Kiran Textiles: valuing a target and advising on the offer

Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• P/E value = 4.0 x 11 = $44.0 million.
• Free cash flow next year = 3.0 x 1.03 = $3.09 million.
• DCF value = 3.09 / (0.09 - 0.03) = $51.5 million.
• The DCF value is higher than the P/E value because it reflects the expected growth and the cost of capital, while the P/E uses another company's multiple.
• Both are sensitive to assumptions: a 1 percentage point increase in the growth rate or fall in the cost of capital changes the value greatly.
• The market capitalisation of $46.0 million is close to the P/E value, suggesting that the market does not expect the growth in the forecast.

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Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• Present value of synergies = 0.5 / 0.09 = $5.56 million.
• Value created = 51.5 + 5.56 = $57.06 million.
• Gain to Zia Industries = 57.06 - 56.0 = $1.06 million.
• Premium paid over market value = 56.0 - 46.0 = $10.0 million, which is 21.7% of the market value.
• Most of the value of synergy (5.56 million) and the intrinsic value above the market (5.5 million) is passed to the shareholders of Kiran Textiles, and so little remains for Zia.

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Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• Gearing and financial risk rise, and interest cover falls, so the bid affects the cost of equity of Zia Industries.
• Covenants and security requirements may restrict the future freedom of the company.
• Interest is tax deductible, so debt gives a tax shield, which might lower the WACC if gearing remains at a reasonable level.
• An exchange of shares would share the risk and the gain with Kiran's shareholders and save the use of cash, but dilutes control and EPS.
• A mixed offer could balance the risks, and the board should check the effect on EPS and the share price.

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Tick each point that your answer made clearly and only once. Points here are this site's own. A real examiner may accept other valid points.

• Give a clear recommendation: the gain at $56.0 million is thin, so negotiate a lower price or proceed only if the synergies are more certain.
• Synergies may not be achieved, and a delay or a shortfall wipes out the gain.
• Integration risk, culture clash and loss of key customers or employees.
• Due diligence on the quality of cash flows and on the growth assumption, and consider a walk away price.

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