Chapter 21-22 Flashcards
Why may it make sense for companies to merge?
A merger may be undertaken in order to replace an inefficient management. But some- times, two businesses may be more valuable together than apart. Gains may stem from economies of scale, economies of vertical integration, the combination of complementary resources, or redeployment of surplus funds. We don’t know how frequently these benefits occur, but they do make economic sense. Sometimes, mergers are undertaken to diversify risks or artificially increase growth of earnings per share. These motives are dubious.
How should the gains and costs of mergers to the acquiring firm be measured?
A merger generates an economic gain if the two firms are worth more together than apart. The gain is the difference between the value of the merged firm and the value of the two firms run independently. The cost is the premium that the buyer pays for the selling firm over its value as a separate entity. When payment is in the form of shares, the value of this payment naturally depends on what those shares are worth after the merger is complete. You should go ahead with the merger if the gain exceeds the cost.
In what ways do companies change the composition of their ownership or management?
If the board of directors fails to replace an inefficient management, there are four ways to effect a change: (1) Shareholders may engage in a proxy contest to replace the board; (2) the firm may be taken over by another; (3) the firm may be purchased by a private group of investors in a leveraged buyout; or (4) it may sell off part of its operations to another company.
What are some takeover defenses?
Mergers are often amicably negotiated between the management and directors of the two companies; but if the seller is reluctant, the would-be buyer can decide to make a tender offer for the stock. We sketched some of the offensive and defensive tactics used in take- over battles. These defenses include shark repellents (changes in the company charter meant to make a takeover more difficult to achieve) and poison pills (measures that make
takeover of the firm more costly).
What are some of the motivations for leveraged and management buyouts of the firm?
LBOs tend to involve mature businesses with ample cash flow and modest growth opportunities. LBOs and other debt-financed takeovers are driven by a mixture of motives, including (1) the value of interest tax shields; (2) transfers of value from bondholders, who may see the value of their bonds fall as the firm piles up more debt; and (3) the opportunity to create better incentives for managers and employees, who have a personal stake in the company. In addition, many LBOs have been designed to force firms with surplus cash to distribute it to shareholders rather than plowing it back. Investors feared such companies would otherwise channel free cash flow into negative-NPV investments.
Do mergers increase efficiency, and how are the gains from mergers distributed between shareholders of the acquired and acquiring firms?
We observed that when the target firm is acquired, its shareholders typically win:
- Target firms’ shareholders earn abnormally large returns. - The bidding firm’s shareholders roughly break even.
This suggests that the typical merger generates positive net benefits, but competition among bidders and active defense by management of the target firm pushes most of the gains toward selling shareholders.
What is the difference between spot and forward exchange rates?
The exchange rate is the amount of one currency needed to purchase one unit of another currency. The spot rate of exchange is the exchange rate for an immediate transaction. The forward rate is an exchange rate agreed upon today for a transaction at a specified future date.
What is the interest rate parity theory?
Interest rate parity theory states that the interest differential between two countries must be equal to the difference between the forward and spot exchange rates. In the international markets, arbitrage ensures that parity almost always holds.
What are some simple strategies to protect the firm against exchange rate risk?
Our simple theories about forward rates have two practical implications for the problem of hedging overseas operations. First, the expectations theory suggests that hedging exchange risk is on average costless. Second, there are two ways to hedge against exchange risk: One is to buy or sell currency forward; the other is to lend or borrow abroad. Interest rate parity tells us that the cost of the two methods should be the same.
How do we perform an NPV analysis for projects with cash flows in foreign currencies?
Overseas investment decisions are no different in principle from domestic decisions. You need to forecast the project’s cash flows and then discount them at the opportunity cost of capital. But it is important to remember that if the opportunity cost of capital is stated in dollars, the cash flows must also be converted to dollars. This requires a forecast of foreign exchange rates. We suggest that you rely on the simple parity relationships and use the interest rate differential to produce these forecasts.
What is an LBO or MBO?
A leveraged buyout (LBO) or management buyout (MBO), is when all public shares are repurchased and the company “goes private.”
What is Purchasing Power Parity?
In its strict form, purchasing power parity states that $1 must have the same purchasing power in every country. You only need to take a vacation abroad to know that this doesn’t square well with all the facts. Nevertheless, on average, changes in exchange rates tend to match differences in inflation rates and, if you need a long-term forecast of the exchange rate, it is difficult to do much better than to assume that the exchange rate will offset the effect of any differences in the inflation rates.
What is the international Fisher effect?
The International Fisher effect suggests that firms should not simply borrow where interest rates are lowest. Those countries are also likely to have the lowest inflation rates and the strongest currencies. Because in an open world, capital market real rates of interest would have to be the same. Thus, differences in nominal interest rates would result from differences in expected inflation rates.
What is the expectations theory of exchange?
The expectations theory of exchange rates tells us that the forward rate equals the expected spot rate (though it is very far from being a perfect forecaster of the spot rate).
