑥 𝐸𝑅2 𝑃2𝑆1

𝐸1 + 𝐸2 𝑥 𝐸𝑅2 − =
𝑃𝐸12 𝑃𝐸12

(𝑃2𝑆2 ) 𝑃2 𝑆 1
(𝐸1 + 𝐸2) 𝑥 𝐸𝑅2 − 𝐸𝑅2 =
𝑃𝐸12 𝑃𝐸12

(𝑃2𝑆2 ) 𝑃 2𝑆 1
(𝐸1 + 𝐸2 − )𝑥 𝐸𝑅2 =
𝑃𝐸12 𝑃𝐸12

𝑷𝟐 𝑺 𝟏
ER2 =
𝑷𝑬𝟏𝟐 𝑬𝟏+𝑬𝟐 −𝑷𝟐𝑺𝟐

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 Boundaries for exchange rate determination
24 contd.

16-04-2024
 Class Exercise on Exchange Ratio
25
Firm 1 Firm 2
Total earnings Rs. 18 mn Rs. 6 mn
No. of Outstanding shares 9 mn 6 mn
EPS Rs. 2 Re. 1
PE ratio 12 8
MPS Rs. 24 Rs. 8

Maximum exchange ratio acceptable to shareholders of firm 1

PE 12 9 10 11 12 15 20
Max ER1

Minimum exchange ratio acceptable to shareholders of firm 2

PE 12 3 9 10 11 12 15 20
Min ER2

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 Class Exercise on Exchange Ratio
26
Firm 1 Firm 2
Total earnings Rs. 18 mn Rs. 6 mn
No. of Outstanding shares 9 mn 6 mn
EPS Rs. 2 Re. 1
PE ratio 12 8
MPS Rs. 24 Rs. 8

Maximum exchange ratio acceptable to shareholders of firm 1

PE 12 9 10 11 12 15 20
Max ER1 0 0.17 0.33 0.50 1.0 1.83

Minimum exchange ratio acceptable to shareholders of firm 2

PE 12 3 9 10 11 12 15 20
Min ER2 3 0.43 0.38 0.33 0.30 0.23 0.17

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 Class Exercise on Exchange Ratio
27

BBA(FIA) Limited is keen on reporting an earnings per share of

Rs. 6 after acquiring BMS Limited. The following financial data
are given.
BBA(FIA) Limited BMS Limited
Earnings per share Rs. 5 Rs. 5
Market price per share Rs. 60 Rs. 50
No. of share 10 Lakh 8 Lakh

There is an expected synergy gain of 5%. What exchange ratio

will result in a post-merger earnings per share of Rs. 6 for
BBA(FIA) Limited?

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 Solution
28

 Total earnings of BBA(FIA) limited = Rs. 50,00,000

 Total earnings of BMS limited = Rs. 40,00,000
 Synergy Gain = 5%
 Total earnings of the combined limited =
90,00,000X1.05= 94,50,000 Rs.

 EPS = 6 = 94,50,000
10,00,000 + (ER x 8,00,000)

ER = 0.71875

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 Question on Exchange Ratio
29

Alpha Corporation plans to acquire Beta Corporation. The following

information is available:
Alpha Corporation Beta Corporation
Total current earnings, E Rs. 50 million Rs. 20 million
Number of outstanding shares, S 20 million 10 million
Market price per share, P Rs. 30 Rs. 20
a) What is the maximum exchange ratio acceptable to the
shareholders of Alpha Corporation if the PE ratio of the combined
entity is 12 and there is no synergy gain?
b) What is the minimum exchange ratio acceptable to the
shareholders of Beta Corporation if the PE ratio of the combined
entity is 11 and there is a synergy benefit of 5%?
c) Assuming that there is no synergy gain, at what level of PE multiple
will the lines ER1 and ER2 intersect?

