Merchant and Investment Banking

Merchant banking & Investment banking
Details of Investment Banking & Public issue

Support Activities:
1. Research activities
2. Consulting activities
3. Professional Fund Management
4. Provide information
These all are discussed below:

01. Research Activities:
Invest banker acts as an outdoor vendor who sells the researched data. They research
on how a company can raise capital, how long it can sustain, how sustainable the
company in future etc. Larger investment banks have large teams that gather
information about companies and offer recommendations on whether to buy or sell
their stock. They may use these reports internally but can also generate revenue by
selling them to hedge funds and mutual fund managers.The sells the findings of
research to the concern company.
02. Consulting activities:
Investment banking acts as a consultant also. Investment banker helps company in
taking proficient decision making. If a company wants to use/run a long term
asset/fixed asset or purchase a fixed asset they should have been asked how
appropriate the asset for future. Investment banker advices about the fruitfulness of
purchase or utilizing asset. In another example if a company has several projects but
limited resource for investment Invest banker advice what project should they invest?
Investment banker do so by Identifying, analysis & evaluation the projects.
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Identifying
Identifying from different sources.
Analysis
Cost benefit analysis
Evaluation
Ultimate decision making.
Investment banker helps in capital budgeting for particular company because Investment banker
has expertise for this field.
03.Professional Fund Management:

Investment banker is given fund by Business Company for better management and
utilization of funds. Invest banker who has Merchant banking license can do it by
some fees. Investment bank daily research the market and they know how to utilize
the deposit fund. They invest portfolio for no or less loss consideration. There are two
types of fund management. One is Investor discretionary account and another is
Portfolio Managers Discretionary Account.
IDA
Plain Vanilla Product, investors wealth can be maximized through availing margin
loans as per BSEC directives. Merchant Banker cannot use the fund without the
permission of the owner.
PMDA
Merchant Banker can use the fund without the permission of the owner. Here
Merchant bank is risk taker. One chief manager exists here. Practice is rare in our
country.
*PMDA can be said also BDA (Banker discretionary account)
04.Information Service:
Investment Banker provides wide information services regarding the market.
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Classification of Investment Bank

A. On the basis of technical position/status/professionalism:
01. Bulge Brackets:
The "bulge bracket" is a slang term to describe the largest and most profitable multinational investment in the world whose banking clients are normally huge institutions,
corporations, and governments.
The tombstone - an advertisement of a new issue - usually has the bulge bracket
listed as the first group. Lead Investment banker they deal the underwriting
procedure.
The name "bulge bracket" originates from the manner in which investment
banks are listed on the public notification of a financial deal or transaction - or the
"tombstone."
The book running manager or bank with control of security allocation to

investors, is listed above all others and on the prospectus cover. The printing size
of the font for this bank is larger than the others.
02. Major brackets:

-They will follow the bulge bracket.
-Their activities are not diversified
-They are not as profitable as bulge bracket
03. Regional (Sub majors):
-Small investment banking firm with a small geographic focus is called regional.
-They form their business with diversified workers at a bulge bracket.
-It is not practiced in our country.
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B. On the basis of areas of activities

01. Fully fledged/Full service shop:
They offer wide range of product under one roof.
02. Boutique:
A boutique investment bank is a non-full service investment bank that specializes in
some aspect of investment banking, generally corporate finance,
Rolodex:
A Rolodex is a rotating file device used to store business contact information currently
manufactured by Newell Rubbermaid. The Rolodex holds specially shaped index cards;
the user writes or types the contact information for one person or company onto each
card. The cards are notched to be able to be snapped in and out of the rotating spindle.
Some users tape the contact's business card directly to the Rolodex index card, or a
plastic or vinyl sleeve in the shape of a Rolodex card to place the business card within.
Some companies have produced business cards in the shape of Rolodex cards, as a
marketing idea.
RSA Capital:
RSA capital is a unique private capital firm whose principals have over 50 years
of experience in direct equity investment and corporate growth. With its roots dating to
the mid-1980s, RSA offers highly specialized expertise focused in two areas.
Dhaka Bank, one of the leading private sector banks in Bangladesh has mandated RSA
Capital to raise BDT 2.00 billion in the form of Subordinated Convertible Bonds as Tier
2 Capital (subject to regulatory approval) from onshore and offshore institutional and
local retail investors. The issue is expected to be listed in the stock exchanges of
Bangladesh. This is the first time that a private sector commercial bank is expecting to
raise Tier 2 capital in the form of subordinated convertible bonds in Bangladesh. RSA
Capital was the sole lead arranger for the worlds first local currency micro credit
securitization. Both RSA Capital and Dhaka Bank expect that this landmark transaction
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will further accelerate the process of deepening the nascent fixed income capital market
of Bangladesh.
Public issue
Pre IPO activates/decisions
After getting green signal from BSEC there are three levels of Pre IPO decision.
a. Strategic dimension:
Strategic decisions are the decisions that are concerned with whole environment in which the
firm operates the entire resources and the people who form the company and the interface
between the two. This includes company corporate related issues. The strategy related to IPO is
the 1st step in pre IPO decision in considering with company strategy, objective etc. Such as
minimum 3 years in commercial exposure & at least 2 years profit is the pre requisite of IPO
floating in capital market.
b. Financial dimension:
After establishing strategic dimension company then concerns with financial aspect. Company
makes decision financial aspect such as how many share to be floated, how much Fund Company
wants to be raised, what is the target/aim for fund collection from public etc. To do so one has to
Justify the financing needs of company and uses of IPO proceeds. Such as, company can use
maximum one third portion of IPO fund for loan repayment.
c. Investment Banker dimension:

After establishing decision regarding above two issue third step is related to Investment bankers
activities/issue terms. Such as, Number of share, offer price etc.
Types of share issuing procedure:

01. Book building method
02. 02. Fixed pricing method.
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01.Book building method:

Book building is the process of price discovering by research the market if any revision
in price is needed or not.
Benefits:
a. Immanent offering.
b. Feedback from public.
c. Market feedback.
02.Fixed pricing method:

An issuer company is allowed to freely price the issue. The basis of issue Price is to be
disclosed in the offer document where the issuer discloses in detail about the qualitative
and quantitative factors justifying the issue price. There is only one price and issue will
be offered at that price. Such type of issue is known as Fixed Price Issue.
Application procedure and method of share issue (Book building method):

1. Formal agreement with Investment Banker
2. Filling of preliminary registration agreement. To highlight company prospect, justify the
companys eligibility along with all financial indicator. ( submit all the document)
3. BSEC scrutinize and assesses the submitted documents
4. BSEC confirms & comments on preliminary registration statement (draft prospectus).
BSEC comments (highlighted by red ink called Red Herring) if any correction is
needed. Unless BSEC approval company cannot issue share.
5. After approval an event named Road Show is being organized to create publicity/
collection of market feedback.
6. Formation & publication of prospectus.
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Application procedure and method of share issue (Fixed pricing method):

1. Formal agreement with Investment Banker
2. Filling of preliminary registration agreement. To highlight company prospect, justify the
companys eligibility along with all financial indicator. ( submit all the document)
3. BSEC scrutinize and assesses the submitted documents
4. BSEC confirms & comment on preliminary registration statement (draft prospectus).
BSEC comments (highlighted by red ink called Red Herring) if any correction is
needed. Unless BSEC approval company cannot issue share.
5. After approval prospectus is being published.
Difference between Book building & fixed pricing method:

Features
Fixed Price process

Price at which the securities are
Book Building process

Price at which securities will be offered/ allotted
Pricing offered/ allotted is known in advance is not known in advance to the investor. Only an
to the investor.
Demand for the securities offered is
Demand known only after the closure of the
issue.
indicative price range is known.

Demand for the securities offered can be known
everyday as the book is built.
Payment if made at the time of

Payment subscription wherein refund is given Payment only after allocation
after allocation.
Weblink: http://www.chittorgarh.com/faq/difference_between_book_building_fixed_price_issue/11/
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Underwriting & Private placement

Underwriting:
The process by which investment bankers raise investment capital from investors on behalf of
corporations and governments that are issuing securities (both equity and debt)
Underwriting also refers to an investment banker's process of packaging and selling a security on behalf
of a client..
In securities trading, underwriting also includes assessing the risk and pricing the security accordingly.
However, the formal underwriting process also involves agreeing to buy the security (by the underwriter)
and then selling the security for a profit. The underwriter effectively takes a risk by agreeing to buy the
security at the established price. In most instances, underwriters will line up buyers for the securities
before they take on the security, so that it can "flip" the security to the buyer immediately.
Types of underwriting:
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Mechanism:
Benefits & function:
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Underwriter:
An investment bank that acts as an intermediary between the issuing company and the investors who
purchase the company's debt instruments and/or stock at the Initial Public Offering (IPO). The
underwriter buys the newly issued securities from the company and sells them to investors on the
secondary market through a stock exchange.
Underlying asset:
An underlying asset is a security on which a derivative is based.
Underwriting agreement:
A contract between an underwriter and a company issuing capital with regard to commitment for
subscription of securities known as Underwriting agreement.
Types of underwriter/Types of agreement:

01. Firm commitment: An arrangement in which a underwriter assume the risk of bringing a new
security issue to market, by buying the issue from the issuer and guaranteeing sale of a certain
number of shared to investor .It is most widely used, popular method.
02. Best effort: An agreement in which an underwriter promises to make a full fledged attempt to
sell as much of an IPO as possible to the public.
Feature of Firm commitment:
An underwriter agreement to assume all inventory risk and purchase all securities directly from
the issuer for sale to the public at the place specified.
Underwriter acts dealer and are responsible for any unsold inventory.
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The dealer profit from the spread.
Feature of Best effort:

Mainly used for security with higher risk
Providing best effort to float the stock
No guarantee for risk
Unsold securities back to the shoulder of issuer
Spread/ Underwriting discount:

Mathematically,
Spared = Price offer- company receive/net to corporation
It serves as a compensation of underwriter.
Under pricing:
When security is floated in consideration of NAV then the price is less than the efficient price.
The pricing of an IPO is below its market value. When the offer price is lower than the price of the first
trade, the stock is considered to be underpriced. A stock is usually only underpriced temporarily because
the laws of supply and demand will eventually drive it toward its intrinsic value.
Reasons:
Stock has been floated lower price than actual cost to down the attention of investor.
In order to boost-up the investors confidence.
In order to reveal strength of the company.
Minimization of risk.
Overallotment option/Green shoe provision:

