Assume is now at the beginning of the year when the acquisition is taking place.

Question

Assume is now at the beginning of the year when the acquisition is taking place. CAT Inc. is acquiring RAT Inc. CAT is offering $56 for each share of RAT Inc. in a share-for- share exchange. The following selected information is provided CAT Inc. Million) 11.62 Earnings to common stocks Common shares/stocks Market price per share (MPS) 6678 12.6 80 $50 After the acquisition the following rationalization costs and benefits will be generated. Sale of surplus warehouse facility one year after acquisition, $12.6 million (ii)Redundancy payments: $19.8 million payable immediately on acquisition (ii)Savings in wages and salaries: $5.4 million at end of every year for 5 years Cix)Savings in advertising costs: $1.2 million per year indefinitely The overall cost of capital of CAT Inc. will remain at 10 % after the acquisition Required a) Compute the percent premium offered to shareholders of RAT Inc. b) The share-exchange ratio and total shares of CAT after acquisition c) Pre and post-acquisition EPS and percentage accretion or dilution for each firm d) Pre-acquisition P/E of each firm and post-acquisition P/E ratio e) Post-acquisition MPS ratio (Including synergistic benefits) of each firm and the percent accretion or dilution

Explanation / Answer

a) Percent premium offered to RAT shareholders = 56/50-1 = 12%

b) RAT is valued at 56*2=$112 mn by CAT. It is paying this amount to RAT in the form of its own shares, each of which is trading at $80 => the no. of shares to be issued by CAT = 112/80 = 1.4 mn

Therefore, total shares of CAT after acquisition = 12.6+1.4 = 14 mn

Here, the buyer (CAT) is offering 1.4 mn shares to seller (RAT), which has 2 mn shares.

So, the share exchange ratio = 1.4:2 => 7:10

c)

CAT: EPS (Pre acquisition) = 66.78/12.6 = 5.3

RAT: EPS (Pre acquisition) = 11.62/2 = 5.81

Earnings post acquisition = Earnings before acquisition of the new entity + benefits due to cost rationalization

Benefits = 12.6/1.1+19.8+5.4*[1-(1.1)^-5)/0.1]+1.2/0.1 = 11.45+19.8+20.47+120 = $ 171.72mn

[Explanation:12.6/1.1 as the benefit is realised after an year; 19.8 is realised immediately ; PV of annuity formula = P[1-(1+r)^-n]/r for 5.4 mn savings for five years; 1.2/r for the indefinite savings]

Therefore, Earnings post acquisition = 66.78+11.62+171.72 =$250.12mn

No. of shares in the new merged entity = 14 mn

Earnings per share = 250.12/14 = $ 17.86 => higher than the EPS pre acquisition. Hence, earnings accretive for the buying company(CAT)

d)

CAT: P/E (Pre acquisition) = 80/66.78 = 1.19

RAT: P/E (Pre acquisition) = 50/11.62 = 4.30

If the price per share after the acquisition remains at 80, then 80/17.86 = 4.47

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