Study Session 9 - Corporate Finance, Financial and Control Issues

Question 1

Who are a company’s stakeholders?

Answer 1

Individuals or groups with an interest, claim, or stake in the company, what it does, and how well it performs. They include stockholders, creditors, employees, customers, the communities in which the company does business, and the general public

Question 2

What is stakeholder impact?

Answer 2

To identify the most important stakeholders and give highest priority to pursuing strategies that satisfy their needs

Question 3

What are the steps in a stakeholder impact analysis?

Answer 3

1. Identify stakeholders
2. Identify stakeholders’ interests and concerns
3. As a result, identify what claims stakeholders are likely to make on the organization
4. Identify the stakeholders who are most important from the organization’s perspective
5. Identify the resulting strategic challenges

Question 4

Who are the 3 most important stakeholder groups to a company?

Answer 4

1. Customers
2. Employees
3. Stockholders

Question 5

What is the position of Milton Friedman on business ethics (ie Friedman Doctrine)?

Answer 5

The only social responsibility of business is to increase profits, as long as the company stays within the rules of law

Question 6

What are the 2 drawbacks to the Utilitarian philosophy?

Answer 6

1. Difficult to measure the benefits, costs, and risks of a course of action
2. Does not consider justice. (The action that produces the greatest good for the greatest number of people may result in the unjustified treatment of a minority).

Question 7

What are two major objectives of corporate governance?

Answer 7

1. Eliminate or reduce conflicts of interest
2. Use the company’s assets in a manner consistent with the best interests of investors and other stakeholders

Question 8

What are the core attributes that all effective corporate governance systems share?

Answer 8

1. Define the rights of shareholders and other important stakeholders
2. Define and communicate to stakeholders the oversight responsibilities of managers and directors
3. Provide for fair and equitable treatment in all dealings between managers, directors, and shareholders
4. Have complete transparency and accuracy in disclosures regarding operations, performance, risk , and financial position

Question 9

What are some factors that may cause directors to align more closely with managers than shareholders?

Answer 9

• lack of independence
• board members have personal relationships with managments
• board members have consulting or other business agreements with the firm
• interlinked boards
• directors are overcompensated.

Question 10

What are some common motivations behind M&A activity?

Answer 10

1. Achieving synergies
2. Growing more rapidly
3. Increases market power
4. Gaining access to unique capabilities
5. Diversifying
6. Gaining personal benefits for managers
7. Taking advantage of tax benefits
8. Unlocking hidden value for a struggling company
9. Achieving international business goals
10. Bootstrapping earnings

Question 11

What are the stages in the industry life cycle?

Answer 11

1. Pioneer/developement
2. Rapid growth phase
3. Mature growth phase
4. Stabilization phase
5. Decline Phase

Question 12

What are some pre-offer takeover defense mechanisms?

Answer 12

1. Poison Pill - gives current shareholders the right to purchase additional shares at extremely attractive prices
2. Poison Put - gives bondholders the option to demand immediate repayment of their bonds if there is a hostile takeover
3. Restrictive takeover laws
4. Staggered board
5. Restricted voting rights
6. Supermajority voting provision for mergers
7. Fair price amendment
8. Golden parachutes

Question 13

What are some post-offer takeover defense mechanisms?

Answer 13

1. “Just say no defense”
2. Litigation
3. Greenmail - a payoff to the potential acquirer to go away
4. Share repurchase
5. Leveraged capitalization
6. Crown jewel defense - target may decide to sell a subsidiary or major asset to a neutral third party
7. Pac-man defense
8. White knight defense
9. White squire defense - a friendly 3rd party that buys a minority stake

Question 14

How do you calculate the Herfindahl-Hirshman Index (HHI) ?

Answer 14

Question 15

How do regulators use the HHI to assess mergers?

Answer 15

They calculate the pre-merger HHI and then the post-merger HHI. If the change is significant the deal may be challenged.