It allows the sale of additional shares that a company plans to issue in an initial public offering or
secondary/follow-on offering. An overallotment option allows underwriters to issue as many as 15% more
shares than originally planned. The option can be exercised within 30 days of the offering, and it does not
have to be exercised on the same day.
In an underwriting agreement, the underwriter agrees with the issuer of a security to place a certain
amount with investors. If demand for the security exceeds the underwriter's supply, the green shoe option
allows the underwriter to avoid a sudden jump in price by increasing supply. Normally, the green shoe
option allows the underwriter to increase supply up to 15%. It is important to note that not all
underwriting contracts have greens hoe options, especially in situations in which the issue is for a limited
project for which the issuer only needs a certain amount of capital. It is also called an overallotment
option.
Season equity offers (SEO) /Repeat public offer:

An issue of additional securities from an established company whose securities already trade in the
secondary market. A seasoned issue is also known as a "seasoned equity offering" or "follow-on
offering." New shares issued by blue-chip companies are considered seasoned issues. Outstanding bonds
trading in secondary markets are also called seasoned issues.
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A seasoned equity offering (SEO) is a new issue of an equity security that has previously been placed in
the market through a prior issuance. Although an SEO is a primary market transaction, it is not the first
time that the security will actually be held by the general investing public; it simply adds to the number of
outstanding shares. Firms, generally, have two options for facilitating an SEO: a cash offer or a rights
offer. In a cash offering, the new shares are issued to the public for cash, which results in a reduction of
the proportional ownership of existing shareholders (i.e., dilution). However, with a rights offering,
existing shareholders are awarded rights to purchase the new shares, many times at a reduced cost relative
to the market value.
Difference between IPO & SEO:

When a privately owned organization decides to raise capital by offering shares of stock or debt securities
to the public for the first time, it conducts an initial public offering (IPO), at which point it becomes a
publicly traded company. When an existing publicly traded company decides to raise additional capital by
selling more shares of its stock or debt instruments to the public, the share offering is considered a
seasoned issue.
Pricing method:
1. Net Asset value:
Mathematically,
NAV =
Example:
???????????????????????????
? ? ?? ????? ???????????
Particular
Share capital
Retained Earnings
Total shareholders equity
Total No. of share
Net Asset per value
Amount in BDT
400,000,000
652,800,000
1,052,800,000
40,000,000
26.32
2. EBVPS: Based on historical economy.

Step 1: EPS = Weighted net profit after tax/ no of stock outstanding in current year.
Step 2: Calculate average market earning multiple.
Step 3: Multiply EPS with average market earning multiple.
Year
(ended in
Dec 2014)
No. of Share
Weight
of
Total
Number of
Shares
0.12
0.16
0.18
0.27
0.27
1.00
Net Profit
After Tax
(BDT)
18,000,000
62,986,000
2010
24,000,000
68,788,000
2011
25,000,000
56,089,000
2012
40,000,000
48,206,000
2013
40,000,000
59,706,000
2014
Total
147,000,000
No. of Shares before IPO
EPS based on Weighted Average of Net Profit After Tax
Market Earnings Multiple
Price per share (BDT)
Weighted Average of
Net Profit after tax
7,558,320
11,006,080
10,096,020
13,015,620
16,120,620
57,796,660
40,000,000
1.46
14.50
21.17
Remarks
Step-01
Step-02
Step-03
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P/E ratio: How much an investor willing to pay per unit of return on earning?
The eligibility to go public:

Fixed price method
Particular
Net worth
Minimum IPO size
Use of IPO proceed
Minimum commercial experience
Profit
Net loss in IPO issue
Capital structure
Promoter/sponsor holding
:
:
:
:
:
:
:
:
:
Criteria
Tk 30 crore
12 crore / 10 % paid up capital (which one is higher).
One third portion can be used for loan repayment.
03 years
At least 2 years
No
Minimum 2 % has to be hold by director
Maximum 30 % (Not director)
Book building method

Particular
Net worth
Minimum IPO size
Use of IPO proceed
Minimum commercial experience
Profit
Net loss in IPO issue
Capital structure
Promoter/sponsor holding
AGM
Director
:
:
:
:
:
:
:
:
:
:
:
Criteria
Tk 30 crore
30 crore / 10 % paid up capital (which one is higher).
One third portion can be used for loan repayment.
03 years
At least 2 years
No
Minimum 2 % has to be hold by director
Maximum 30 % (Not director)
Regular in holding AGM
Should not defaulter.
Private placement:
A private placement is an offering of securities that is not registered with the Securities and Exchange
Commission (SEC).Private placement is the opposite of a public issue, in which securities are made
available for sale on the open market.
It is two types
01. Standby private placement
02. Private equity & debt offer
01. Standby private placement:

It remains standby with IPO (No large deal).It h=gears up the price of prospectus.30 % share are kept to
the Institutional Investor.
Method of issue:
a) Inform QIB/ Angel investor by road show.
b) Underwriter offers to the Institutional buyers/Investor.
c) Institutional Investors are bidding from maximum to minimum.
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d) Set the appropriate price/average also including the prospectus.
02. Private placement of debt and equity:

The company which is not listed in market floated in this private placement. Investments are investment
opportunities that are not offered to the general public. Instead, the investments are offered to a select
group in a non-public offering. Investment banker helps not listed companies. Debt private placement is
regular in BD.
Private placement (debt) is the sale of a bond or other security directly to a limited number of investors;
used in the context of general equities. For example, sale of stocks, bonds, or other investments directly to
an institutional investor like an insurance company, avoiding the need for the registration with the
regulator if the securities are purchased for investment as opposed to resale. An "equity" offering is where
the company sells partial ownership in the company (via the sale of stock or a membership unit) to raise
capital.
Private placement (equity) is the issues stock to selected private investors in exchange for venture capital
to continue operations or fund growth and expansion into the marketplace. Equity placements can also be
used to restructure a company's debt as an alternative to obtaining bank loans. A "debt" offering is where
the company raises debt financing by selling a note instrument to investors with a set annual rate of return
and a maturity date that dictates when the funds will be paid back to investors in full. A "debt" offering is
where the company raises debt financing by selling a note instrument to investors with a set annual rate of
return and a maturity date that dictates when the funds will be paid back to investors in full. Debt offering
functions much like a business loan except instead of a bank providing the financing it is a group of
investors lending funds to the company
Rock Asset Management:

Rock Asset Management is an independent portfolio management company that specializes in the
management of domestic and international multi-manager investment solutions for both individual and
corporate clients. Its dedication to portfolio management provides a purposeful approach to achieving
superior investment results.
Anchor/angel investor:
Angel investor is an investor who provides financial backing for small startups or entrepreneurs. In a
word it denotes the willingness and eligibility to buy. Some individual help to create capital in exchange
return.
Features of private placement:
Private placements are generally considered a cost-effective way for small businesses to raise
capital without "going public" through an initial public offering
It is negotiable deal. After negotiation the stock has been floated.
It has to be informed BSEC before floating with mandatory reporting of private placement
memorandum.
Three years Lock in provision has been imposed for investors. It is most appropriate for Standby
private placement to mitigate any imbalance.
Small scale issue
Liquidity problem may arise. In case of private placement liquidity problem may arise because of
Lock in provision.
No excess with open market.
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No need of preliminary registration.

No extension formality is required and cost effective.
Short process
Advantages of private placement:

Allow one to choose own investors-this increases the chances of having investors with similar
objectives to you and means they may be able to provide business advice and assistance, as well
as funding.
Allow own to remain private company.
Provide flexibility in the amount and type of funding.
Provide faster turnaround on raising finance than IPO
Short process
Disadvantages of private placement:

One disadvantage of a private placement is that it significantly narrows the range of investors you can
reach. This narrow range means your investors will probably need to have more capital to invest in your
bonds. Because you typically can't advertise on a wide scale and qualify for private placement, you may
also need to expend more effort and expense to sell your bonds than in the typical public offering. A wide
market will not exist for your bonds, so investors may also demand more equity in your company to
protect their investments.
Shelf Registration
Innovative issue method (USA innovative, 1982-83)
A shelf offering is an offering of new securities that are released to the public market incrementally over a
period of time.
Under Rule 415, the SEC allows an issuer to register new securities, and then shelve the public offering
for up to two years. This lets the company make a public offering any time it wants. During this time, any
shares of unreleased stock are not treated as shares outstanding for purpose of valuing the company.
A company must first complete a shelf registration with the Securities and Exchange Commission (SEC)
before it begins its shelf offering. Because of the lead time involved in the registration process, a shelf
offering allows a company to act quickly when the time is right to issue additional shares in the market,
which can be a huge advantage. A company can use a shelf offering to its benefit by waiting for favorable
market conditions to release shares. A shelf offering allows a company to save on the cost of registration
with the SEC by not having to re-register each time it wants to release new shares.It requires little
additional paperwork with short notice.
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Right issue & Dilution effect

Part-01: Right issue
Right issue:
An issue of common stock to existing shareholder is called right issue.
Here each shareholder is issued an option to buy specified number of new shares (proportion basis) from
the firm at a specified time within a specified price, after which the right is expired. \
Example: A firm whose stock selling at $ 30 may let current stockholders buy a fixed number of shares at
$ 20 per share within two months.
It can be said privilege subscription.
Features:
a. Not opened for public.
b. It is preemptive rights for existing shareholders before going to public.
c. Rights are always transferable, allowing the holder to sell them on the open market.
d. Having loc in provision.
e. ROD (Right offer document)
f. A company will offer more shares to its shareholders to raise extra money for the company.
Companies with a poor cash flow will often use a rights issue to increase cash flow and pay off
existing debts.
g. Rights issues however are sometimes issued by companies with healthy balance sheets in order to
fund research and development projects or to purchase new companies.
h. Troubled companies typically use rights issues to pay down debt, especially when they are unable
to borrow more money. But not all companies that pursue rights offerings are shaky. Some with
clean balance sheets use them to fund acquisitions and growth strategies.
Implication of Rights Issue:
Rights issue is an issue of additional shares by a company to raise capital for expansion or to
solve a liquidity problem. With the issued rights, existing shareholders have the privilege to buy
new shares of a company in proportion to their existing holding, and at a discounted price.
Shares issued in a rights issue have an exercise price below the prevailing market price of similar
shares.
The company will also set a time limit for the shareholder to buy the share.
If a shareholder does not take the company up on their rights issue then they have the option to
sell their rights on the stock market just as they would sell ordinary shares, however their
shareholding in the company will weaken.
Company can offer right share after 3/5 yrs later of listing.
How are rights distributed?

