S & D PROFESSIONAL INSTITUTE

THE INSTITUTE OF CHARTERED ACCOUNTANTS GHANA - ICAG

PAPER 2.4 FINANCIAL MANAGEMENT

NOVEMBER 2025 DIET

LECTURE NOTE FOUR

MERGERS AND ACQUISITIONS

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MERGERS AND ACQUISITIONS
A merger is simply an amalgamation of two or more companies of approximately equal size.
In an acquisition, a large (predator) company usually takes over a majority stake in a smaller (target)
company. In practice, business combinations are usually an acquisition of one company by another.
TYPES OF MERGERS
1. Horizontal Merger
This involves two companies operating in the same industry at a similar level of production, combining
their operations. Horizontal takeovers take the form of one competitor company acquiring another
competitor company that is in the same industry.
Eg, GCB Bank taking over UT bank and Capital Bank, the merging of Airtel-Tigo, First Atlantic Bank
and Energy Bank, etc.
2. Vertical Merger
Vertical mergers are mergers between firms that operate at different stages of the same production
chain, or between firms that produce complementary goods such as a newspaper acquiring a paper
manufacturer. Vertical mergers are either backward when the firm merges with an upstream firm in their
supply chain to improve its ability to control its own manufacturing or forward when the firm merges with a
with a downstream firm, i.e, rely on acquiring distributors rather than manufacturers of raw materials.
3. Diversification
Diversification involves the acquisition decision of a company to acquiring or merging with another
company in a different industry. Could be a concentric Diversification or Conglomerate Diversification
Concentric - when companies are of different industries but depend on each other. Eg, a school
acquiring a bookshop
Conglomerate - when companies do not have anything in common. Eg. A school acquiring a football
club.

MOTIVES/REASONS FOR MERGERS & ACQUISITIONS

The broad motive for takeover is for synergy. It is the concept that the combined sum of two separate
entities after a merger or acquisition will be worth more than their sum as two separate entities. Known
as the “2 +2 = 5” effect. Synergies might be divided into revenue synergies, cost synergies and
financial synergies. Under Synergy, we have the following reasons;
1. Economies of scale: Refer to the reduction of operating cost in the expectation to increasing
operating profits resulting from large scale of operations. They are most likely to arise with
horizontal mergers but may also be present in vertical mergers as well. Many different types of
economies of scale exist, including those associated with production, marketing, distribution,
management and finance. Other economy of scale may arise from bulk purchase to enjoy
quantity discount.
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 2. Entry to new markets: Companies may want to develop into a new markets or jurisdiction,
both geographically and from a business or product perspective, in order to meet their strategic
objectives.
3. Risk reduction: A company may acquire another company in a different line of business (a
conglomerate take-over) in order to reduce risk. Thus, if one industry fails, they will still exist
in other industries.
4. To get rid of managerial inefficiencies: A takeover brings in new management policies to get
rid of any inefficiencies.

REASONS FOR FAILURE (WHY MERGERS FAIL)

• Serious problem with integrating the acquired company into the new group.
• Employees in the acquired company might finds it difficult to accept the different culture of the
acquiring company.
• Loss of staff might be high, and valuable knowledge and expertise might be lost.
• There might be difficulties/problems with establishing effective management control in the
acquired company.
• Control systems might have to be reviewed and changed.
• Senior management in the acquiring company might not give the acquired company sufficient
time and attention to make the acquisition operationally and financially successful.

ORGANIC GROWTH VERSUS INORGANIC GROWTH (MERGERS & ACQUISITION)

Every entity can grow in two ways – organic (by itself) or inorganic (by acquisition). How the entity
intends to grow will depend on the prevailing conditions and the underlying intent.
Organic growth refers to the expansion and development of a company's business through internal
efforts, such as increasing sales, launching new products or services, expanding into new markets, or
enhancing existing operations.
Inorganic growth, also known as external growth or growth through acquisition, involves expanding a
company's business operations through mergers, acquisitions, joint ventures, or strategic partnerships
with other firms.
Advantages of Organic Growth
(a) Organic growth is less risky compared to inorganic growth.
(b) It allows planning for strategic growth in line with stated objectives.
(c) It is less expensive to acquisitions.
(d) Acquisition brings pressure on the current management to learn how to apply the assets of the
newly acquired business.
(e) It helps avoid the pressure often exerted when a new company is acquired for integration.