16-04-2024
 Solution
30

a) Maximum exchange ratio acceptable to the

shareholders of Alpha Corporation

−𝑆1 𝐸1 + 𝐸2 𝑃𝐸12
𝐸𝑅1 = +
𝑆2 𝑃1𝑆2
−20 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 50+20 12 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
𝐸𝑅1 =
10 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
+
30 𝑥10 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
= 0.80

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 Solution
31

b) minimum exchange ratio acceptable to the shareholders

of Beta Corporation

𝑃2𝑆1
𝐸𝑅2 =
𝑃𝐸12 𝐸1 + 𝐸2 − 𝑃2𝑆2

20 𝑥 20 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
𝐸𝑅2 =
11 𝑥 70 𝑚𝑖𝑙𝑙𝑖𝑜𝑛 𝑥 1.05 −20 𝑥 10 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
= 0.657

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 Solution
32

c) Level of PE multiple: The lines ER1 and ER2 will

intersect at the weighted average of the two PE multiples,
wherein the weights correspond to the respective earnings
of the two firms.
𝐸1 E2
𝑃𝐸12 = 𝑃𝐸1 + PE2
𝐸1 + 𝐸2 𝐸1 + 𝐸2
(𝑃𝐸1 & 𝑃𝐸2 = MPS/EPS)

50 20
𝑃𝐸12 = PE1 + PE2
70 70

50 20
𝑃𝐸12 = x 12 + x 10 = 11.43
70 70

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 Class Exercise on Exchange Ratio
33
The following information is provided relating to the acquiring company BBB(FIA) Ltd. and
the target company BMS Ltd.
BBA(FIA) Ltd. BMS Ltd.
No. of shares (F.V. Rs. 10 each) 10.00 lakhs 7.5 lakhs
Market capitalisation 500 lakhs 750 lakhs
P/E ratio 10 5
Reserve and Surplus 300 lakhs 165 lakhs
Promoter’s Holding (No. of shares) 4.75 lakhs 5 lakhs
Board of Directors of both the companies have decided to give a fair deal to the
shareholders and accordingly for swap ratio the weights are decided as 40%, 25% and
35% respectively for Earning, Book value, Market price of share of each company:
1. Calculate the swap ratio and also calculate Promoter’s holding % after acquisition.
2. What is the EPS of BBA(FIA) Ltd. after acquisition of BMS Ltd.?
3. What is the expected market price per share and market capitalisation of BBA(FIA)
Ltd. after acquisition, assuming P/E ratio of firm BBA(FIA) Ltd. remains unchanged.
4. Calculate free float market capitalisation of the merged firm.

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 Solution
34
Particulars BBA(FIA) Ltd. BMS Ltd.
Market capitalisation
No. of shares
Market price per share
P/E ratio
EPS
Profit
Share capital
Reserves and surplus
Total
Book value per share

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 Solution
35
Particulars BBA(FIA) Ltd. BMS Ltd.
Market capitalisation 500 lakhs 750 lakhs
No. of shares 10 lakhs 7.5 lakhs
Market price per share Rs. 50 Rs. 100
P/E ratio 10 5
EPS Rs. 5 Rs. 20
Profit Rs. 50 lakhs Rs. 150 lakhs
Share capital Rs. 100 lakhs Rs. 75 lakhs
Reserves and surplus Rs. 300 lakhs Rs. 165 lakhs
Total Rs. 400 lakhs Rs. 240 lakhs
Book value per share Rs. 40 Rs. 32

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 Solution
36

1. Calculation of swap ratio

EPS 4 :1 4 x 40% = 1.6
Book Value 0.8:1 .8x 25% = 0.2
Market Price 2 :1 2 x 35% = 0.7
Total = 2.5
Swap ratio is for every 1 share of BMS Ltd. to issue 2.5
shares of BFIA Ltd.
Total no. of shares to be issued: 7.5 lakh x 2.5 = 18.75 lakh
shares.
Promoters holding= 4.75 lakh shares + (2.5 x 5 lakh shares)
= 4.75 + 12.5 = 17.25 lakh
Promoters holding % = 17.25 lakh / (18.75 + 10 lakh) x 100
= 60%

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 Solution
37

2. EPS of BBA(FIA) Ltd. after acquisition of BMS Ltd.

Total no of shares 10 lakh + 18.75 lakh = 28.75 lakh
EPS Total profit / No. of shares
= 50 L + 150 L / 28.75 L = 200 / 28.75
= Rs. 6.956

3. Expected market price per share and market

capitalisation of BBA(FIA) Ltd. after acquisition, assuming
P/E ratio of firm BBA(FIA) Ltd. remains unchanged.