All shareholders are given the right to purchase shares based on the number of shares they own on a
specified record date, so there is no dilutive effect to shareholders who exercise the rights issued to them.
Subscription price:
The price, that existing shareholders are allowed to pay for a share of stock. It should be below market
price.
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Implication of subscription price:
If XYZ Company has 1,000,000 shares and wants to raise $ 5,000,000 and the subscription price would
be $ 10.
Number of new share =
??????? ?? ??????
???????????? ?????
Number of new share = 5,000,000/10 = 500000

Number of rights needed to buy a share of stock = old share/ new share
= 1,000,000/500,000
= 2 rights
Thus a shareholder must give up two rights+ $ 10 to receive a share of new stock
Objective of right issue:

Standby underwriter: When existing shareholders do not agree to receive rights offer then it would be a
big loss for company with the unsold security. In this situation underwriter works as a back up and unsold
stock have been given to underwriter as per agreement. Here underwriter makes a firm commitment to
purchase the unsubscribed portion at subscription price less take up fees.
Standby fees:
Underwriter usually receives fees called Standby fees as compensation of risk bearing
function.
ROD:
Right offer documents
Types of right issue:

a. Renounceable rights: it has the option of exercising the Rights, re-selling them on the market, or
letting them lapse.
b. Non-renounceable rights: it has no option of re-selling them on the market.
Right share decision/ three types of attempt/ how Rights Issues Work:
1. Buy the shares
2. Ignore rights issue.
3. Sell his rights on the stock market and make a profit (providing the rights are renounceable, if a
company issues non-renounceable right then they cannot be traded)
Uses of rights offer:
Troubled companies typically use rights issues to pay down debt, especially when they are unable to
borrow more money. But not all companies that pursue rights offerings are shaky. Some with clean
balance sheets use them to fund acquisitions and growth strategies. For reassurance that it will raise the
finances, a company will usually, but not always, have its rights issue underwritten by an investment
bank.
Ex-right share price:
Ex-Rights Price is a value which is attributed to a company's share immediately after a rights issue
transaction occurs. It is denoted by Me.
Mathematically,
Ex-Rights Price =
? ?????????? ??????????????? ???????????????? ???? ???? ???????????

? ?? ?????????? ???????????????
Theoretical value of rights (TVR):

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It represents the minimum value that an investor receives from share.
Mathematically,
TVR =
? ?????????????? ?????
??? ??? ?? ???????????? ???? ??????
Number of shares after rights issue = minimum value of single share
Nil Paid rights:

Rights that can be traded are called "renounceable rights", and after they have been traded, the rights
are known as "nil-paid rights".
Security that is tradable but originally posed no cost to the seller. For example, a renounceable right being
sold by the original owner to another investor is considered nil-paid. A right is an opportunity to purchase
more shares, usually at discount, given to shareholders by a corporation. The shareholders receive these
rights at no cost, and if the rights are renounceable, the shareholders can choose to sell them on the
market. Though the word "nil-paid" may suggest that nil-paid rights give shareholders the right to acquire
new shares for no cost, this is not the case. Nil-paid rights are only the right to acquire more shares at the
current share price or a discount. The corporation issuing the rights to its shareholders does not receive
payment for the rights, but if the shareholders decide to exercise the rights, they must pay for the
securities they are given the right to buy.
Nil-paid rights arise when a firm sells new shares for cash to existing shareholders via a rights issue. So,
for example, a firm might offer one new share priced at, say, 1 for every four currently held. Thats
called a one for four issue. Lets say the current share price is 2.50. So after the new share has been
issued you would expect the firms shares to trade at around 2.20 (4 x 2.50 = 10. And (10 + 1)/5 is
2.20). Thats called the ex-rights price.
Any shareholder can choose not to take up their rights, in which case they can often be sold. The nilpaid price is the difference between the issue price and the expected ex-rights price. Here thats 2.20
1 = 1.20. Another investor who was not invited to participate in the original rights issue might be
interested in paying for nil-paid rights instead.
Nil-paid rights will create a capital gain.
Mathematical Problem
Problem 01:
MAA Company has 400,000 $1 ordinary shares as at 30 June 2011. The company decided to make a
rights issue to its existing shareholders by offering 1 new share for every 4 shares held, at $1.20 each.
Calculate the amount received from the issue?
Solution:
Therefore, with 400,000 shares, the rights issue = 400,000 / 4 = 100,000 shares.
The amount received from the issue = 100,000 shares * $1.20 = $120,000.
Problem 02:
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Golden plc. Had the following information:
Authorized Capital 5,000,000 $0.50 ordinary shares
Issued Capital 3,000,000 $0.50 ordinary shares
The company decided to make a rights issue of two ordinary shares for every fifteen ordinary shares held
at a premium of $0.15 each.
Calculate the amount received from the issue?
Solution:
Therefore, with 3,000,000 shares issued, the rights issue = 3,000,000 * (2/15) = 400,000 shares
the amount received from the issue = 400,000 shares * ($0.50 + 0.15) = $260,000.
Problem 03:
Oasis Ltd. intends to raise 4000000 tk. of equity capital through a rights offer. It currently has 1000000
shares outstanding which have been most recently selling for tk. 54. In consultation with BSEC, OL has
set the subscription price for the rights at 50tk.
a) Determine the no. of shares OL should sell to raise the desired capital.
b) Find out the no. of shares each right would entitle a holder of one share to purchase? How many
additional shares can an investor buy for having 10000 shares?
c) Compute the TVR when the share is trading at ex-right.
Solution:
a. The no. of shares OL should sell to raise the desired capital= 4000000/50 = 80000
b. Number of new share per right = 80000/1000000= 0.08
Additional share that a investor can buy for having 10000 shares= 10000*0.08= 800 shares
c. Me =
(???????)?(?????)
?????
= 53.70
N= (10000/800) = 12.5
TVR =
??.?????
??.?
= 0.296
So, for every single share the investor must held 12.5 shares+ $ 50.
Part-02: Dilution effect

Page 19 of 55

Definition:
Dilution is a reduction in proportional ownership caused when a company issues additional shares.
Example
Let's assume you own 100,000 shares of XYZ Company. The company has 1,000,000 shares outstanding,
meaning that you own 10% of the company. Shares of XYZ Company are trading at $5, so the company's
current market value is $5,000,000 and your investment is worth $500,000.
XYZ Company wants to build a new plant, so it issues 500,000 shares. Your 100,000 shares are now
only 6.67% of the company (100,000/1,500,000 = 6.67%).
In the end, the dilution may be worth it if the plant makes XYZ Company more profitable. If however,
the company issued those shares as part of an overly generous stock option program or to raise funds for
projects that fail to contribute profit, the dilution may cause permanent damage to the value of your
holding
. Mathematical
Problem
Problem 01:
Morgan Company has $ 6 million shares outstanding with total earnings $12 million. The company
considers issuing 1.5 million new shares.
a) What will be dilution on EPS?
b) If the new share can be sold@ $ 25 per share and proceeds will earn 12 percent, will there still e
dilution? Based on the new EPS should the new shares be issued?
Solution:
a. EPS = 12/6 = 2
After new share EPS = 12/7.5 = 1.60
Immediate dilution = 2-1.60 =0.40\
b. New share value= 1.5* 25 = 37.5 million
Income from new share = 12 % of 37.5 = 4.5
New income = 12+4.5 = 16.5
EPS = 16.5/7.5 = 2.20
EPS is maximum in this situation and EPS has no dilution effect. So, new share can be issued.
Problem 02:
Blueline corporation will issue 300000 shares at a retail (public) price of $ 40.The company will receive $
37.90 per share and incur $ 160000 in out of pocket expenses.
a. What is the percentage underwriter spread per share?
b. What percent of the total value of the issue (based on retail price) are the out of pocket costs?
Solution:
a. Spread = 40-37.90 = 2.10
Spread % = 2.10/40 = 5.25 %
b. Total value of issue= 300000*40 = 1200000
Total value of the issue is the out of pocket costs %= 160000/1200000 =13.33 %
Problem 03:
Page 20 of 55

AHS currently has 7000000 shares of stock outstanding and will report earnings of $ 15 million in the
current year. The company is considering the issuance of 2000000 additional shares that will net $50 per
share to the corporation.
a. What is the immediate diluted potential for this new issue?
b. If AHS can earn 14% on the proceeds of the stock issue, should the new issue be undertaken?
Solution:
a. Current EPS = 15000000/7000000 = 2.14
After issuing new EPS = 15000000/9000000 = 1.67
Immediate dilution = 2.14-1.67 =0.47\
b. New share value= 2000000* 50 = 100000000
Income from new share = 14 % of 37.5 = 14000000
New income = 15+14 = 29
EPS = 29/9 = 3.22
EPS is maximum in this situation and EPS has no dilution effect. So, new share can be issued.
Page 21 of 55
Bonus share
Bonus share:
Bonus shares are shares issued by a company to its shareholders free of charge by transfer of an amount
from the Companys reserves to its share capital. Bonus sharesare allotted in proportion to the
shareholders current holding of shares in the company.
Fully paid-up new common stock (ordinary shares) issued free to existing stockholders (shareholders) in
proportion to their current stock/shareholdings. A bookkeeping transaction (because no cash changes
hands), it capitalizes a part of reserves (retained earnings) to bring (1) share capital more in line with the
assets employed; and (2) a high share price back to a more manageable amount, thus enhancing its
marketability. Although the number of shares held by each shareholder increases, the value of the total
shareholding remains the same as before the bonus issue.
A company may decide to distribute further shares as an alternative to increasing the dividend payout. An
issuance of bonus shares is approved by the general meeting of a limited company on the basis of
proposal made by the board of directors or a shareholder. Regarding the issuance and allotment please see
Bonus Share Issuance Relevant Dates.
When is a bonus share acquired?

If all parent shares (i.e. the shares giving the right to receive bonus shares) have been acquired at the same
time the same acquisition date will apply to the allotted bonus shares. If the parent shares have been
acquired over time the bonus shares will be allotted to the different acquisition dates proportionately.
What is the difference between bonus shares and a share split?

