You are on page 1of 5

Master of Business Administration- MBA Semester 3 MF0011 Mergers and Acquisitions- 4 Credits (Book ID: B 1208) Assignment Set

-1 (60 marks)

Q1. Give the meaning of merger and acquisition. What are the key motives behind the merger and acquisitions? Answer: Merger is defined as a combination where two or more than two companies combine into one company. In this process one company survives and others lose their corporate existence. The survivor acquires assets as well as liabilities of the merged company or companies. In other form of merger one company purchases another company without giving proportionate ownership to the shareholders of the acquired company or without continuing the business of acquired company. Merger is also defined as Amalgamation, especially in Indian law. Merger or Amalgamation may take two forms i.e. Merger through Absorption and Merger thru Consolidation. Absorption is a combination of two or more than two companies into an existing company. All companies except one lose their identity in a merger through absorption. Consolidation is known as the fusion of two or more than two company into a new company in which all the existing companies are legally dissolved and a new entity or company is created. Acquisitions: It refers to the acquisition of assets by one company from another company. In an acquisition, both companies may continue to exist. An acquisition also known as a takeover, is the buying of one company by another. An acquisition may be friendly or hostile. Motives behind the Mergers and Acquisitions There are a number of possible motivations that may result in a merger or acquisition. One of the most oft cited reasons is to achieve economies of scale. Economies of scale may be defined as a lowering of the average cost to produce one unit due to an increase in the total amount of production. The idea is that the larger firm resulting from the merger can produce more cheaply than the previously separate firms. The most plausible reasons in favor of mergers are: Strategic benefits: If a firm has decided to enter or expand in a particular industry, acquisition of a firm engaged in that industry, rather than dependence on internal expansion, may offer several strategic advantages like. As a pre-emptive move it can prevent a competitor from establishing a similar position in that industry.

It offers a special timing advantage because the merger alternative enable a firm to leap frog several stages in the process of expansion. It may entail less risk and even less cost. Economies of scale: When two or more firms combined certain economies are realized due to the larger volume of operations of the combined activity. This economies arise because of more intensive utilization of production capabilities, distribution networks, engineering services, research and development facilities, data processing systems, so on. Economies of vertical integration: When companies engaged at different stages of production or value chain merge, economies of vertical integration may be realized. For example, the merger of a company engaged in oil exploration and production with a company engaged in refining and marketing may improve coordination and control. Complementary resources: If two firms have complementary resources, it may make sense for them to merge. For example a small firm with an innovative product may need the engineering capability and marketing reach of a big firm. Tax Shield: When a firm with accumulated losses and / or absorbed depreciation merges with a profit making firm, tax shields are utilized better. The firm with accumulated losses and / or unabsorbed depreciation may not be able to derive tax advantage for long time. Utilization of Surplus funds: A merger with another firm involving cash compensation often represent a more efficient utilization of surplus finds. Managerial effectiveness: One of the potential gain of the merger is an increase in managerial effectiveness.

Q2. Explain the different types of synergy. Answer: Synergy is the additional value that is generated by the combination of two or more than two firms creating opportunities that would not be available to the firms independently. There are two main types of Synergy: i. Operating Synergy and ii. Financial Synergy Operating Synergies are those synergies that allow firms to increase their operating income from existing assets, increase growth or both. Operating Synergies can be categorized into four types. Economies of scale: It may arise from the merger, allowing the combined firm to become more cost efficient and profitable. Economies of scale can be seen in mergers of firms in the same business.

Greater Pricing power: This Synergy is also more likely to show up in mergers of firms which are in the same line of business and should be more likely to yield benefits when there are relatively few firms in the business. When there are more firms in the industry ability of firms to exercise relatively higher price reduces and in such a situation the Synergy does not seem to work as desired. Higher Growth: Higher growth in new or existing markets arising from the combination of the two firms. Combination of different functional strengths: It may enhance the revenues of each merger partner thereby enabling each company to expand its revenues.

Financial Synergy: In case of financial Synergies, the benefits can take the form of either higher cash flows or a lower cost of capital or both. Financial Synergies can be present in the following cases. When two firms combine with each other where one is having surplus of excess cash but does not have good investment opportunities and other firm is having excellent investment opportunities but is facing cash crunch, then the combination can result in higher value for the combined firm. Variability in earning of the firm. In other words wide fluctuations in the combined firm's cash flows would be less likely. Tax benefits can arise either from the acquisition taking advantage of tax laws to write up the target company's assets or from the use of net operating losses to shelter income.

Q3. Merger should be a capital budgeting decision. Explain. Answer: In a merger or acquisition the acquiring firm is buying the business of the target firm rather than a specific asset. Thus merger is a special type of capital budgeting decision. This should include the effect of operating efficiencies and synergy. The acquiring firm should appraise merger as a capital budgeting decision. The acquiring firm incurs a cost in the expectation of a stream of benefits in the future. The merger will be advantageous to the acquiring firm if the present value of the target merger is greater than the cost of acquisition. Mergers and acquisitions involve complex set of managerial problems than the purchase of an asset. Discounted cash flow approach is an important tool in analyzing mergers and acquisitions. Earnings are basis for estimating cash flows. Cash flows include adjustments for depreciation capital expenditure and working capital. When a firm plans to acquire any firm then it should consider the acquisition as a capital budgeting decision. Hence, such a proposal must be evaluated as a capital budgeting decision.

Q4. Explain the following (a) Spin-off (b) Sell-off (c) Equity carve out (d) LBO (e) ESOP Answer: Spin-off: in a spin off, new shares are issued, but they are distributed to stockholders on a pro rata basis. As a result of the proportional distribution of shares, the stockholder base in the new company is the same as that of the old company. Although the stockholders are initially the same the spun off firm has its own management and is run as a separate company. There is a difference between simple divestiture and spin off. Divestiture involves a cash inflow into the parent corporation, whereas a spin off normally does not provide the parent with a inflow of cash, although the debt allocation between the parent and the subsidiary has capital structure implications. This form of restructuring creates a new, publicly traded company that is completely separate from the former parent firm. Sell-off: Selling a part or all the firm by any one of means: sale, liquidation, spin-off & so on or general term for divestiture of part/ all of a firm by any one of a no. of means: sale, liquidation, spin off and so on. Equity carve out: An equity carve out is a variation of a divestiture that involves the sale of an equity interest in a subsidiary to outsiders. The sale not necessarily leave the company in control of the subsidiary. The new equity gives the investors shares of ownership in the portion of the selling company that is being divested. In an equity carve out, a new legal entity is created with a stockholder base that may be different from that of the parent selling company. The divested company has a different management tam and is run as a separate firm. This mode of restructuring creates a new publicly traded company with partial or complete autonomy from the parent team. Leveraged Buy Outs (LBO): A buyout is a transaction in which a person, group of people, or organization buys a company or a controlling share in the stock of a company. Ina leveraged buyout, the company is purchased primarily with borrowed funds. In fact, as much of 90% of the purchase price can be borrowed. This can be a risky decision, as the assets of the company are usually used as collateral, and if the company fails to perform, it can go bankrupt because the people involved in the buyout will not be able to service their debt. Leveraged buyouts wax and wane in popularity depending on economic trends. ESOP (Employee Stock ownership plans): An employee stock option is a type of defined contribution benefit plan that buys and holds stock. ESOP is a qualified, defined contribution, employee benefit plan designed to invest primarily in the stock of the sponsoring employer.

Q5. Explain the meaning of joint venture. What are the characteristics of joint venture?