Expected market price = EPS 6.956 x P/E 10 = Rs. 69.56

Market Capitalisation = 69.56 per share x 28.75 Lakh shares
= Rs. 1999.85 Lakh

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 Solution
38

4. Free float market capitalisation of the merged firm

Free float of market cap.

= MPS x (Total shares – Promoters
holding)
= 69.56 x (28.75L – 17.25L)
= 69.56 x (11.5L)
= Rs. 799.94 Lakh

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 Economic Value Added
39

 Concept of EVA was developed by Joel Stern and

Bennett Stewart.
 EVA is the after tax cash flow generated by a business
minus the cost of the capital it has deployed to generate
that cash flow.

EVA= NOPAT - (k0 x TCE)

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 EVA
40

 Sales – Total cost (Except interest) = operating Profit

 Operating Profit – tax = NOPAT

NOPAT - Total funds * WACC = EVA

Capitalised value = EVA/ WACC

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 EVA
41
Approach 1 Approach 2
Sales Amount Sales Amount
Total Cost Less Total Cost less
(excluding interest) (including interest)

Operating Profit (EBIT) Balance EBT Balance

Tax Less Tax Less
NOPAT Balance EAT / PAT Balance
(E+R+P+D) Less E+R * KE Less
total funds * WACC
P*Kp Less
EVA Balance EVA Balance

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 Class Exercise (EVA)
42

A company generates before tax profit of Rs. 2 million (No

interest has been deducted). By deploying a capital
expenditure of 0.75 million, it incurs a cost of 10% after tax
(cost of debt is 5%, cost of equity is 15% weighted equally).
What is EVA generated by the company? (Assume tax rate
@ 35%)

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 Economic Value Added Solution
43

NOPAT = Rs. 2 x (1-35%) = Rs. 1.3 million

Cost of capital = 10% x 0.75 = Rs. 0.075 million
EVA of the investment is Rs. 1.3 m – Rs. 0.075 m = Rs. 1.225 million
Cost of debt 5%
Cost of equity 15%
Debt / Equity ratio 50%
WACC 10%
EBIT 2000000
Tax rate 35%
EBIT (1-T) 1300000
WACC 10%
Total Capital employed 750000.0
WACC x TCE 75000.0
EVA 1225000
Value of investment 1225000 16-04-2024
 Class Exercise (EVA)
44

A firm generates Rs. 1 million in profits expected to grow at

10% for the next five years and perpetually @ 9%. The cost
of capital is 10%, tax rate is 35% and total capital employed
is Rs. 0.5 million. The capital expenditure increases at 7.5%
per annum. Determine the EVA value of the firm.

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 Solution (EVA)
45
Year EBIT Tax EBIT(1-T) WACC Total Capital WACC EVA PV of
rate NOPAT Employed x TCE EVA
0 1000 500.00
1 1100 35% 715 10% 537.5 53.75 661.25 601.14
2 1210 35% 786.5 10% 577.81 57.78 728.72 602.25
3 1331 35% 865.15 10% 621.15 62.11 803.03 603.33
4 1464 35% 951.665 10% 667.73 66.77 884.89 604.39
5 1611 35% 1046.8315 10% 717.81 71.78 975.05 605.43
TY 1756 35% 1141.4 10% 771.65 77.17 1064.23
Total 3016.54
TV 106423 66080.31
Value 69096.85
of
Firm

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 Class Exercise (EVA)
46

The capital structure of BBA(FIA) Ltd. is as under:

• 80,00,000 Equity shares of Rs. 10 each
• 1,00,000, 12% Preference shares of Rs. 250 each
• 1,00,000, 10% Debenture of Rs. 500 each
• Terms loan from bank @ 10%, Rs. 450 lakhs

The company’s statement of Profit and Loss for the year

showed PAT of Rs. 100 lakhs, after appropriating Equity
Dividend @ 20%. The company is in the 40% tax bracket.
Treasury bonds carry 6.5% interest and beta factor for the
company may be taken as 1.5. The long run market rate of
return may be taken as 16.5%. Calculate Economic Value
Added.