An issuance of bonus shares is a conversion of a companys equity reserves to share capital. No new
capital is contributed to the company but the free reserves are transferred to share capital while the equity
remains the same. A bonus share issuance is a share capital increase where new shares are ordinarily
allotted to the companys existing shareholders. Given that the number of shares is increased while the
nominal share value remains unchanged, a bonus share issuance will result in a downward adjustment of
the share price.In comparison a share split will result in a split of a companys existing share capital
whereby the nominal value of each share is reduced. Because the share capital remains the same while the
aggregate number of shares is increased a share split will result in a downward adjustment of the share
price as is also the case with a bonus share issuance.
Description: The basic principle behind bonus shares is that the total number of shares increases with a
constant ratio of number of shares held to the number of shares outstanding. For instance, if Investor A
holds 200 shares of a company and a company declares 4:1 bonus, that is for every one share, he gets 4
shares for free. That is total 800 shares for free and his total holding will increase to 1000 shares.
Features:
01.
02.
03.
04.
05.
06.
When a company issue bonus share per value of share never change.
Bonus share issue will create increase number of total share outstanding.
Bonus share creates dilution effects.
In case of bonus share firm total value remain same.
After bonus share with end up the similar position/overall ownership proportion remain same.
Total net worth remains same.
Page 22 of 55
Why company issue bonus share?

Company plans to ride on retain earning, so they issue bonus share.
Mathematical problem
Problem 01: A company declared 5 % bonus share. Its existing capital structure is as follow:
Fig in lac Tk
Particular
Amount
Common stock ( Tk 5 per value)
20 lac
Additional paid up
10 lac
Retain earning
70 lac
Total
100 lac/ 10 million
If market price is Tk 40/share, Show the post dividend capital structure:
Solution:
Here, number of existing common stock: 400,000
5 % bonus share= 400000 X 5% =20,000 bonus share
So, total Common stock = 400000+20000 = 420000
Value of total common stock = 420000 X 5 = Tk 2,100,000 /21 lac
Market value is Tk 40
So, Additional paid up capital = (35 X 20000) + 1000000 = 1,700, 000
Now, Bonus share has been issued if company wants to ride on retained earnings
So, new value comes from bonus share is = (40 X 20000) = 800,000
TK 8 lac has been deducted from Retain earning.
So retain earning is = 70-8 = Tk 62 lac
Post dividend capital structure
Fig in lac Tk
Particular
Common stock ( Tk 5 per value)
Additional paid up
Retain earning
Total
Amount
21 lac
17 lac
62 lac
100 lac/ 10 million
Page 23 of 55
Convertibles
Derivative Security A financial contract whose value derives in part from the value and
characteristics of one or more underlying assets (e.g., securities, commodities), interest rates,
exchange rates, or indices.
Straight debt or equity cannot be exchanged for another asset, but options are
exchangeable.
An option is part of the broader category of derivative securities.
Straight bond: A bond that pays interest at regular intervals and at maturity pays back the
principal that was originally invested but does not have any fancy features such as call
dates and/or conversion privileges.
A straight bond is the most basic of debt investments. It is also knows as a plain
vanilla bond because there are no additional features that other bonds might have.
Convertible Bond: The security which has conversion features an investment that can be
changed into another form. A bond or a preferred stock that is convertible into a specified
number of shares of common stock at the option of the holder.
Convertibles are a category of financial instruments, such as convertible bonds and preferred
shares that can be exchanged for an underlying asset.
The most common convertible securities are convertible bonds or convertible preferred stock,
which can be changed into equity or common stock. A convertible security pays a periodic fixed
amount as a coupon payment (in the case of convertible bonds) or a preferred dividend (in the
case of convertible preferred shares), and specifies the price at which it can be converted into
common stock.
Features:
This provides the convertible holder a fixed return (interest or dividend) and the option to
exchange a bond or preferred stock for common stock.
The option allows the company to sell convertible securities at a lower yield than it would
have to pay on a straight bond or preferred stock issue. Yield depends on issuer rating.
More risky more yield and vice verse.
Convertible interest is one kind of derivative interest because it has underlying asset.
New security has been issued by revaluing old security.
Bonds are called fixed income security because it has fix income (coupon).
Convertible Equity: Preferred stock that includes an option for the holder to convert the
preferred shares into a fixed number of common shares, usually anytime after a predetermined
date.
Page 24 of 55
Conversion Price: The price per share at which common stock will be exchanged for a
convertible security. It is equal to the face value of the convertible security divided by the
conversion ratio.
Mathematically,
Conversion Price =
???? ????? ????????????? ????????

?????????? ?????
Conversion Ratio: How many securities one gets in exchange of convertible security. The
number of shares of common stock into which a convertible security can be converted. It is equal
to the face value of the convertible security divided by the conversion price.
The higher the ratio, the higher the number of common shares exchanged per convertible
security . The conversion ratio is determined at the time the convertible security is issued and
will have an impact on the relative price of the security.
Mathematically,
Conversion Ratio =
???? ????? ????????????? ????????

?????????? ?????
Conversion Value/ Conversion Option Value: The value of the convertible security in terms of
the common stock into which the security can be converted. It is equal to the conversion ratio
times the current market price per share of the common stock. Market establishes it.
Mathematically,
Conversion Value = Conversion Ratio X Market value
Premium Over Conversion Value: The amount by which the price of a convertible
security exceeds the current market value of the common stock into which it may be converted
The market price of a convertible security minus its conversion value; also called conversion
premium. It expressed as percentage also.
Mathematically,
Premium over Conversion Value = The market price of a convertible security- conversion value
Example:
For example, convertible preferred stock is preferred stock that holders can exchange
for common stock at a set price after a certain date. Let's assume you purchase 100 shares of
XYZ Company convertible $ 100 per value preferred stock, which pays 8 % dividend, on June 1,
2006. The security has a conversion price of $30 per share.
Conversion Ratio =
???
??
= 3.33
Page 25 of 55
According to the registration statement, each share of preferred stock is convertible after January
1, 2007, (the conversion date) to certain amount of shares of Company XYZ stock. (The
number of common shares given for each preferred share is the conversion ratio. In this example,
the ratio is 3.33). The market value per share of common stocks was trading at $42 per share &
the market value per share of preferred stock in were trading at $154 per share
Conversion Value = 3.33 X $ 42
= $ 140
Conversion Premium = $ 154- $ 140
= $ 14 premium per share of preferred stock (or a 10% premium).
If after the conversion date arrives Company XYZ preferred shares are trading at $154 per share
and the common shares are trading at $42 per share, then converting the shares would effectively
turn $154 worth of stock into only $140 worth of stock (the investor has the choice between
holding one share valued at $140 or holding three shares valued at $42 each). The difference
between the two amounts, $14, is called the conversion premium (although it is typically
expressed as a percentage of the preferred share price -- in this case it would be 10%).
By dividing the price of the preferred shares ($154) by the conversion ratio (3.33), we can
determine what the common stock must trade at for you to break even on the conversion. In this
case, Company XYZ common must be trading at a minimum of $46.25 per share for you to
seriously consider converting.
Use of Convertible Securities:
In many cases, convertible securities are employed as deferred common stock
financing.
The interest or dividend rate is likely to be less than that of straight debt or preferred
stock. The greater the growth prospects of the firms common stock, the lower the stated
rate the firm will need to pay.
Determining fair price of the bond.
Convertible Value: The financial worth of the securities obtained by exchanging a convertible
security for its underlying assets.
Convertible Bond Value = Straight Bond Value + Option Value
Volatility in cash flows of firm

Decreases straight bond value
Increases option value
Suggests that convertibles are useful when a companys future is highly uncertain
Page 26 of 55
Why volatility of the firm tends to convertible security?

When a firm is facing volatility then straight bond value will be decreased because market thinks
it would not do well. In this situation there is no way then establish convertible features (Increase
option value) to make it lucrative among investor. Investor may be attracted by this features as
they will be a part of that companys equity
Conversion Value: The value of the convertible security in terms of the common stock into
which the security can be converted. It is equal to the conversion ratio times the current market
price per share of the common stock.
Why Care About Straight Bond Value?
The convertible bond value equals straight bond value plus conversion option value.
It represents a floor (minimum) below which the convertible value will not fall. This
occurs when the conversion option value is essentially worthless.
The straight bond value is subject to change as interest rates, firm risk, and time change.
This, in turn, is likely to impact the convertible bond value.
Page 27 of 55
Warrants
Warrant It is a derivative security that gives the holder the right to purchase securities (usually
equity) from the issuer at a specific price within a certain time frame. Warrants are often
included in a new debt issue as a "sweetener" to entice investors and an option to purchase
common stock at a specied exercise price (usually higher than the market price at the time of
warrant issuance) for a specied period (often lasting for years and, in some cases, in perpetuity).
In contrast, a right is also an option to buy common stock, but normally it has a subscription
price lower than the market value of the common stock and a very short life (often two to four
weeks).If one hold debt for long time and company provides special options after certain period
to purchase common stock of this company by strike price/ exercise price. It is a kind of dual
participation.
Warrant is a relatively long-term option to purchase common stock at a specified exercise price
over a specified period of time.
Warrants are employed as sweeteners:
To obtain a lower interest rate.
To raise funds when the firm is considered a marginal credit risk. (Why warrant is
attached with debts?)
To compensate underwriters and venture capitalists when founding a company.
Warrant Features:
The warrant contains provisions for:
It states the number of shares the holder can buy for each warrant. Frequently, a
warrant will provide the option to purchase 1share of common stock for each
warrant held, but it might be 2 shares, 3 shares, or 2.54 shares. The price at which
the warrant can be exercised. The warrant expiration date.
The price at which the warrant is exercisable, such as $12 a share. This means that
in order to buy 1 share, the warrant holder must put up $12 a share. This exercise
price may either be xed or stepped up over time. For example, the exercise
price might increase from $12 to $13 after three years and to $14 after another
three years.
The warrant expiration date.
Warrant holders are not entitled to any dividends nor do they have any voting power.
The exercise price is generally adjusted for any common stock dividends and splits.
Page 28 of 55

