Mock Exam with solutions(2)

Explain in detail what is meant by synergy and how it

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Explain in detail what is meant by synergy and how it might arise Explain what is meant by agency costs why such costs arise and why managers may engage in wealth decreasing mergers for their own benefit ii. Give reasons why (i) bidding and (ii) target companies may experience abnormal stock returns around the time of takeover announcements. (15 %) Target shareholders tend to gain because the bidder offers more than the market price whereas evidence is mixed for bidder shareholders some gain some don’t depending on expected synergy and offer terms Part B (45 %) Purse plc Wallet plc Current share price £ 6.50 3.40 Current dividend £ 1.10 0.85 Number of shares 1 million 0.5 million Purse plc.’s management has announced a bid to takeover Wallet plc. You estimate that investors currently expect Purse plc’s earnings and dividends to grow steadily at 2% and Wallet plc’s earnings and dividends to grow steadily at 4% per annum. Purse plc’s management have announced that they expect the growth rate for Wallet plc’s earnings and dividends to immediately increase to 5% per annum under their management after takeover. Purse plc’s management also believe that they will be able to reduce Wallet plc's costs by £30,000 per annum indefinitely, as a result of the acquisition. Required a) What is Wallet plc’s cost of capital? (10 %) ([0.85(1.04)]/3.4) + 0.04 = 0.3 b) Use the cost of capital you have found in (a) to determine the maximum amount Purse plc should be prepared to pay for Wallet plc. (12 %) new share price = ([0.85(1.05)]/(0.3-0.05) = 35.7 x 500,000 = 1.785m savings = 0.03m/0.3 = £0.1m total value = £1.885m
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c) If Purse plc offers Wallet plc‘s shareholders £3.60 per share, what is the gain or loss to Purse plc’s shareholders as a result of the acquisition? (8 %) 3.6 x 500,000 = £1.8m gain to Purse plc’s shareholders of £0.085m d) What is the gain or loss to Purse plc’s shareholders if Purse plc offers Wallet plc’s shareholders 1 share in Purse plc for every 2 shares in Wallet plc? (15 %) 1.885m + 6.5m = 8.385m Number of shares = 1m + 0.25m = 1.25m Each share will be worth £6.708 Gain to Purse plc’s shareholders = £0.708m Section C - You must choose at least one question from this section
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