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 Solution (EVA)
47

Calculation of Profit before tax

Particulars Computation Rs. In lakhs
Profit before Interest and Taxes
Less: Interest on Debentures 500 x 10%
Interest on bank term loan 450 x 10%
Profit before tax
Less: Tax @ 40%
Profit after Tax
Less: Preference Dividend 250 x 12%
Profit available for equity SH
Less: Equity Dividend 800 x 20%
Net balance in P & L Account

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 Solution (EVA)
48

Calculation of Profit before tax

Particulars Computation Rs. In lakhs
Profit before Interest and Taxes 578.33
Less: Interest on Debentures 500 x 10% (50.00)
Interest on bank term loan 450 x 10% (45.00)
Profit before tax 483.33
Less: Tax @ 40% (193.33)
Profit after Tax 290.00
Less: Preference Dividend 250 x 12% (30.00)
Profit available for equity SH 260.00
Less: Equity Dividend 800 x 20% (160.00)
Net balance in P & L Account 100.00

16-04-2024
 Solution Contd. (EVA)
49

Computation of Cost of equity

= Rf + β x (MR - Rf)
= 6.5% + 1.5 (16.5% - 6.5%) = 21.5%

Computation of Cost of debt

Interest 45 L +50 L
Less: Tax @40% (18 L)+ (20 L)
Interest after tax 27L+ 30L
57/950*100= 6%

Cost of debt = I (1-t)

= 10% (1- 40%) = 6%

16-04-2024
 Solution Contd. (EVA)
50

Computation of weighted average cost of capital

Component Amount Ratio Individual cost WACC

Rs. Lakhs
Equity 800 800/ 2000 = 0.40 Ke = 21.5 8.6
Preference 250 250/2000 = 0.125 Kp= 12 1.5
Debt 950 950/ 2000 = 0.475 Kd= 6 2.85
Total 2000 12.95%

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 Solution Contd. (EVA)
51

Particulars Rs. In Lakhs

Profit before interest and taxes 578.33
Less: Interest (50+45) (95.00)
Profit before tax 483.33
Less: Taxes (193.33)
Profit after tax 290.00
Add: Interest (net of tax) [95 x (1- 0.40)] 57.00
Net operating profit after taxes 347.00
Less: Cost of capital (259.00)
(WACC x Capital Employed)
(12.95% x 2000)
EVA 88.00

16-04-2024
 Solution Contd. (EVA)
52
Particulars Approach 1 Rs. In Particulars Approach 2 Rs. In Particulars Approach 3 Rs. In
Lakhs Lakhs Lakhs
Profit before interest and 578.33 Profit before interest and 578.33 Profit before interest and 578.33
taxes taxes taxes
Less: Interest (50+45) (95.00) Less: Interest (50+45) (95.00)

Profit before tax 483.33 Profit before tax 483.33

Less: Taxes (231.33) Less: Taxes (193.33) Less: Taxes (193.33)

Profit before interest but 347.00 Profit after tax 290.00 Profit after tax 290.00
after tax
Less: Cost of (202.00) Add: Interest (net of tax) 57.00
Kp 12 = 30 [95 x (1- 0.40)]
Ke 21.5 = 172.0
Net operating profit after 347.00 Net operating profit after 347.00
taxes taxes
Less: Cost of capital (259.00) Less: Cost of capital (259.00)
(WACC x Capital (WACC x Capital Employed)
Employed) (12.95% x 2000)
(12.95% x 2000)
EVA 88.00 EVA 88.00 EVA 88.00

16-04-2024
 Class Exercise (EVA)
53

Compute EVA of A Ltd. from the information given.