Strike price/Exercise price: The price at which the common stock associated with a warrant or
call option can be purchased over a specified period.
Warrant has three issues:
01. Strike price/Exercise price
02. No voting rights, No dividend.
03. Warrant has an expiration date.
Exercise of Warrants:
When warrants are exercised (used), the common stock of the company is increased. Moreover,
the debt that was issued in conjunction with the warrants remains outstanding. At the time of the
issue of the warrants, the exercise price is usually set in excess of the market price of the
common stock. The premium is often 15 percent or so above the stocks value. If the share price
is $40, and the holder can purchase one share of common stock for each warrant held, this
translates into an exercise price of $46.To see how new capital can be infused with the exercise
of warrants, let us take a look at a company we will call Black Shoals, Inc. It has just raised $25
million in debt funds with warrants attached. The debentures carry a 10 percent coupon rate.
With each debenture ($1,000 face value) investors receive one warrant entitling them to purchase
four shares of common stock at $30 a share. The capitalization of the company before financing,
after financing, and after complete exercise of the warrant options is as follows (in millions):
Fig in million doller
Before financing After financing
After exercise
A. Debentures
$0
$ 25
$25
Common stock ($10 par value)
$ 10
$ 10
$ 11
Additional paid-in capital
$0
$0
$ 02
Retained earnings
$ 40
$ 40
$ 40
B. Shareholders equity
$ 50
$ 50
$ 53
Total capitalization (A+B)
$ 50
$ 75
$ 78
The retained earnings of the company remain unchanged, and the debenture issue has neither
matured nor been called. Exercising their warrant options, the warrant holders purchase 100,000
shares of stock at $30 a share, or $3 million in total. Consequently, the total capitalization of the
company is increased by that amount.
Page 29 of 55

Theoretical Value of a Warrant
The theoretical value of a warrant consists of two components: intrinsic value (formula value)
and time value:
Warrant value = formula value + time value
The formula value is the difference between the underlying share price and the warrants
exercise price, multiplied by the number of new shares issued on exercise. This value is either
positive or zero, but cant be negative. On the other hand, the time value is the premium over
formula value (this premium is known as the price). The time value is always positive and
approaches zero with the passage of time (up until the expiration date).
Valuation of a Warrant:
Theoretical value of a warrant = max [(N) (Ps) E, 0]
N = number of shares per warrant
Ps = market price of one share of stock
E = exercise price associated with the purchase of N shares
Max means the maximum value of (N) (Ps) E, or zero, whichever is greater.
The theoretical value of a warrant is the lowest level at which the warrant will generally sell. If,
for some reason, the market price of a warrant were to go lower than its theoretical value,
arbitragers would eliminate the differential by buying the warrants, exercising them, and selling
the stock.
Page 30 of 55

When the market value of the associated stock is less than the exercise price, the theoretical
value of the warrant is zero, and it is said to be trading out of the money. When the value of
the associated common stock is greater than the exercise price, the theoretical value of the
warrant is positive, as depicted by the solid diagonal line in above Figure. Under these
circumstances, the warrant is said to be trading in the money.
Example: if N = 1, Ps = $10, E = $5 max [(1) ($10) $5, 0] = $5
And if N = 1, Ps = $15, E = $5 max [(1) ($15) $5, 0] =$10
Summary of the Example of Warrant Valuation

The market value of a warrant equals or exceeds the theoretical value of the warrant.
The greater market value is generated by the unlimited upside potential of the stock price
combined with the limited downside risk to the warrant holder (minimum value is 0).
The greater the time to expiration, the greater the opportunity of the upside potential of
the stock and the greater the market value of the warrant.
Page 31 of 55
Premium over Theoretical Value

The primary reason that a warrant sells at a price higher than its theoretical value is the
opportunity for leverage. To illustrate the concept of leverage, consider the Textron warrants. For
each warrant held, one share of common stock can be purchased, and the exercise price is $10.
If the common stock were selling at $12 a share, the theoretical value of the warrant would be
$2.
N = 1, Ps = $12, E = $10 max [(1) ($12) $10, 0] = $2
Suppose, however, that the common stock increased by 25 percent in price to $15 a share. The
theoretical value of the warrant would go from $2 to $5, a gain of 150 percent.
N = 1, Ps = $15, E = $10 max [(1) ($15) $10, 0] = $5
Gain % = (5-2) / 2 *100 = 150 %
The opportunity for increased gain is attractive to investors when the common stock is selling
near its exercise price. For a particular dollar investment, the investor can buy more warrants
than common stock. If the stock moves up in price, the investor will make more money on the
warrants than on an equal dollar investment in common stock.
Page 32 of 55
Mathematical problems
01. Summit Ltd. has current earnings of $3 a share with 5, 00,000 shares of common stock
outstanding. The company plans to issue 40,000 shares of 7 percent, $50 par value
convertible preferred stock at par. The preferred stock is convertible into two shares of
common stock for each preferred share held. The common stock has a current market
price of $21 per share.
Requirements:
a. What is the preferred stocks conversion value?
b. What is the premium over conversion value?
c. What will be the effect of the issue on basic earnings per share
i) Before conversion
ii) on diluted basis
d. If profits after taxes increase by $1 million, show the impact
Solution:
Given, market price of common stock= $ 21/share
Market price of convertible security = $ 50/share
No of share= 5, 00,000
Conversion ratio= 2:1
EPS= $3.00
Total earning= $ 3X 5, 00,000 = $ 15, 00,000
a. Conversion Value = Conversion Ratio X Market value
= $ 21* 2
= $ 42
b. Premium = The market price of a convertible security- conversion value
= $ 50- $42
=$8
c. Dividend = 40000X50X7% = $ 1, 40,000
Total earning = $ 15, 00,000
Dividend (-) = $ 1, 40,000
EACS = $ 13, 60,000
Here Number of new common stock after converting of preferred stock
= Conversion ratio X Number of converted security
= 2 X 40000
= 80,000
After conversion total number of security = 5, 00,000+ 80,000
= 5, 80, 000
Page 33 of 55
i)
Before conversion Basic EPS =
???????
??????
= $ 2.72
ii)
Dilute EPS =
???????
??????
= $ 2.59
d. If profit after taxes increased by $ 10,00,000,

Total earning = $ 25, 00,000
Dividend (-) = $ 1, 40,000
EACS = $ 23, 60,000
i)
Before conversion Basic EPS =
???????
??????
= $ 4.72
ii)
Dilute EPS =
???????
??????
= $ 4.31
02. The common stock of the Blue Sky Corporation earns $3 per share, has a 60 percent
dividend payout and sells at a P/E ratio of 8.333. Blue Sky wishes to offer $10 million
of 9 percent, 20 year convertible debentures with an initial conversion premium of 20
percent. Blue Sky currently has 1 million common shares outstanding.
a) What is the conversion price?
b) What is the conversion ratio per $ 1000 debenture?
c) What is the initial conversion value of each debenture?
d) How many new shares of common stock must be issued if all debentures are converted
Solution:
Given, No of Common stock = 10, 00,000
Earn per share = $ 3
Dividend payout = 60 %
P/E ratio = 8.333
Conversion premium = 20 %
Page 34 of 55
Here,
a. P/E ratio =
? ??
???
MPS = P/E ratio X EPS

= 8.333X 3
= 25
Conversion price = $ (25 + 20 % of 25)
= $ 30
b. Conversion ratio = 1000/30
= 33.33
c. Conversion value = Conversion ratio X MPS
= $ 33.33 X 25
= $ 833.25
????????
d. Number of convertible security =
????
= 10,000
The number of common stock must be issued if all debentures are converted
= Conversion ratio X Number of convertible security
= 33.33 X 10000
= 3, 33,300
03. Lumpkin Limited is composed of 10 million of common stock ($ 10 par value) and $
40 million of retained earnings. It has just raised 25 million of debt funds with warrants
attached.
Now we have to see how capital can be infused with the exercise of warrants.
*The debentures carry a 10 percent coupon rate. With each debenture (1000 par value)
investors receive one warrant entitling them to purchase four shares of common stock at
$30 per share. Now derive the total capitalization of the company after the exercise of
warrants.
Solution:
Given, Common stock= $ 1,00,00,000
Retained earnings = $ 4,00,00,000
One warrant = four common stock
Exercise price = $ 30/share
Page 35 of 55
Total Value = No of exchangeable common stock X exercise price/share

= 04 X $ 50
= $ 200
Number of debt security =
????? ??????????????
????????
25000000
1000
= 25000
Number of common stock after exercise = 25000 X 4 = 100000

Share value = $ 30 X 100000 = $ 3,00,00,000
Here par value is $ 10 so
New Common stock after exercise = $ 10 X 100000 = $ 1,00,00,000
Additional paid-in capital = $ 20 X 100000 = $ 2,00,00,000
So total capitalization is as follow:
C. Debentures
Retained earnings
D. Shareholders equity
Before financing
$0
$ 10
$0
$ 40
$ 50
$ 50
After financing
$ 25
$ 10
$0
$ 40
$ 50
$ 75
Fig in million doller

After exercise
$25
$ 11
$ 02
$ 40
$ 53
$ 78
Page 36 of 55

04. Greenville has outstanding warrants, where each warrant entitles the holder to purchase
two shares of common stock at $24 per share. Market price per share of stock was
taken from the following observations throughout the last year:
Stock
price
20
18
27
32
24
Determine the theoretical value per warrant for each of these observations.
Solution:
N = 1, Ps = $10, E = $5 max [(1) ($10) $5, 0] = $5
Theoretical value of a warrant = max [(N) (Ps) E, 0]
N = number of shares per warrant
Ps = market price of one share of stock
E = exercise price associated with the purchase of N shares
Theoretical value of a warrant= max [(2) (20) (24X2)]
= -8
=0
Theoretical value of a warrant= max [(2) (32) (24X2)]
= 16
When stock price is lower than exercise price than it is trade able.
05. The Rambutan Fruit Company needs to raise $10 million by means of a debt issue. It
has the following two alternatives: a 20-year, 8 percent convertible debenture issue with
a $50 conversion price and $1,000 face value; or a 20-year, 10 percent straight debt
issue. Each $1,000 bond has a detachable warrant to purchase four shares of stock for a
total of $200. The company has a 50 percent tax rate, and its stock is currently selling at
$40 per share. Its net income before interest and taxes is a constant 20 percent of its
total capitalization, which currently appears as follows:
Common stock (par $5)
Retained earnings
Total capitalization
$ 5,000,000
$10,000,000
$15,000,000
$ 30,000,000
Page 37 of 55
38

a. Show the capitalization from each alternative, both before and after conversion and after
exercise (a total of four different capitalizations).
b. Compute earnings per share currently under each of the four capitalizations determined in Part
(a).
c. If the price of Rambutan stock went to $75, determine the theoretical value of each warrant
issued under the second alternative.
Solution:
Given, Debt issue = $ 10,000,000
Conversion price = $ 50
One warrant= Four share
Exercise price= 200/5 = $ 40
Conversion ratio = 1000/50
= 20
Number of convertible security = 10000000/1000
= 10000
Number of common security = 10000 X 20 = 200000
New common stock value = $ 5 X 200000 = $ 1000000
Paid in capital = $ 45 X 200000 = $ 9000000
Number of debenture = 10000000/1000= 10000
No of common stock purchase after exercise= 10000X4= 40000
For equity= 40000 X 5 = $ 200000
Additional = 40000 X 45= $ 1800000
a.
Fig in million Dollar
A. Debentures
Retained earnings
A. Debentures
Retained earnings
Before financing
$0
$5
$ 10
$ 15
$ 30
$ 30
Before financing
$0
$5
$ 10
$ 15
$ 30
$ 30
Before conversion
$ 10
$5
$ 10
$ 15
$ 30
$ 40
After conversion
$0
$6
$ 19
$ 15
$ 40
$ 40
Before exercise
$ 10
$5
$ 10
$ 15
$ 30
$ 40
Fig in million Dollar

