Acquisition of Rustic Plc by Triumph Plc - Assignment Example

Acquisition of Rustic plc by Triumph plc Acquisition is the purchase of shares or assets on another company so as to achieve managerial influence not necessarily on mutual agreement. This process requires the evaluation of the target enterprise so as to strike a deal (Hubbard, Nancy, 2001). There are various methods of evaluation that can be adopted as per the preference of the parties involved. In this case Triumph plc employees three of these methods as follows: Dividend valuation model without a growth rate P0 = the current price of the stock Div = the dividend paid at the end of year 1 Ke   = required return on equity investments P1   = the price at the end of period one P0 = Div1/ (1 + ke) + P1/ (1 + ke) Ke=.20 Div=2 P1=3.68 The combined company value will be as follows: P0=2/1+.20 + 3.68/1+.20=.20/1.20 +3.68/1.20= .1667+3.0667=4.73 The current stock price for the combined company is £ 3.23 Dividend evaluation model with a growth rate Vs=D0 (1+g)/rs-g Where Vs is the current value of the stock D0 is dividend time 0 g is the growth rate r is the stockholders required rate of return. Do =2 R=.20 G=.10 In this case we will have Vs=.2 (1+.10)/.20-.10=.22/.10=£ 22. The share value added approach to estimation of cash flows for the first five years Po = D1/(1+i)¹  + D2/(1+i)²  + D3/(1+i)³ + (Dn + Pn)/(1+i)ⁿ Div =.20 i=.10 Pn=3.68 P0=.20/1.10+.2/1.12+.2/1.13+.2/1.14+ (.2+3.68)/1.15 =3.315=$3.32 The value of stock of the combined company would be $ 3.32. Similarly shareholder value added approach could be worked out as follows: SAV=net operating profit after tax (NOPAT)-(capital x WACC) This requires the correct adjustment of the various figures from the statements of finance to be able to bring out the desired results. For instance in this case we have a combined net operating profit after tax as triumph plc £ 11,040 + Rustic plc £5,400=£16440. Wacc=Rd (1-t) D/V +ReE/V. Re=Rf + β (Rm-Rf) Valuation of stock concept Basically the basis of stock valuation is that in a market that has rational markets, the stock value today is the same as the present value of all cash flows that will accrue to the very investor in the stock (Hubbard, Nancy, 2001). To put in other words is that the investor gets what he pays for in the sense of the present value. We can therefore use the principles of time value of money to get the value of the stock now base the future cash flows’ discounted value. This is an intrinsic value of stock since it is found basing on all available information. Provided for indefinite time dividends are constant, the value of a share of stock is the same as the present value of the dividends per share per period, in perpetuity. Taking D1 to be a constant dividend per share of common stock expected for every period to come, P0 to be a price of a share of stock now, and r the stockholders required rate of return on common stock. The present price of a share of common stock, P0, is: P0=D1/r. The required rate of return represents the compensation to an investor for the time value of money that is bound in the investment as well as uncertainty of getting future cash flows from the investment. The greater the risk the greater the return, for instance in this case the current dividend is £ 2 per share and the required rate of return is 20 percent, the value of the share stock is £ 20. Thus, if one pays £ 20 per year and dividends stay constant at the £ 2 per share, the person will earn a 20 percent return on his investment every year. If the dividends happen to grow at a constant rate, the value of a share stock will be the present value of a growing cash flow. Say D0 shows the dividend for this period. If dividends happen to grow at a constant rate, g, for every period in the future the present value of the common stock is the present value of all dividends in future that in the unique case of dividends growing at the constant rate g it gives birth to the dividend valuation model Where Po= D0 (1+g)/r-g=D1/r-g Analysis of the stock valuations Normally companies that pay dividends they have policies to the effect of the dividend per share: they will either raise the dividends or keep the dividend per share (Limmack, 1990). This is majorly because the companies are not willing to peg then dividends on the earnings since the earnings are very volatile and would mean a constant change in the value of the dividend. In this case considering the first method the value of the stock is more than the current one an indication that the stock is cheap and fairly valued. At this point Triumph plc can peaceful take over Rustic plc without having to spend expensively. The shareholders of Triumph will have a gain on the value of their shares by a smaller margin but more important is that the shareholders of the Rustic plc will agree to move to the new company as their dividend per share will is constant and the value of their stock will rise from the current £1.62 to £4.73. Now this is a significant move that as the project is worthy investing in as par the dividend valuation model. The assumption is of zero growth rates of the dividend in perpetuity meaning that the dividends remain at the same level even under the acquisition. This is an important decision as it cushions the existing shareholders of any possible changes in the earnings because their dividends are constant. The company can also cheaply acquire capital under this arrangement now that the combination provides a better level of security in terms of volume of sales, profits and asset base. The company will still enjoy the credit facilities enjoyed with its northern counterparts. Both companies have the same asset base which imply that they acquisition is doubling the asset base and increasing the opportunity of taking business risks. The share of the company as indicated will go up with a significant margin. It is a clear outline of better pick up of the company under the new arrangement. The second calculation under the dividend valuation model show a higher value of the stock price which indicates that with a growth rate of 10 percent the company is actually going to appreciate its value. Triumph Company is now going to perform