To continue my ACCA support blogs, today I am going to look at if Stephen & Rita made the correct decision to sell their company. Who may you ask are Stephen & Rita

For those who are not aware, there was a question in the last AFM exam about a small accountancy training company owned by Stephen & Rita.

The question was about business valuations & purchase consideration.

This topic can tie students in knots. It has so many terms – pre acquisition, post acquisition, maximum to pay, bid premium etc.

Let me clarify these with a simple example.

Example

Co X is buying Co Y. Co X is listed Co Y is not.

1) What is the PreAcq’n values ?

Co X = Number of Issued Shares x Current Market Value per share (Po).

Co Y = method will be specified in the question & please RTQ !

So now we can say “2 + 2 = 4”

2) How do you find the post acquisition value of XY?

There are several methods that can be used & the question will clearly state which you have to user. Synergies will be accrued for.

End Result:

X + Y = XY
“2 + 2 = 5”

3) What is the gain to be shared by each group of shareholders ?

5 – 4 = 1

4) What is the MAXIMUM X can afford to pay for Y ?

XY – X = Max to pay for Co Y

5 – 2 = 3

5) What is a bid premium ?

This is the profit% Co Y wants to sell their shares. This is what Stephen & Rita want as their return.

Co Y x ??%

6) What in PRACTICE is regarded as a MINIMUM BID PREMIUM that is acceptable ?

It’s generally accepted (not a fact) that a 20% return on the pre-acquisition value is what Stephen & Rita will accept.

So if 20% bid premium is paid for Y

20% x 2 = 0.4

Price paid for Co Y is 2 + 0.4 = 2.4.

Gain left for Co X s/h is

1 – 0.4 = 0.6.

7) How does Co X pay for Co Y ?

This is known as purchase consideration and the exam choices are:

Cash
Share for share
Bonds for shares
Mix

Stephen & Rita will take into account which gives them the best return. Also a paper for paper swap is better for tax planning.

Finally, My wife’s name is Rita. We own a small accountancy training company & I wrote the official ACCA article on Business Valuations.