After exercise
$ 10
$ 5.2
$ 11.8
$ 15
$ 32
$ 42
Page 38 of 55
Fig in 000 Dollar

b.
*EBIT
Interest(-)
EBT
Tax(-)
EAT
No of C/S
EPS
Before
After
conversion
conversion
8000
8000
800
0
7200
8000
3600
4000
3600
4000
*1000
*1200
3.60
3.33
Before exercise
After exercise
8000
1000
7000
3500
3500
*1000
3.50
8400
1000
7400
3700
3700
*1040
3.56
*Note: Measurement of common stock

Before
After
conversion conversion
5000000
6000000
=5000000/5 =6000000/5
Common stock value

No of Common stock
Fig in Dollar
Before
After
exercise
exercise
5000000
5200000
=5000000/5 =5200000/5
= Common stock value/ per value
Result
1000000
1200000
1000000
1040000
c. If price is $ 75
TVW= (4*75)-200
= 100
Page 39 of 55
Mergers and Other Forms of Corporate Restructuring

Corporate Restructuring:
The concept of restructuring involves embracing new ways of running an organization and abandoning
the old ones. It requires organizations to constantly reconsider their organizational design and structure,
organizational systems and procedures, formal statements on organizational philosophy and may also
include values, leader norms and reaction to critical incidences, criteria for rewarding, recruitment,
selection, promotion and transfer.
Any change in a companys:
1. Capital structure,
2. Any change of Operations
3. Any change of Ownership
Change of anyone above can create corporate restructuring.
Investment banker plays vital role in corporate restructuring
Role of Investment banker in corporate restructuring:

The corporate restructuring process combines numerous specialties from within the accounting, finance
and legal professions. However, its main goal is to take control of a financially distressed companys dayto-day operations in order to maximize the probability that the company will only require one
restructuring in order to emerge financially sound.
That is outside its ordinary course of business.
Page 40 of 55

So where is the value coming from (why restructure)?
Why Engage in Corporate Restructuring?
Sales enhancement and operating economies*

Improved management
Information effect
Wealth transfers
Tax reasons
Leverage gains
Hubris hypothesis
Managements personal agenda
Sales Enhancement and Operating Economies
Sales enhancement can occur because of market share gain, technological advancements to the
product table, and filling a gap in the product line.
Operating economies can be achieved because of the elimination of duplicate facilities or
operations and personnel.
Synergy Economies realized in a merger where the performance of the combined firm exceeds
that of its previously separate parts.
Synergy: when the combination of two firms together results in greater value than if they were to operate
separately, is a financial benefit that a corporation expects to realize when it merges with or acquires
another corporation.
If, 1+1 = 3 or more it is positive synergy or vice verse.
Hubris hypothesis: The characteristic of excessive confidence or arrogance which leads a person to
believe that he or she may do no wrong. The overwhelming pride caused by hubris is often considered a
flaw in character. While these hubris feelings are often justified, they often cause irrational and harmful
behavior.
The theory that contends that some manager overestimate their own managerial capabilities and pursue
take over with the belief that they can better manage their takeover target than the targets current
managements.
In a word big venture targets small for capture.
Types of corporate restructure:

a. Merger
b. Acquisition
c. Consolidation
Mergers and acquisitions are both changes in control of companies that involve combining the
operations of multiple entities into a single company.
Page 41 of 55

Merger: A merger refers to the absorption of one firm by another. The acquiring firm retains its name
and identity and it acquires all of the assets and liabilities of the acquired firm. In merger two companies
agree to combine their operations into a single entity. A merger is a corporate strategy of combining
different companies into a single company in order to enhance the financial and operational strengths of
both organizations.
If A & B are two company.
So, A+B = A/B
Example: Facebook & WhatsApp merged in a deal worth $19 billion
Acquisition :In an acquisition, one company purchases another company, and has the right to sell off
operations, merge them into similar groups in the purchasing company, or close facilities or cancel
products altogether.
If A & B are two company.
So, A
B=A
Example: Microsoft
Nokia= Microsoft
Consolidation: The unification of two or more corporations by dissolution of existing ones and creation
of a single new corporation.
For example company A and Company B consolidate to form company C.
Types of M & A:
01. Friendly tender offer: If majority shareholders of target firm support the endorsement of outside
firm in BOD.
02. Hostile takeover: Acquiring a firm despite the disapproval of, or open resistance from, its board
of directors. The acquirer ('raider') usually takes the takeover offer direct to the target firm's
stockholders (shareholders) or seeks their approval to remove the obstructing board members.
The acquisition of one company (called the target company) by another (called the acquirer) that
is accomplished not by coming to an agreement with the target company's management, but by
going directly to the company's shareholders or fighting to replace management in order to get the
acquisition approved.
Why Merge?
Companies would choose to merge together for different reasons:
The combined entity would be larger, and have corresponding larger resources for marketing,
product expansion, and obtaining financing. This could help them better compete in the
marketplace.
The combined entity could merge similar operations to reduce costs. Corporate and
administrative functions, such as human resources and marketing, are often targets for
combinations. They might also combine the production areas if the companies produce similar
products and reduce costs by having fewer plants or facilities in operation.
The combined entity might have less competition in the marketplace. If the products of the two
companies competed for customers, they could combine their offerings and use resources for
improving the product, rather than marketing against each other.
Page 42 of 55
The combined entity might have synergy in operations. Synergy is when combined operations
show lower costs or higher profits than would be expected by just adding their financial
information together on paper. This could be due to economies of scale, where costs are lower
due to higher volume of production, or due to vertical integration, where greater control over the
production process is achieved due to owning more steps in the production process.
Why Acquire?
A company might acquire another company to obtain a specific product. It can be less expensive
to purchase a company offering a product you'd like to sell than building the product yourself.
Software companies often purchase smaller companies that offer extensions to their product line
if they become popular with customers, so they can add the functionality to their primary
offering.
A company might acquire other companies to increase its size. A larger company may have more
visibility in the marketplace, and also better access to credit and other resources.
A company might acquire another to obtain control over a critical resource. For example, a
jewelry company might acquire a gold mine, to ensure they have access to gold without market
price fluctuations.
Types of merger:
01. Horizontal Merger:
Horizontal merger is a business consolidation that occurs between firms who operate in the same line of
business, often as competitors offering the same good or service. Horizontal mergers are common in
industries with fewer firms, as competition tends to be higher and the synergies and potential gains in
market share are much greater for merging firms in such an industry. Best chance for economies
Example
A merger between Coca-Cola and the Pepsi beverage division, for example, would be horizontal in
nature.
The goals of a horizontal merger:
To create a new, larger organization with more market share. Because the merging companies'
business operations may be very similar, there may be opportunities to join certain operations,
such as manufacturing, and reduce costs.
To drive away very opponent enemy
To increase dominancy in the business.
02. Vertical Merger: A merger between two companies producing different goods or services for
one specific finished product. A vertical merger occurs when two or more firms, operating at
different levels within an industry's supply chain, merge operations. Most often the logic behind
the merger is to increase synergies created by merging firms that would be more efficient
operating as one. Supplier of raw materials & finished goods manufacturer.
Page 43 of 55

Example
A vertical merger joins two companies that may not compete with each other, but exist in the same supply
chain. An automobile company joining with a parts supplier would be an example of a vertical merger.
Such a deal would allow the automobile division to obtain better pricing on parts and have better control
over the manufacturing process. The parts division, in turn, would be guaranteed a steady stream of
business.
The goals of a vertical merger:
To increase control over the acquisition of raw materials.
Lead to greater control in market.
03. Conglomerate
A merger between firms that are involved in totally unrelated business activities. There are two types of
conglomerate mergers: pure and mixed. Pure conglomerate mergers involve firms with nothing in
common, while mixed conglomerate mergers involve firms that are looking for product extensions or
market extensions. May lead to economies.
Example
A leading manufacturer of athletic shoes, merges with a soft drink firm. The resulting company is faced
with the same competition in each of its two markets after the merger as the individual firms were before
the merger. One example of a conglomerate merger was the merger between the Walt Disney Company
and the American Broadcasting Company.
The goals of a Conglomerate merger/Why conglomerate merger are the best option:
Risk reduction by establishing new business
To attain synergic benefits
04. Congeneric merger:

Merger between two firms in the same general industry but having no mutual buyer-seller relationship.
Two company lies in same business but not same line of business. Few operating economies
Example
The goals of a Congeneric merger
Both party can entry in new business.
05. Divestiture:
Selling of some parts of business. Divestiture is the reduction of some kind of asset, for either
financial or social goals. reverse synergy may occur.
Economies of Scale The benefits of size in which the average unit cost falls as volume increases. An
economy of scale is the cost advantage that arises with increased output of a product.
Economics of scale can be internal to an organization (cost reduction due to technological and
management factors) or external (cost reduction due to the effect of technology in an industry).
Economies of scale arise because of the inverse relationship between the quantity produced and per-unit
fixed costs; i.e. the greater the quantity of a good produced, the lower the per-unit fixed cost because
these costs are shared over a larger number of goods.
Page 44 of 55

Economies of scale may also reduce variable costs per unit because of operational efficiencies and
synergies. Economies of scale can be classified into two main types: Internal arising from within the
company; and External arising from extraneous factors such as industry size.
Difference between merger and acquisition:
Basis for
Comparison
Merger
Acquisition
Meaning
The merger means the fusion of two or more

than two companies voluntarily to form a new
company.
When one entity purchases the business

of another entity, it is known as
Acquisition.
Nature of
Decision
The mutual decision of the companies going

through mergers.
Friendly or hostile decision of acquiring

and acquired companies.
Purpose
To decrease competition and increase

operational efficiency.
For Instantaneous growth
Size of
Business
Generally, the size of merging companies is

more or less same.
The size of the acquiring company will

be more than the size of acquired
company.
Legal
Formalities
More
Less
Some useful terms:

Buyout firm= Acquiring firm
Bought Firm= Acquired firm= Target firm
Types of acquisition:
Strategic Acquisition
Financial Acquisition
Strategic Acquisitions Involving Common Stock

Strategic Acquisition: Occurs when one company acquires another as part of its overall business
strategy.
Financial Acquisition: A financial acquisition occurs when a buyout firm is motivated to purchase the
company (usually to sell assets, cut costs, and manage the remainder more efficiently), but keeps it as a
stand-alone entity.
Ratio of exchange:
The rate of amount per share paid for the target firm to the market price per share of acquiring
firm/The number of shares of the acquiring company that a shareholder will receive for one share of the
acquired company.
Mathematically,
Exchange ratio = offer price/ MPS of acquiring firm
It denotes the relative weighting of the two companies with regard to certain key variables, results.
Page 45 of 55

The ratio of exchange of market price (Market impact)
When the acquiring company knows the ratio of exchange, it can be used to find the market price
ratio of exchange
Mathematically,
The ratio of exchange of market price =
? ?? ??????????? ??? ???? ? ???????? ?????

