Lecture 9

Question 1

1. What is a horizontal merger
2. What is a vertical merger
3. What is conglomerate Merger

Answer 1

1. A merger between tow firms in the same line of business ( former competitors)
2. A merger between companies at different stage of production. A manufacture buys a supplier, Soft drink firms buy a fast food firm to reach ultimate customers.
3. A merger between companies in unrelated lines of business

Question 2

Mergers are due to possible gains in efficiency from combing operations “synergies”. Explain the following types of synergies

1. Economies of Scale
2. Economies of vertical integration
3. Combing Complementary Resource
4. Merger as a use for surplus Funds
5. Eliminating inefficiencies

The above are sensible reasons for a merger

Answer 2

1. Economies of scale: the opportunity to spread fixed costs over a larger volume of output, especially in horizontal mergers
2. Economies of vertical integration; Expanding backward toward the supplier of raw material or forward to the ultimate customers. However, it was found that the bargaining power with independent suppliers is more cost effective.
3. Combing complementary resources: Each has what the other needs
4. Mergers as a use for surplus Funds: to acquire another firm and expand the current firm rather than paying out surplus cash as dividends. Cash cow firms are also target for other cash hungry firms.
5. Eliminating inefficiencies: When the target firm has unexploited opportunities

Question 3

Diversification and Bootstrap Game are dubious Reasons for mergers explain what they mean.

Answer 3

Diversification: however, investors should not pay a premium for diversification since they can do it themselves for free by holding a well-diversified portfolio

Bootstrap Game: Giving false short term impression of improvement in EPS as follows.

1. Acquiring firm has high P/E ratio
2. Selling firms has low P/E ratio (due to low number of shares)
3. After merger, acquiring firms has short term EPS rise
4. Long term, acquirer will have slower than normal EPS growth due to share dilution.

Question 4

Explain the three forms of acquisitions

1. Mergers
2. Tender offer
3. Asset Purchase

Answer 4

1. Merger: When acquiring firms buys all the assets and assumes all the liabilities of the other firm and combines them into on firm. The acquired firm ceases to exist and its shareholders receive cash and/or securities, one management comes to on top usually appointed by the acquirer.
2. Tender offer: The acquiring firms buys all the stocks of the target firm in exchange for cash, shares or other securities. The target firm may continue to exist.
3. Asset Purchase: When the acquiring firm buys only the asset of the target. The target continues to exist as firms with cash instead of assets. Cash is paid to the firm not to the shareholders.

2 & 3 are usually called acquisition.

Question 5

What are the questions asked by the firm if the decide to acquire another firm.

Answer 5

Is there an overall economic gain to the merger

Do the terms of the merger make the company and its shareholder better off.

Question 6

What is the equation for a merger to payoff

Answer 6

PV ( A + B) > PV ( A ) + PV ( B )