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Disadvantages of Organic growth
(a) Quickest way is to enter a new product or geographical market
(b) Fewer competitors
(c) Reduces the risk of over-supply and excessive competition
(d) Acquiring the target company's staff highly trained staff – may give a competitive edge
(e) It increases the market power of the acquirer to be able to exercise control over prices of the
product.

DEFENSIVE TACTICS AGAINST TAKE- OVER BID

Pre-bid Defences: Defenses put in place to prevent a bid in the first place
• Improving operational efficiency
• Restructuring of Equity (Buy your own share and leave a limited amount of shares on the
market).
• Management retrenchment packages
• The use of cross-bidding
Post-bid Defences
• Rejection of initial offer
• Dividend increase announcement
• Searching for a White Knight: A more friendly company to also put in a bid at a higher price.
• Pac-man defence
• Crown Jewel Defense: Sell off the company's most valuable assets to make the takeover less
appealing.

DUE DILIGENCE
Due diligence is a process which attempts to reduce the risk associated with a transaction. It is an
investigation of a business or person prior to signing a contract.
Due diligence can be financial due diligence – a review of the target company’s financial position,
financial risk and projections or legal due diligence – a focus on any legal matters which might be relevant
to the value of the company or its continued success in the future.

Due diligence will thus attempt to achieve the following;

• Confirm the accuracy of information and assumptions on which a bid is based
• Provide an independent assessment and review of the target business
• Identify and quantify areas of commercial and financial risk
• Provide assurance to providers of finance.

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REVERSE TAKEOVER
Reverse takeovers sometimes occur in acquisitions where the purchase price is paid in new shares issued by
the acquirer. A reverse takeover is a transaction in which an entity acquires another entity and the
shareholders of the acquired entity end up with control of the combined entity.
A reverse takeover can be used by a private company to become publicly traded without going through an
initial public offering.

NEED FOR A VALUATION

• The acquiring company needs to decide what price it is prepared to offer for the target company
• The directors of the target company need to decide whether the offer is acceptable and whether it
should be recommended to the shareholders
• The shareholders in the target company need to decide whether they are willing to accept the offer
made for their shares.

FACTORS TO CONSIDER IN PRICING A TAKEOVER BID

• Synergy
• Risk exposure
• Real options – an option to take a course of action at some time in the future often depending on how
the business develops
• Financing
• Valuation assumptions – Valuations are based on assumptions, but many assumptions are based on
judgements rather than hard evidences.

FINANCING MERGERS & ACQUISITIONS

• Cash
• Issuing new shares to the shareholders in the target company
• Issuing debt securities in exchange for some of the shares in the target company

VALUATION OF COMPANIES FOR MERGERS / ACQUISITION

If one company is acquiring or merging with another company, an important consideration is the effect of
the combination on the level of risk of the companies. Two types of risks can be identified;
• Business risk – the variability of the earnings of a company due to the uncertainty in the business
environment in which the company is operation; and
• Financial risk – the variability of earnings of a company due to changes in its capital structure.
On the basis of these risks, we can classify acquisition or merger into three;
• Type 1 Acquisition – This is an acquisition where after acquiring the victim company, the existing
business and financial risks of the predator would not change. In the case of merger, the firm’s
exposure to business and financial risks do not change.
• Type 2 Acquisition – An acquisition where after acquiring the victim company, the existing
business risk would not change but financial risk changes.
• Type 3 Acquisition – An acquisition where after acquiring the victim company, both business and
financial risks changes.
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Class Discussion 1
P Company is acquiring K Ltd Company Ltd. P will pay 0.5 of its shares to the shareholders of K Ltd for
each share held by them. The data for the two companies are given below:

P Ltd K Ltd
Profit after (¢'000) 150 30

Number of shares (000) 25 8

EPS 6 3.75
Market price (¢) 78 33.75
PE Ratio 13 9
Required:

a) Calculate the EPS of the surviving firm after the merger assuming no synergy
b) If the PE ration falls to 12 after the merger, what is the premium received by the shareholders of
K Ltd, using the surviving firm's new price
c) Is the merger beneficial for P Ltd's shareholders?
Suggested Solution
a) No of shares to K Ltd (0.5/1 x 8,000) 4,000 shares in P Ltd
Total Number of shares in the enlarged company (4,000 + 25,000) 29,000
Post-merger earnings (150 + 30) ¢180,000
EPS ¢6.21

b) Post-merger company value (12 x 180,000) ¢2,160,000

No of shares 29,000
Value of K Ltd after merger (4,000/29,000 X 2,160,000) 297,931
Pre-merger value of K Ltd (33.75 X 8,000) 270,000
Premium to K Ltd (297,931 – 270,000) 27,931
Premium per share (27,931/8,000) 3.49

c) The merger is beneficial to P Ltd in terms of the earnings per share as the post-merger EPS is ¢6.21.
However, in terms of market value, they loss by ¢3.5 per share (78 – 74.5).
Class Discussion 2
Cante plc and Pele plc are planning to merge to form Stadium plc. It has been agreed that Pele's
shareholders will accept three shares in Cante for every share in Pele they hold. Other details are as
follows:
Cante plc Pele plc
Number of shares 40m 10m
Annual earnings ¢10m ¢5.8m
P/E ratio 8 10

