The Hindu Business Line : Allocation and valuation of shares

AB Ltd is planning to acquire and absorb the running business of XY Ltd. The valuation is to be based on the recommendation of merchant bankers and the consideration is to be discharged in the form of equity share to be issued by AB Ltd. As on March 31, 2006, the paid-up capital of AB Ltd consists of 80 lakh shares of Rs 10 each. The highest and lowest market quotation during the last six months were Rs 570 and Rs 430. For the purpose of the exchange, the price per share is to be reckoned as the average of the highest and lowest market price during the last six months ended on March 31, 2006.

The balance-sheet of XY Ltd as at March 31, 2006, is : Sources: Share capital: 20 lakh equity shares of Rs 10 each fully paid — Rs 200 lakh

10 lakhs equity shares of Rs 10 each, Rs. 5 paid — Rs 50 lakh.

Loans — Rs 100 lakh

Total — Rs 350 lakh

Uses: Fixed assets (Net) — Rs 150 lakh

Net current assets — Rs 200 lakh

Total — Rs 350 lakh

An independent firm of merchant bankers engaged for the negotiation have produced the estimates of cash flows (see Table 1) from the business of XY Ltd:

It is the recommendation of the merchant banker that the business of XY Ltd may be valued on the basis of the average of (i) aggregate of discounted cash flows at 8 per cent; ii) net assets value.

Present value factors at 8 per cent for years 1-5 are: 0.93; 0.86; 0.79; 0.74; and 0.68

You are required to:

Calculate the total value of the business of XY Ltd; the number of shares to be issued by AB Ltd; and the basis of allocation of the shares among the shareholders of XY Ltd.

Answer: As per question, the total value of the business of XY Ltd is the average of aggregate of discounted cash flow at 8 per cent and net asset value.

a) The net assets of XY Ltd as on March 31, 2006, are presented in Table 2.

b) The discounted cash flow value as on March 31, 2006, is shown in Table 3.

Total value of equity shareholders = (250 + 592.40)/2 = 421.20

Total value of business (enterprise value) = 421.20 + 100 = 521.20

ii) Number of shares to be issued by AB Ltd:

Average price of AB Ltd = 570 + 430/2 = 500

No. of shares to be issued = 421.20/500 = 84240 of Rs 10 each

iii) Basis of allocation: Ten lakh equity shares of Rs 10 each, Rs 5 paid (partly) is equivalent to 5 lakh equity shares of Rs 10 each fully paid.

Therefore, the ratio of allocation should be 20/5 = 4/1. That is, out five shares received from AB, four should go to shareholders who have fully paid and one share to those who have partly paid.