Particulars Year 1
Average Capital Employed 4,000.00
Operating Profit before Interest and Tax 1600.00
Corporate Income Taxes 120.00
Average Debt (In %) 13.00
Beta Variant 1.30
Risk Free Rate (%) 12.50
Equity Risk Premium (%) 10.00
Cost of Debt (Post Tax) (%) 20.00

16-04-2024
 Solution Contd. (EVA)
54 EVA Statement of Sarin Ltd.
Particulars Year 1
Cost of Equity (Ke) = Risk Free Rate+ (Beta x Equity Risk Premium) 12.5 +(1.3 x 10) = 25.50%
Cost of Debt (Kd) (given) 20.00%
Debt – Equity Ratio (Debt = given; Equity is bal. fig) 13% & 87%
WACC = [(Kd) x Debt % + (Ke) x Equity%] 24.79%
(25.50 x 87% + 20 x 13%)
Average Capital Employed (given) 4,000.00
Capital Charge (Fair Return to Providers of Capital i.e. Average Capital 4,000 x 24.79% = 991.60
Employed x WACC)
Operating Profit before Taxes & Interest 1,600.00
Less: Taxes Paid 120.00
Operating Profit after Taxes 1,480.00
(This is the return to the Providers of Capital i.e. Debt and Equity)
Capital Charge 991.60
Economic Value Added 488.40
EVA as a % of Average Capital Employed 12.21% 16-04-2024
 Class Exercise (EVA)
55

From the following information, compute EVA of A Ltd.

Equity Share Capital 1,000 Lakhs PE Ratio 5 times

Financial Leverage 1.5 times 12% Debentures 500 Lakhs Deb
Tax rate 35% PBT Rs. 120.00 Lakhs

16-04-2024
 Solution Contd. (EVA)
56

Profit and Loss Statement

Particulars % Rs. Lakhs
Profit before Interest and Taxes 150% 180.00
Less: Interest on Debentures Rs. 500 x 12% 50% 60.00
Profit before Tax 100% 120.00
Less: Tax at 35% 35% 42.00
Profit after tax 65% 78.00

Financial Leverage = PBIT / PBT = 1.5.

(Let PBT = 100%), then
PBIT = 150%
hence, Interest = 50%.

16-04-2024
 Solution Contd. (EVA)
57

Computation of WACC
Component Amount Ratio Individual Cost WACC
Equity Rs. 1,000 Lakhs 2/3 Ke = 1 ÷ PE Ratio = 20% 13.33%
Kd = I (1 - T)
Debt Rs. 500 Lakhs 1/3 2.60%
= 12% x (1 - 35)= 7.8%
Total Rs. 1,500 Lakhs Ko = Ke x We + Kd x Wd 15.93%

16-04-2024
 Solution Contd. (EVA)
58

Computation of EVA
Particulars Rs. Lakhs
Profit before Interest and Taxes 180.00
Less: Taxes 42.00
Net Operating Profit After Taxes 138.00
Less: Capital Charge
238.95
= WACC x Cap. Emp = 1,500 x 15.93%
Economic Value Added Nil

16-04-2024
 Class Exercise (EVA)
59

With the help of the following information of BBA(FIA)

Limited compute the Economic Value Added:

Capital Structure Equity capital Rs. 160 Lakhs

Reserves and Surplus Rs. 140 lakhs
10% Debentures Rs. 400 lakhs
Cost of equity 14%
Financial Leverage 1.5 times
Income Tax Rate 30%