better than it used is now performing which translate equally to the return that its shareholders will have under the new arrangement. Assuming that the dividends are cushioned at the £ 2 level the shareholders will be assured of their return at any time since the earnings can be volatile at any given point in time and thus it is worth to make the takeover under the condition. With the cost of capital maintained at 20 percent and the growth rate of the dividend raised to 10 percent the business is able to pick up and add value to the stock of the investors. This means that the investors can now visualize a higher return on their investment. The risk is now worth taking because a higher risk always goes with a higher return. The higher the return the better placed is the investor with his investment. These developments may be linked to various changes that the company will enjoy when it acquires Rustic plc. These comprise of the following: the access to the northern markets; economies of scale and the potential to utilize Rustic plc’s production techniques to enhance the quality of the products in the combined as well as expanded company. Under the shareholder value added approach the value of the share slightly goes below the current price of the stock. This method of stock valuation is complex and requires the adjustment in the financial statements on issues such as amortization of assets to come up with the right capital and as well as weighted average cost of capital. However, the calculation still shows that the acquisition is viable in the long-term since the difference in the price of the share is not very much significant to cause an alarm in the long-run. The difference in this case can be changed with the use of other viable methods of evaluating stock. The other methods that can be employed include debt assumption method, discounted cash flow, market/multiplier valuation and cash flow method. The cash flow method helps to find out how much loan a company could get with the existing cash flow (Limmack, 1990). The amount of the loan arrived at the value of the business. The debt assumption methods often result in the highest price. It fundamentally underlies on the level of debt that a business could have and continue in operation using the cash flow. Discounted cash flow on the other end is based on the presumption that a dollar in received today is worthy more than the one that will be received sometime in the future. It carries out discounting of the projected earnings of the business to adjust for the actual growth, risk as well as inflation. Market or multiplier valuation utilizes the average figure of sales of an industry from recent business sales in similar businesses as a multiplier. For example, the industry multiplier for an advertisement organization might be 75percent which is multiplied by yearly gross sales to arrive at the value of the business. These methods look at various parts of the business and thus a mixture of these methods helps bring out the best decision to be undertaken. Several acquisitions have been done around the world for instance Total East Africa undertook to buy acquire Caltex east Africa. There are several problems that are associated with acquisition the first one being the purchase price. There is always a disagreement between the buyer and the seller on the price since most of the sellers fear the prices quoted by the buyers as too high. Another problem is that the client is always overoptimistic of the timing of the preparation phase. In this phase the, the client as well as other players from outside such as the lawyers and accountants could face, some difficulties which might lengthen the preparations of the information needed. Due to this some information might not be available from the side of the client at the agreed timing which results in the delay of the whole process (Hubbard, Nancy, 2001). Another issue that comes up in this project is lack agreement on the value of the company. This could result on different perspectives such as lack of agreement on the valuation method to use. If these perspectives differ at great degree then it becomes an issue. This could also be linked to the coordination issue which might emerge with the client and external consultants as well as the counterparty and their advisors. Last but very important arises from the likely problems emanating from the business environment, comprising of uncertainty in timing terms, development of the market, price expectations as well as strategy or devices from the counterparty (Limmack, 1990). Usually as noted by most companies it takes sometime from the launching to the closing of the deal. As this time goes the company itself develops at the same time the market develops. A number of parameters may have changed by the time of closing the deal. Due to this the valuation of the organisation might change. You might likely loose you seller for that matter. However, these problems are not so severe to prevent a deal to be closed; they only bring to attention the factors that have to be taken into account when looking at acquisitions. This is because when you make an investment decision there are forces in your environment that are competing with you. There your counterparties as well as market forces that will come in tactically and with time respectively. Better understanding of the concept of risk management and more so evaluation methods is critical to the success of an acquisition. Dividend evaluation model is one of the very best models as it works in favor both the current and potential investors in the corporation. Thus, a clear combination of this method with other method of evaluation gives the better value of an enterprise. However, according the issues mentioned above it is critical that the parties on the deal agree on the methods of valuation as well as the timing of the deal. This will help by reducing the cost as well as the time that it consumes on the process. References Hubbard, Nancy, (2001), Acquisition: strategy and implementation Basingstoke, Palgrave. Limmack R.J. (1990), Takeover activity and differential returns to shareholders of bidding companies. Edinburgh: David Hume Institute, Read More