#4- Chapter 4 Merger strategy Flashcards
What should a firm examine to determine if it should pursue a proposed merger?
Whether the risk-adjusted return from the deal is greater than the next best use of the invested capital.
How does an acquirer know if the merger was successful after the fact?
By comparing benchmark-adjusted returns (abnormal returns) or accounting ratios to what would have occurred with the next best use of capital.
What is the primary focus of a successful merger strategy?
Long-term sustainable competitive advantage.
List some key motives for mergers (10)
- Growth
- Operating synergy
- Financial synergy
- Diversification
- Horizontal mergers
- Vertical integration benefits
- Hubris hypothesis
- Higher executive compensation
- Improved management
- Tax benefits
What does operating synergy refer to?
Revenue enhancements and cost reductions.
What are economies of scale?
Declining per unit costs as output rises.
What is the economic basis for mergers represented by the formula NAV?
NAV = PV(A+B) - [PV(A) + PV(B)] - PV(Expenses).
What should firms do if the Net Acquisition Value (NAV) is positive?
Proceed with the merger if the return exceeds the risk-adjusted hurdle rate.
True or False: Financial synergy refers to increasing the cost of capital by combining companies.
False.
What is a common motive for diversification in mergers?
To enter more profitable industries.
What is a hubris hypothesis in the context of mergers?
Managers may overestimate their own valuations and pay a premium for acquisitions.
What is the relationship between firm size and executive compensation in the context of acquisitions?
Positive relationship; firms engaging in acquisitions tend to see higher executive compensation.
What are horizontal mergers?
Combinations of two firms producing the same product at the same level in the production process.
What is the primary benefit of vertical mergers?
Backward or forward expansion toward the source of supply or ultimate consumer.
What is the P/E Ratio
Price-to-Earnings (P/E) Ratio: used to evaluate a company’s valuation.
P/E= EarningsperShare(EPS)/MarketPriceperShare .
How do you find EPS
EPS= (NetIncome−PreferredDividends) / (WeightedAverageSharesOutstanding)
What is the significance of a low P/E ratio in desirable characteristics of target firms?
Indicates potential undervaluation and attractiveness for acquisition.
Fill in the blank: The belief that the acquiring firm’s management can better manage the target firm resources is known as _______.
Improved management.
What example illustrates a failed growth-through-acquisition strategy?
Quaker Oats’ acquisition of Snapple.
What is a diversification discount?
Evidence suggesting that diversified firms may be valued less than their single-segment counterparts.
What is one strategic advantage of diversification?
Stability of income can permit research programs and other long-term necessities.
What was a significant outcome of the Exxon Mobil merger?
Expected $4.6 billion in cost savings.
What is the managerialism hypothesis in the context of acquisitions?
Managers may know they are overpaying but pursue acquisitions for personal goals.
What does the term ‘debt coinsurance’ refer to in financial synergy?
Reduced risk of bankruptcy due to less correlated cash flow streams.
What does it mean for a company to engage in backward expansion?
Acquiring firms toward the source of supply.
What is a common characteristic of firms that are good acquisition targets?
- High liquidity
- High steady cash flows
- No antitrust problems
- High cash on hand
True or False: Shareholders incur the same transaction costs as companies when diversifying their portfolios.
False.
What is the role of the P/E game in acquisitions?
To evaluate the impact of acquisitions on the acquiring firm’s stock price based on P/E ratios.