? ?? ?????????? ??? ????
The market price ratio of exchange indicates how much of market price per share of the acquiring firm is
exchanged for every Tk 1.00 of the market price per share of the target company. If the ratio is less than
or nearly equal to 1, the shareholders of the acquired firm are not likely to have a monetary incentive to
accept the merger offer from the acquiring firm.
Example: ABC (acquiring company) is acquiring BCD (Target Company) with the use of a stock swap
transaction. ABCs market price is $60 and BCDs market price is $55. However, during merger
negotiations, ABC agreed to a 1.5 ratio of exchange where it valued BCDs shares at $90.
So, the market price per share in the ABC/BCD merger = (60*1.5)/55=1.6
This means that ABC gives $1.6 of its market price in exchange for every dollar of the BCDs market
price
Bootstrapping; both earnings per share and market price per share have risen because of the acquisition
but P/E ratio remain constant. This is known as bootstrapping.
It is the sign of progressing faster.
FCFF: A measure of financial performance that expresses the net amount of cash that is generated for the
firm, consisting of expenses, taxes and changes in net working capital and investments.
Free to utilize, no obligation has been imposed to use.
Mathematically,
FCFF= Operating CF-Capitalized expenditure-Net working capital + Noncash charge
An acquisition can be treated as a capital budgeting project. This requires an analysis of the free
cash flows of the prospective acquisition.
Free cash flows are the cash flows that remain after we subtract from expected revenues any
expected operating costs and the capital expenditures necessary to sustain, and hopefully
improve, the cash flows.
Free cash flows should consider any synergistic effects but be before any financial charges so that
examination is made of marginal after-tax operating cash flows and net investment effects.
Goodwill The intangible assets of the acquired firm arising from the acquiring firm paying more for
them than their book value.
Page 46 of 55
Theory & terms of M &A:

Tender offer: An offer to buy current shareholders stock at a specified price, often with the objective of
gaining control of the company. The offer is often made by another company and usually for more than
the present market price.
An offers share purchase at a premium above market to the firm T (target firm)
Features:
Allows the acquiring company to bypass the management of the company it wishes to acquire.
It is not possible to surprise another company with its acquisition because the SEC requires
extensive disclosure.
The tender offer is usually communicated through financial newspapers and direct mailings if
shareholder lists can be obtained in a timely manner.
Two-tier Tender Offer Occurs when the bidder offers a superior first-tier price (e.g., higher amount or
all cash) for a specified maximum number (or percent) of shares and simultaneously offers to acquire the
remaining shares at a second-tier price. First offer would be lucrative than the second offer. e.g.: offer
more premiums in first offer.
Features:
Increases the likelihood of success in gaining control of the target firm.
Benefits those who tender early.
Defensive Tactics
The company being bid for may use a number of defensive tactics including:
(1) Persuasion by management that the offer is not in their best interests,
(2) Taking legal actions,
(3) Increasing the cash dividend or declaring a stock split to gain shareholder support.
(4) Looking for a friendly company (i.e., white knight) to purchase them.
White Knight A friendly acquirer who, at the invitation of a target company, purchases shares from the
hostile bidder(s) or launches a friendly counter-bid in order to frustrate the initial, unfriendly bidder(s).
Target firm T
closely related Partner P
Partner plays counter bid to protect T from acquiring firm.
Motivation Theories:
Managerial Entrenchment Hypothesis
This theory suggests that barriers are erected to
protect management jobs and that such actions
work to the detriment of shareholders
Shareholders Interest Hypothesis

This theory implies that contests for corporate
control are dysfunctional and take management
time away from profit-making activities.
Shark Repellent In a simple sentence a shark repellent is any method of driving sharks away from an
area. Defenses employed by a company to ward off potential takeover bidders the sharks. Also known
as "porcupine provision
Page 47 of 55

A shark repellent is a strategy taken by public companies to ward off unwanted takeovers. It is a generic
term for periodic or continuous measures taken by the management of a firm to discourage unwanted or
hostile takeovers. These measures benefit the firms management more than the stockholders, as they
damage the firm's financial position. Some of the common measures include macaroni defense, poison
pills, and golden parachute
Stagger the terms of the board of directors
Change the state of incorporation
Supermajority merger approval provision
Fair merger price provision
Leveraged recapitalization
Poison pill
Standstill agreement
Premium buy-back offer
Leveraged recapitalization: When target firm is in danger and going to be acquired anytime than BOD
of target firm issue debt and provide dividend for all shareholders for compensation than Acquiring
Company demotivates to take over because with debt.
Poison pill: A strategy used by corporations to discourage hostile takeovers. With a poison pill, the target
company attempts to make its stock less attractive to the acquirer. There are two types of poison pills:
Poison pill takes several forms: (1) provision that makes the firm's all debts immediately payable if the
board of directors is changed; (2) distribution of warrants or purchase rights for buying the firm's stock
(shares) at a heavy (usually 50 percent) discount when a triggering event (takeover attempt) occurs, thus
immediately diluting the raider's ownership interest and voting rights; and/or (3) issuance of a new series
of preferred stock (preference shares) that gives stockholders/shareholders (not including the raider) right
to redeem them at a hefty premium after a takeover.
For right issuing of share acquiring firm has to purchase more share than before so they discourage to take
over.
Standstill agreement:
An agreement between a target company and a potential hostile acquirer whereby the acquirer agrees not
to buy any more of the target company in exchange for some compensation. The compensation may be
monetary; that is, the company can simply buy off the acquirer. More commonly, it involves some other
incentive such as a seat on the board of directors or an agreement for the company to repurchase its own
stock, which would increase the value of the shares the acquirer already owns. A standstill agreement has
an expiration date after which the acquirer can continue buying the company if it wishes, but the time in
between gives the target company time to form a more effective antitakeover strategy.
Golden parachute:
A clause in an executive's employment contract specifying that he/she will receive large benefits in the
event that the company is acquired and the executive's employment is terminated. These benefits
can take the form of severance pay, a bonus, stock options, or a combination thereof. Golden parachutes
are contracts given to key executives and can be used as a type of antitakeover measure taken by a firm to
discourage an unwanted takeover attempt.
Page 48 of 55

Premium buy-back offer/ Green mail:
An antitakeover measure that arises when a large block of stock is held by an unfriendly company that is
threatening a hostile takeover. Greenmail is a term that applies to mergers and acquisitions, and refers to
the money that is paid by the target company to another company, known as a corporate raider, that has
purchased a majority of the target company's stock. The greenmail payment is made in an attempt to stop
the takeover bid. The target company is forced to repurchase the stock at a substantial premium (the
greenmail payment) to prevent the takeover. This is also known as a "bon voyage bonus" or a "goodbye
kiss."
Divestiture
Divestiture The divestment of a portion of the enterprise or the firm as a whole.
Liquidation The sale of assets of a firm, either voluntarily or in bankruptcy.
Sell-off The sale of a division of a company, known as a partial sell-off, or the company as a whole,
known as a voluntary liquidation
Spin-off A form of divestiture resulting in a subsidiary or division becoming an independent company.
Ordinarily, shares in the new company are distributed to the parent companys shareholders on a pro rata
basis.
Equity Carve-out The public sale of stock in a subsidiary in which the parent usually retains majority
control.
If any unit of a company going to be separated and form a separate entity than they float IPO (40% of
existing share) by splitting capital structure and 60 % remain for BOD.
Empirical Evidence on Divestitures
For liquidation of the entire company, shareholders of the liquidating company realize a +12 to
+20% returns.
For partial sell-offs, shareholders selling the company realize a slight return (+2%). Shareholders
buying also experience a slight gain.
Shareholders gain around 5% for spin-offs.
Shareholders receive a modest +2% return for equity carve-outs.
Divestiture results are consistent with the informational effect as shown by the positive market
responses to the divestiture announcements.
Ownership Restructuring
Leverage Buyout (LBO) A primarily debt financed purchase of all the stock or assets of a company,
subsidiary, or division by an investor group.
The debt is secured by the assets of the enterprise involved. Thus, this method is generally used
with capital-intensive businesses.
A management buyout is an LBO in which the pre-buyout management ends up with a
substantial equity position.
Going Private Making a public company private through the repurchase of stock by current
management and/or outside private investors.
Page 49 of 55
The most common transaction is paying shareholders cash and merging the company into a shell
corporation owned by a private investor management group.
Treated as an asset sale rather than a merger.
Eligibility for target firm for LBO
a. Stable outlook-Growth condition in industry, solid profit potential & long term growth potential.
b. Less amount of debt in capital restructuring.
c. High label of bankable asset for collateralization.
d. Predictable & stable Cash flow to meet periodic interest payment & working capital requirement.
e. A proven and established market position.
f. Less cyclical product sales.
g. Experienced and quality management.
Motivation and Empirical Evidence for Going Private
Elimination of costs associated with being a publicly held firm (e.g., registration, servicing of
shareholders, and legal and administrative costs related to SEC regulations and reports).
Reduces the focus of management on short-term numbers to long-term wealth building.
Allows the realignment and improvement of management incentives to enhance wealth building
by directly linking compensation to performance without having to answer to the public.
Motivations (Offsetting Arguments):
Large transaction costs to investment bankers.
Little liquidity to its owners.
A large portion of management wealth is tied up in a single investment.
Empirical Evidence:
Shareholders realize gains (+12 to +22%) for cash offers in these transactions.
Developments in Mergers and Acquisitions