16-04-2024
 Solution Contd. (EVA)
60

Financial Leverage = PBIT/PBT

1.5 = PBIT / (PBIT – Interest)
1.5 = PBIT / (PBIT – 40)
1.5 (PBIT – 40) = PBIT
1.5 PBIT – 60 = PBIT
1.5 PBIT – PBIT = 60
0.5 PBIT = 60
or PBIT = 60 = Rs. 120 lakhs
0.5
NOPAT = PBIT – Tax = Rs. 120 lakhs (1 – 0.30) = Rs. 84 lakhs.
Weighted Average Cost of Capital (WACC)
=14%×(300/700)+(1–0.30)×(10%)×(400/700) =10%
EVA = NOPAT – (WACC × Total Capital)
EVA = Rs. 84 lakhs – (0.10 × Rs. 700 lakhs)
EVA = Rs. 14 lakhs
16-04-2024
 Class Exercise (EVA)
61
RST Ltd.’s current financial year's income statement reported its net income as Rs.
25,00,000. The applicable corporate income tax rate is 30%.
Following is the capital structure of RST Ltd. at the end of current financial year:
Rs.
Debt (Coupon rate = 11%) 40 lakhs
Equity (Share Capital + Reserves & Surplus) 125 lakhs
Invested Capital 165 lakhs

Following data is given to estimate cost of equity capital:

Beta of RST Ltd. 1.36

Risk –free rate i.e. current yield on Govt. bonds 8.5%
Average market risk premium 9%

Required:
(i) Estimate Weighted Average Cost of Capital (WACC) of RST Ltd.; and
(ii) Estimate Economic Value Added (EVA) of RST Ltd. 16-04-2024
 Solution (EVA)
62

Cost of Equity
ke = Rf + β x Market Risk Premium
= 8.5% + 1.36 x 9%
= 8.5% + 12.24% = 20.74%

Cost of Debt
kd = 11%(1 – 0.30) = 7.70%

WACC
(ko) = ke x We + kd x Wd
= 20.74 x 125 + 7.70 x 40
165 165
= 15.71 + 1.87 = 17.58%

16-04-2024
 Solution (EVA)
63

Taxable Income
= Rs. 25,00,000 / (1 - 0.30)
= Rs. 35,71,429 or Rs. 35.71 lakhs

Operating Income
= Taxable Income + Interest
= Rs. 35,71,429 + Rs. 4,40,000
= Rs. 40,11,429 or Rs. 40.11 lacs

EVA
 = EBIT (1-Tax Rate) – WACC x Invested Capital
= Rs. 40,11,429 (1 – 0.30) – 17.58% x Rs. 1,65,00,000
 = Rs. 28,08,000 – Rs. 29,00,700 = - Rs. 92,700

16-04-2024
 Class Exercise
64

BBA(FIA)A Ltd. Wants to acquire BBA(FIA)B Ltd. at a swap ratio of 0.5.

BFIA_A Ltd. BFIA_B Ltd.
PAT 18 Lakh 3.6 Lakh
Outstanding Shares 6 Lakh 1.80 Lakh
EPS Rs. 3 per share Rs. 2 per share
PE 10 times 7 times
MPS 30 per share 14 per share
1. Calculate the No. of equity shares to be issued by BBA(FIA)A Ltd.
For acquisition of BBA(FIA)B Ltd.
2. What is the EPS of BBA(FIA)A Ltd. After acquisition?
3. Determine the equivalent EPS of BBA(FIA)B Ltd.
4. What is the expected market price per share of A Ltd. After the
acquisition, assuming that its PE multiple remains unchanged?
5. Determine the market value of the merged firm.

16-04-2024
 Class Exercise Solution
65

1. 90,0000
2. New EPS = Total Net Profit / Total no. of Equity shares
= 18 L +3.6 L / 6 L + 90000
= 21.6 L / 6.9 L
= 3.13 Rs. per share

