Page 287 - AFM Integrated Workbook STUDENT S18-J19

Business valuation

Question 4

Nixey Co has a P/E ratio of 14 and annual earnings of $235 million.

It is considering making a bid for the entire equity capital of Wine Co, a firm
which has a P/E ratio of 10 and annual earnings of $96 million.

It is thought that $28 million of annual synergistic savings will be made as a
consequence of the takeover. The P/E ratio of the combined company is
expected to be 13.

Required:

Calculate the minimum value acceptable to Wine Co's shareholders, and
the maximum amount which Nixey Co should consider paying.

Solution

The minimum acceptable value to Wine Co's shareholders will be the current
value of the equity, i.e. 10 × $96m = $960 million

However, from Nixey Co’s perspective, it is important to estimate the value
created by the likely synergies as well as the basic value of Wine Co. Hence:

Value of Wine Co to Nixey Co

= Value of the combination – Value of Nixey Co at the moment

This measures the likely increase in value if Wine Co is acquired, so will
indicate the maximum amount payable.

Therefore, value of Wine Co to Nixey Co

= (New P/E × Total forecast earnings) – (14 × $235m)

= (13 × ($235m + $96m + $28m)) – $3,290m

= $4,667m – $3,290m = $1,377 million

In reality, following negotiations, the final value is likely to be somewhere
between these two figures.

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