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Post-merger earnings of the enlarged company are expected to be 8% higher than the sum of the earnings
of each company before the merger, due to economies of scale and other benefits. The market is
expected to apply a P/E ratio of 9 to Stadium plc.

Required
Determine the extent to which the shareholders of Pele will benefits from the proposed merger.

Suggested Solution

To the determine whether or not the shareholders of Pele PLC will gain after the merger, it is important
for us to first ascertain their current position, in terms of Earnings and Market Values.

Current Market Values Cante PLC Pele PLC

Current Earnings: (¢) 10m 5.8m
P/E ratio 8 10
Market Value (P/E X Earnings) 80m 58m

Let now determine what value Pele PLC has after the merger (Stadium PLC):

Combined Earnings (10 + 5.8) 15.8m

Enlarged Earnings after synergy of 8%: (1.08 X 15.8) 17.064m
P/E ratio 9
Market value of Stadium PLC (17.064 X 9) 153.58m

From this value, let determine how much Pele PLC is worth in Stadium PLC.

Shares in Cante PLC 40m

Shares in Pele PLC (10m)
Issue to Pele PLC (3 for 1) 30m

Total no shares in Stadium PLC (40 + 30) 70m

Value of Pele PLC (30/70 X 153.58m) ¢65.82

Benefit of the merger to Pele

Compare Pre-acquisition Value to post acquisition value:
Value of Pele prior to the merger ¢58.00m
Value after merger ¢65.82m
Benefits after merger 7.82m

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Class Discussion 3
a) K Asante and Co is analyzing the possible acquisition of Pumbros Ltd. Neither firm has debt in
its capital structure. K Asante estimates that purchase of Pumbros would increase K Asante's after-
tax cash flow by ¢960,000 indefinitely.

Required:
What is the synergy from this merger if the discount rate for the incremental cash flow is 24%?

Suggested Solution
The synergy value is simply the present value (PV) of the perpetual incremental cash flow:
Synergy Value = Incremental Cash Flow / Discount Rate =¢960,000 / 0.24 =¢4,000,000
The synergy from the merger is ¢4,000,000.

b) The current value of K Asante is ¢40m, while that of Pumbros is ¢12m. K Asante is trying to
decide whether to offer 25% of its shares or ¢15m to shareholders of Pumbros. The share offer
will mean issue of additional shares
i) What is the cost to K Asante of each alternative?
ii) What is the NPV to K Asante of each alternative?
iii) What is the NPV to Pumbros of each alternative?

Suggested Solution
i) Cost of:
Cash offer = 15 – 12 = ¢3
Share offer:
Value of merged company (40 + 12 + 4) = ¢56m
Share offer (25% x 56) = ¢14m
Cost of share offer (14 – 12) = ¢2m

ii) NPV = Gain – Cost of each offer:

Cash offer = 4 – 3 = ¢1m
Share offer = 4 – 2 = ¢2m

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 iii) NPV (Pumbros Ltd)
Cash offer = 15 – 12 = ¢3m
Share offer = 14 – 12 = ¢2m

Class Discussion 4 – To be solved in class

Nana Kofi Company Ltd (Nana Kofi) has a market value of GH¢50million. Otabil Company Ltd (Otabil)
has a market value of GH¢200million. Otabil has determined that if it combines resources with Nana Kofi,
cost savings will be worth GH¢25 million today. On this basis, Otabil makes an offer to buy Nana Kofi.
i. If Otabil makes a cash offer of GH¢65million for all the shares of Nana Kofi, what is the cost of this
purchase to Otabil?
ii. What are the gains of this transaction?
iii. Suppose Otabil has issued 100million of its shares to its shareholders, and is considering issuing
30million shares to the shareholders of Nana Kofi, what is the cost of the share offer?
iv. What is the net present value of the transaction under the cash offer to Otabil?
v. What is the net present value under the share offer?

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