3. 0.5 ER :1
? : 3.13
Rs. 1.57 per share

4. New MPS = 10 x 3.13 = Rs. 31.30

5. Market value= 6,90,000 x 31.30 = Rs. 2,15,97,000

16-04-2024
 Class Exercise
66

BBAFIA Ltd. is a highly successful company and wishes to

expand by acquiring other firms. Its expected high growth in
earnings and dividends is reflected in its PE ratio of 17. The
Board of Directors of BBAFIA Ltd. has been advised that if it
were to take over firms with a lower PE ratio than its own,
using a share for share exchange, then it could increase its
reported earnings per share. BMS Ltd. has been suggested
as a possible target for a takeover, which has a PE ratio of
10 and 1,00,000 shares in issue with a share price of Rs.
15. BBAFIA Ltd. has 5,00,000 shares in issue with a share
price of Rs. 12.
Calculate the change in earnings per share of BBAFIA Ltd.
if it acquires the whole of BMS Ltd. by issuing shares at its
market price of Rs. 12. Assume the price of BMS Ltd.
shares remains constant.
16-04-2024
 Class Exercise Solution
67

Total market value of BMS Ltd.

PE ratio
Earnings

Total market value of BBAFIA Ltd.

PE ratio
Earnings

The number of shares to be issued by

BBAFIA Ltd.
Total number of shares of BBAFIA Ltd.
EPS of new firm
Present EPS of BBAFIA Ltd.
Change in EPS
16-04-2024
 Class Exercise Solution
68

Total market value of BMS Ltd. 1,00,000 X Rs. 15 = 15,00,000 Rs.

PE ratio 10
Earnings 15,00,000 / 10 = 1,50,000 Rs.

Total market value of BBAFIA Ltd. 5,00,000 X Rs. 12 = 60,00,000 Rs.

PE ratio 17
Earnings 60,00,000 / 17 = 3,52,941 Rs.

The number of shares to be issued by Rs. 15,00,000 / 12 = 1,25,000

BBAFIA Ltd.
Total number of shares of BBAFIA Ltd. 5,00,000 + 1,25,000 = 6,25,000
EPS of new firm (3,52,941 + 1,50,000) / 6,25,000 = Rs. 0.80
Present EPS of BBAFIA Ltd. 3,52,941 / 5,00,000 = Rs. 0.71
Change in EPS 0.80 - 0.71 = 0.09
16-04-2024
 Valuation for Slump Sale under Income-tax
69 Act, 1961
 As per section 2(42C) of Income-tax Act 1961, ‘slump sale’ means the transfer of
one or more undertakings as a result of the sale for a lump sum consideration
without values being assigned to the individual assets and liabilities in such
sales.
 Section 50B of the Income-tax Act, 1961 provides the mechanism for
computation of capital gains arising on slump sale. Section 50B reads as
‘Special provision for computation of capital gains in case of slump sale’.
 As per section 50B(1), any profits or gains arising from the slump sale effected in
the previous year shall be chargeable to income-tax as capital gains arising from
the transfer of long-term capital assets and shall be deemed to be the income of
the previous year in which the transfer took place. The salient features of these
provisions are:
 The capital asset was held for more than 36 months preceding the date of
transfer
 The cost of acquisition will be the net worth of the undertaking or division
 A certificate of Chartered Accountant certifying the net worth will be required
to be obtained
 For the purpose of this ‘slump sale’ the net worth is calculated as shown below:
Net worth = WDV of assets – liabilities as per books
(Where the entire value of the asset has been depreciated, its value will be
taken as Nil)
16-04-2024
 Valuation under SEBI (Substantial Acquisition
70 of Shares and Takeovers) Regulations, 2011
 As per Securities and Exchange Board of India (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011, the open
offer for acquiring shares under regulation 3, regulation 4, regulation
5 or regulation 6 shall be made at a price not lower than the price
determined in accordance with sub-regulation (2) or sub-regulation
(3), as the case may be.
 As per regulation 3, a person acquiring shares of a company has to
make a public announcement of an open offer for acquiring shares of
the company if,
 As per the SAST regulations, any person acquiring 25% or more
of voting rights of a target company
 If any person already holding 25%, acquiring further voting rights
of 5% or more
 As per regulation 4, making a public announcement of an open offer
for acquiring shares of the company will be required if a person
acquires directly or indirectly, control over such target company.
 Regulation 5(1) covers indirect acquisition by any person and
persons acting in concert which may enable him to exercise or direct
the exercise of such percentage of voting rights in, or control over, a
target company.

16-04-2024