• A change of 100 or more in a moderately concentrated market is likely to invoke antitrust concerns.
• A change of 50 or more in a highley concentrated market is likely to invoke antitrust concerns.

Question 16

What are the 3 basic valuation techniques that companies and their advisors use to value companies in an M&A context?

Answer 16

1. Discounted Cash Flow Analysis
2. Comparative Company Analysis
3. Comparable Transaction Analysis

Question 17

What are the 6 steps to DCF analysis in an M&A context?

Answer 17

1. Determine which free cash flow model to use for the analysis (2-stage or 3 stage)
2. Develop pro forma financial estimates
3. Calculate free cash flow using the pro forma data
4. Discount free cash flows back to the present using the appropriate discount rate (WACC or WACC_adjusted)
5. Determine the terminal value and discount it back to the present
6. Add the discount FCF values and the terminal value together

Question 18

How do you calculate free cash flows using pro forma date?

Answer 18

Net Income

+Net Interest after tax

=Unlevered net income

+- Change in deferred taxes

=Net operating Profit less adjusted taxes (NOPLAT)

+Net noncash charges

-Change in net working capital

-Capital Expenditures (capex)

=Free Cash Flow

Question 19

What are some of the advantages and disadvantages of using Discounted cash flow analysis to value a target company?

Answer 19

Adv:

• It is relatively easy to model
• Easy to customize
• estimate of value if based on forecasts of fundamental conditions

Dis:

• Difficult to apply when FCF is negative
• estimates of cash flows are highly subject to error
• discount rates change over time

Question 20

What are some of the advantages and disadvantages of using Comparative Transaction Analysis ?

Answer 20

Adv:

• Since approach uses data from actual transactions, there is no need to estimate a seperate takeover premium
• Estimates of value are derived directly from recent prices for actual deals completed in the marketplace
• Using prices from recent transactions reduces the risk that the target’s shareholders could file a lawsuit against management for mispricing the deal

Dis:

• Approach assumes previous deals were priced correctly
• May not be enough deals to calculate the estimated target value. Then may try to use deals from other industries that are not similar

Question 21

What are some of the advantages and disadvantages of using Comparable Company Analysis ?

Answer 21

ADV:

• Data for comparable companies is easy to use
• Assumption that similar assets should have similar values is fundamentally sound
• Estimates of value is derived directly from the market, not assumptions about the future

DIS:

• Assumes market’s valuation of comparable company is accurate
• Does not include a takeover premium
• Can’t incorporate merger synergies or changing capital structures into the analysis
• Historical data used to estimate takeover premium may not be up to date

Question 22

How do you calculate the Gains Accrued to the Target?

Answer 22

****Also know as the takeover premium

GainT = TP = P_T - V_T

GainT = gains accrued to target shareholders

TP = Takeover premium

P_T = price paid for target

V_T = pre-merger value of target

Question 23

How do you calculate the Gains Accrued to the Acquirer?

Answer 23

** Is equal to the synergies from the deal - the takeover premium

Gain_A= S - TP = S - (P_T- V_T)

Question 24

What is the Post-merger value of an acquirer ?

Answer 24

V_AT = V_A + V_T + S - C

V_AT = post-merger value of the combined company

V_A = pre-merger value of the acquirer

V_T = pre-merer value of the target

S = synergies created by the merger

C = cash paid to target shareholders

Question 25

What are the types of deals in which mergers do actually enhance value for the acquirer?

Answer 25

1. Strong Buyer - Acquirers that have exhibited strong performance in the prior 3 years
2. Low Premium - the acquirer pays a low takeover premium
3. Few Bidders - The lower number of bidders, the greater the acquirer’s future returns
4. Favorable Market Reaction - positive market reaction to the acquirer’s stock

Question 26

What are some common reasons for companies to restructure?

Answer 26

1. Division no longer fits into management’s long term strategy
2. Lack of profitability
3. Individual parts are worth more than the whole
4. Infusion of cash