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SWAP RATIO DETERMINATION & EVALUATION OF MERGER PROPOSAL

 The ratio in which an acquiring company will offer its own shares in exchange for the target company's shares during a merger or acquisition. To calculate the swap ratio, companies analyze financial ratios such as book value, earnings per share, profits after tax and dividends paid, as well as other factors, such as the reasons for the merger or acquisition. The swap ratio determines the control that each group of shareholders of the companies shall have over the combined firm. It is an indicator of relative values of financial and strategic results of the company.

 In finance, a swap ratio is an exchange rate of the shares of the companies that would undergo a merger. For Example If a company offers a swap ratio of 1:1.5, it will provide one share of its own company for every 1.5 shares of the company being acquired.

 The commonly used bases for establishing the exchange ratio are: 1. Earnings Per Share 2. Market Price Per Share 3. Book Value Per Share

 Earning per share is one of the important factor to

determine the exchange ratio. Suppose the earnings per share of the acquiring firm are Rs 5.00 and the earnings per share of the target firm Rs 2.00. An exchange ratio based on earnings per share will be 0.4 that is (2/5). This means 2 shares of the acquiring firms will be exchanged for 5 shares of the target firm.

While earnings per share reflect prime facie the earnings power, there are some problems in an exchange ratio based solely on current earnings per share of the merging companies because it fails to take into account the following: * The difference in the growth rates of earnings of the two companies * The gains in earnings arising out of merger * The differential risks associated with the earnings of the two companies

2. MARKET PRICE PER SHARE

The exchange ratio may be based on the relative market prices of the shares of the acquiring firm and the target firm. For example, if the acquiring firms equity share sells for Rs 50 and the target firms equity share sells for Rs 10 the exchange ratio based on the market price is 0.2 that is (10/50). This means that 1 share of the acquiring firm will be exchanged for 5 shares of the target firm.

3. BOOK VALUE PER SHARE

The relative book values of the two firms may be used to determine the exchange rate. For example, if the book value per share of the acquiring company is Rs 25 and the book value per share of the target company is Rs 15, the book value based exchange ratio is 0.6 =(15/25). This means that 3 share of the acquiring firm will be exchanged for 5 shares of the target firm.

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The proponents of book value contend that it provides a very objectives basis. This however is not convincing argument because book values are influenced by accounting policies which reflect subjective judgments. There are still serious objections against the use of the book value. Book values do not reflect changes in purchasing power of money. Book values often are highly different from true economic values.

 An acquiring firm should pursue a merger only if it creates some real economic values which may arise from any source such as better and ensured supply of raw materials, better access to capital market, better and intensive distribution network, greater market share, tax benefits etc. The financial evaluation of a target candidate, therefore, includes the determination of the total consideration as well as the form of payment, i.e., in cash or securities of the acquiring firm.

 Valuation based on assets. Valuation based on earnings. Market value approach. Earnings per share. Share exchange ratio. Other methods of valuation.

The worth of the target firm, no doubt, depends upon the tangible and intangible assets of the firm. The value of a firm may be defined as:Value of all assets External Liabilities = Net Assets The assets of firm may be valued on the basis of the book values or realizable values

BOOK VALUE OF THE ASSETS

In this case, the values of various assets given in the latest balance sheet of the firm are taken as worth of the assets. From the total of the book values of all the assets, the amount of external liabilities is deducted to find out the net worth of the firm. The net worth may be divided by the number of equity shares to find out the value per share of the target firm.

 In this case, the current market prices or the realizable values of all the tangible and intangible assets of the target firm are estimated and from this the expected

external liabilities are deducted to find out the net

worth of the target firm.

2. VALUATION BASED ON EARNING

In the earnings based valuation, the PAT (Profit after taxes) is multiplied by the Price Earnings ratio to find out the value. MARKET PRICE PER SHARE = EPS * PE RATIO The earnings based valuation can also be made in terms of earnings yield as follows:EARNINGS YIELD = EPS/MPS *100 Earnings valuation may also be found by capitalizing the total earnings of the firm as follows:VALUE = EARNINGS/ CAPITALIZATION RATE * 100

3. MARKET VALUE APPROACH

This approach is based on the actual market price of securities settled between the buyer and seller. The price of a security in the free market will be its most appropriate value.

Market price is affected by the factors like demand and supply and position of money market.
Market value is a device which can be readily applied at any time.

According to this approach, the value of a prospective merger or acquisition is a function of the impact of merger/acquisition on the earnings per share.

As the market price per share is a function (product) of EPS and Price- Earnings Ratio, the future EPS will have an impact on the market value of the firm.

5. SHARE EXCHANGE RATIO

The share exchange ratio is the number of shares that the acquiring firm is willing to issue for each share of the target firm. The exchange ratio determines the way the synergy is distributed between the shareholders of the merged and the merging company. The swap ratio also determines the control that each group of shareholders will have over the combined firm.

METHODS OF CALCULATION
BASED ON EARNINGS PER SHARE (EPS)

Share Exchange Ratio = EPS of the target firm /

EPS of the Acquiring firm BASED ON MARKET PRICE (MP) Share Exchange Ratio = MP of the target firms share / MP of the Acquiring firms share

BASED ON BOOK VALUE (BV)

Share Exchange Ratio = BV of share of the target firm / BV of share of the Acquiring firm

6. OTHER METHODS OF VALUATION

ECONOMIC VALUE ADDED EVA is based upon the concept of economic return which refers to excess of after tax return on capital employed over the cost of capital employed. MARKET VALUE ADDED MVA is another concept used to measure the performance and as a measure of value of a firm. MVA is determined by measuring the total amount of funds that have been invested in the company (based on cash flows) and comparing with the current market value of the securities of the company.