Roll-Up Transactions The combination of multiple small companies in the same industry to create one
larger company.
IPO Roll-Up An IPO of independent companies in the same industry that merge into a single company
concurrent with the stock offering.
Page 50 of 55
Mathematical Problems
Problem 01:
Company As income is Tk 60000.00 lac and Com[any Bs is Tk 300.00 lac. What is the
earnings/ income of surviving company A after takeover B?
Solution:
Income of surviving company A = income of A + income of B
= Tk 60000.00 + Tk 300.00
= Tk 60300.00 lac
Problem 02:
Company As price per share is Tk 35.00, company B is Tk 20.00. Company B has agreed on an
offer of Tk 30.00 in common stock of Company A. What is the Exchange ratio?
Solution:
Exchange ratio = offer price/ MPS of acquiring firm
= 30/35 = 0.8571
Problem 03:
Company As price per share is Tk 35.00, company B is Tk 20.00. Company B has agreed on an
offer of Tk 30.00 in common stock of Company A. The Shares outstanding of both companies
are 5,000,000 and 2,000,000. How many shares come from exchange and how many share
outstanding for surviving company A?
Solution:
Exchange ratio = offer price/ MPS of acquiring firm= 30/35 = 0.8571
New shares come from exchange = Exchange ratio X no of share of target firm B
= 0.8571 X 2,000,000 = 1, 714, 285
Total shares outstanding for surviving company A = Company As share + New shares come
from exchange
= 5,000,000 + 1, 714, 285
= 6,714,285
Problem 04:
Company A will acquire Company B with shares of common stock.
Company A
Company B
Present earnings
$20,000,000
$5,000,000
Shares outstanding
5,000,000
2,000,000
Earnings per share
$4.00
$2.50
Price per share
$64.00
$30.00
Price / earnings ratio
16
12
i.
Company B has agreed on an offer of $35 in common stock of Company A.

Page 51 of 55

a)
b)
c)
d)
Calculate EPS after Company A after takeover Company B.

Calculate EPS of Company B after acquired.
P/E ratio paid for Company B.
Comment about post merger scenario.
Solution:
Exchange ratio = 35/64 = 0.546875
New shares from exchange = (0.546875 x 2000000) = 1,093,750
Total Share of Company A will be = 5000000+1093750 = 6093750
Total earning after merger/acquisition= $20,000,000 + $5,000,000 = $ 25,000,000
So, EPS =
????????????
?????????? ?? ????????? ????
It can be represent by this way
????????
???????
= 4.10
Surviving Company A
Present earnings
Shares outstanding
Earnings per share
$25,000,000
6,093,750
$4.10
EPS of Company B after acquired =.546875 x $4.10 = $ 2.24

P/E ratio paid for Company B = $35/$2.50 = 14
Observation:
The shareholders of Company A will experience an increase in earnings per share
because of the acquisition [$4.10 post-merger EPS versus $4.00 pre-merger EPS].
The shareholders of Company B will experience a decrease in earnings per share because
of the acquisition [$2.24 post-merger EPS versus $2.50 pre-merger EPS].
Surviving firm EPS will increase any time the P/E ratio paid for a firm is less than the
pre-merger P/E ratio of the firm doing the acquiring. [Note: P/E ratio paid for
Company B is $35/$2.50 = 14 versus pre-merger P/E ratio of 16 for Company A.]
ii.
a)
b)
c)
d)
Company B has agreed on an offer of $45 in common stock of Company A.

Calculate EPS after Company A after takeover Company B.
Calculate EPS of Company B after acquired.
P/E ratio paid for Company B.
Comment about post merger scenario.
Solution:
Exchange ratio = 45/64 = 0.703125
New shares from exchange = (0.703125x 2000000) = 1,406,250
Page 52 of 55

Total Share of Company A will be = 5000000+1406250 = 6406250
Total earning after merger/acquisition= $20,000,000 + $5,000,000 = $ 25,000,000
So, EPS =
????????????
?????????? ?? ????????? ????

It can be represent by this way
????????
???????
= 3.90
Surviving Company A
Present earnings
Shares outstanding
Earnings per share
$25,000,000
6,406,250
$ 3.90
EPS of Company B after acquired = 0.703125x $ 3.90= $ 2.74

P/E ratio paid for Company B = $45/$2.74 = 18
Observation:
The shareholders of Company A will experience a decrease in earnings per share because
of the acquisition.
The shareholders of Company B will experience an increase in earnings per share
because of the acquisition.
Surviving firm EPS will decrease any time the P/E ratio paid for a firm is greater than
the pre-merger P/E ratio of the firm doing the acquiring.
Problem 05:
Acquiring Company offers to acquire Bought Company with shares of common

stock at an exchange price of $40.
Present earnings
Shares outstanding
Earnings per share
Price per share
Company A
$20,000,000
6,000,000
$3.33
$60.00
18
Company B
$6,000,000
2,000,000
$3.00
$30.00
10
Calculate Market price exchange ratio, MPS of Surviving Company A and comment
Solution:
Exchange ratio
Market price exchange ratio
New shares from exchange
MPS of Surviving Company A
Present earnings
Shares outstanding
Earnings per share
MPS
= $40 / $60 = .667

= $60 x .667 / $30 = 1.33
= 0.666667 x 2,000,000 = 1,333,333
= P/E X EPS = 18 X 3.55 = $ 63.90
Surviving Company A
$26,000,000
7,333,333
$ 3.55
18
$63.90
Page 53 of 55

Observation:
The apparent increase in the market price is driven by the assumption that the P/E ratio
will not change and that each dollar of earnings from the acquired firm will be priced the
same as the acquiring firm before the acquisition (a P/E ratio of 18).
Problem 06:
The following data are pertinent for companies A and B:
Particulars
Company A
Company B
Present earnings
$20 million
$4 million
Number of shares
10 million
1 million
Price/earnings ratio
18
10
a. If the two companies were to merge and share exchange ratio was 1 share of company A for each
share of company B, what would be the initial impact on EPS of the two companies? What is the
market value exchange ratio? Is a merger likely to take place?
b. If the exchange ratio is 1.5 shares of company A for each share of company B, what would
happen?
Solution:
a. Here, Exchange ratio =1
Pre merger:
Particulars
Company A
Company B
Present earnings
$20 million
$4 million
Number of shares
10 million
1 million
18
10
EPS= Present earnings/

Number of shares
$ 2.00
$ 4.00
MPS = P/E ratio * EPS
$ 36.00
$ 40.00
New shares from exchange
= 1 x 1 million = 1million
Post merger:
Surviving Company A
Present earnings
Shares outstanding
Earnings per share
MPS
$ 24 million
11 million
$ 2.18
18
$ 39.27
EPS of Company B after acquired = 1 x $ 4.00 = $ 4.00

P/E ratio paid for Company B = $ 36/$ 4.00 = 9
Page 54 of 55
The shareholders of Company A will experience a increase in earnings per share because
of the acquisition.
The shareholders of Company B will experience ame in earnings per share because of
the acquisition.
Surviving firm EPS will increase any time the P/E ratio paid for a firm is smaller than
the pre-merger P/E ratio of the firm doing the acquiring.
Market value exchange ratio = $36 x 1.00 / $40 = 0.90
As MVER is less than 1. So, company B will not likely to accept merger.
b. Market value exchange ratio = $36 x 1.50 / $40 = 1.35

As MVER is greater than 1. So, company B will accept merger.
Problem 07:
Cengage Company is considering the acquisition of Yawitz Wire and Mesh Corporation with
common stock. Relevant financial information is as follows:
Cengage
YAWITZ
Present earnings (in thousands) $4,000
$1,000
Common shares outstanding
2,000
800
Earnings per share
$2.00
$1.25
12
8
Cengage plans to offer a premium of 20 percent over the market price of Yawitz stock.
a. What is the ratio of exchange of stock? How many new shares will be issued?
b. What are earnings per share for the surviving company immediately following the merger?
c. If the price/earnings ratio for Cengage stays at 12, what is the market price per share of the
surviving company? What would happen if the price/earnings ratio went to 11?
Solution:
Here, Market price of Cengage = 12 *2 = $ 24
Market price of YAWITZ = 8 *1.25= $ 10
Offer price = 10+ (20 % 10) = $12.00
Exchange ratio = 12/24 = 0.5
a. MVER = $ 24 x 0.50 / $10 = 1.20
New shares will be issued = 800 * 0.5 = 400
b. Total share of surviving company Cengage = 2000+400 = 2400
Earning of surviving Cengage = $ 5,000
EPS of surviving Cengage = $ 2.08
c. Price/earnings ratio for Cengage is 12
MPS of surviving Cengage = 12 * $ 2.08 = $ 24.96
Price/earnings ratio for Cengage is 11
MPS of surviving Cengage = 11 * $ 2.08 = $ 22.88
Page 55 of 55

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Merchant banking & Investment banking

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Merchant banking & Investment banking

Identifying from different sources.

Cost benefit analysis

Ultimate decision making.

03.Professional Fund Management:

*PMDA can be said also BDA (Banker discretionary account)

Merchant banking & Investment banking

Classification of Investment Bank

The book running manager or bank with control of security allocation to

02. Major brackets:

Merchant banking & Investment banking

B. On the basis of areas of activities

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c. Investment Banker dimension:

Types of share issuing procedure:

Merchant banking & Investment banking

01.Book building method:

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Application procedure and method of share issue (Book building method):

Merchant banking & Investment banking

Application procedure and method of share issue (Fixed pricing method):

Difference between Book building & fixed pricing method:

Fixed Price process

Book Building process

indicative price range is known.

Payment if made at the time of

Merchant banking & Investment banking

Underwriting & Private placement

Merchant banking & Investment banking

Benefits & function:

Merchant banking & Investment banking

Types of underwriter/Types of agreement:

Merchant banking & Investment banking

The dealer profit from the spread.

Feature of Best effort:

Spread/ Underwriting discount:

Overallotment option/Green shoe provision:

Season equity offers (SEO) /Repeat public offer:

Merchant banking & Investment banking

Difference between IPO & SEO:

2. EBVPS: Based on historical economy.

Merchant banking & Investment banking

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Book building method

01. Standby private placement:

Merchant banking & Investment banking

02. Private placement of debt and equity:

Rock Asset Management:

Features of private placement:

Merchant banking & Investment banking

No need of preliminary registration.

Advantages of private placement:

Disadvantages of private placement:

Merchant banking & Investment banking

Right issue & Dilution effect

Implication of Rights Issue:

How are rights distributed?

Merchant banking & Investment banking

Number of new share = 5,000,000/10 = 500000