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Applied corporate Finance

Assignment Of Applied Corporate Finance

Submitted to:

Sir. Asif I. Malik

Submitted by:

M.Yaqoob Khan

Roll #


Section B MBA (1.5)

Table of contents

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Applied corporate Finance

Table of contents

(i) Difference between Merger&Acquisation .3 (ii) Types of merger.......3 (iii)The effect of voluntary divestiture (spin off and sell off) on shareholder wealth?...5 (iv) Impact of macro factors on merger activity. 7 (v) Does the corporate performance improve after the merger?.......................................8 (vi) Causes of merger failure9 (vii) Means of merger financing with respect to advantages and disadvantages .10 (viii) Referencing11

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QA Difference between Merger and Acquisition:

Merger & Acquisition are considered to be a single terminology. But there is a difference exists between merger & acquisition. David, (1995), pointed out that merger take place when two or more companies combine together for the purpose of expanding their business by making a new single entity. e.g. Daimler/Chrysler. While in case of acquisition, It is nothing but the purchase of one company by the other. e.g. Oracle takeover People Soft. Merger will only take place with the consensus of both companies while in acquisition consensus between both parties is not necessary.

Types of Merger:
Sean, (1986), pointed out that there are three main types of merger exist in corporate world that are Horizontal merger Vertical merger Conglomerate merger

Horizontal Merger: In this type of merger two competing firms combine together to sell the same product in the same market. This type of merger reduces the number of competitors. Horizontal merger would take place in such industries where fewer firm exist with high competition. e.g. Merger between Coca- Cola and Pepsi beverages division is the best example of Horizontal merger.

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Vertical merger: When two companies operating at different level of supply chain, merge together for the purpose of producing final product. This kind of merger enhances the operational effectiveness of both companies that could not be achieved without merging together. Conglomerate merger: It is a type of merger in which two companies merge together that are different in type of business nature. One of the major benefit of this kind of merger is that new, parent organization could obtain a diversify business portfolio. United Aircraft purchase the Otis elevator company is to be the best example of conglomerate merger. (Sean, 1986) The effect of voluntary divestiture (spin off and sell off) on shareholder wealth? Divestiture is a process in which companies sells or dispose of those assets that are not doing well and that become a liability for a company in future or those assets that have a worth more, when they are treated as a separate entity rather than part of the company. James, (1984), state that the divestiture is basically an alteration regarding the company productive portfolio asset and it is done either spinning-off or selling-off unwanted assets. He pointed out that the spin-off is a situation in which firm distribute all the common stock it owns in a controlled subsidiary to its existing shareholder for the purpose of creating a separate publically-traded company. While sell-off is a situation in which divested asset are purchased. His work regarding to see the impact of voluntary divestiture (spin-off and sell-off) on firm shows that divestiture has a significant positive impact on the shareholder wealth. Empirical studies

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show that the sell-off has a positive impact on shareholder wealth because shareholder perceive such transaction in a positive way.

QB Merger motives:
Jrisy, (2007), Classify merger motives into two main groups. One group includes all the drivers that enhance the shareholder wealth while second group includes drivers that increase the value of the manager instead of firm value. These two groups are referred to shareholder gains and managerial gain respectively.

Shareholder Gain:
Jrisy, (2007), pointed that increase in market value of the firm due to merger also directly enhances the shareholder wealth that is known as shareholder gain. Following are the factors that enhance that shareholder gain. Economies of scale Jrisy, (2007), state that due to merger economies of scale could be achieved because of decrease in average cost and increase in output that directly increase the value of shareholder wealth. Synergy gain To get the efficiency among the various processes that could be achieved by sharing technologies, innovation, learning process, Transfer of technical knowledge and R&D, Thus by merging together firms could get synergy among different processes that lead to enhance the firm value. (Jrisy, 2007)

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Interest rates Small firms could not be able to borrow funds at competitive rate as large firm can do, thus it is also the motive of merger for small companies to become the part of larger firm. (Jrisy, 2007) Diversification Modern portfolio theory states that diversification would be the source of increasing market value. Thus for the purpose of diversification firms merge together. (Jrisy, 2007)

Managerial Gains:
Empire building Jrisy, (2007), pointed out that here the manager goal is to increase the size of the firm for the purpose of growing rapidly that is only possible by merging with other firm. Hubris Managers have incorrect believe that they are better able to manage other companies. Actually here manages are overconfident regarding their abilities and paying more focus on target firm as a result acquiring firm face a loss. (Jrisy, 2007) Personal diversification For merger manager have a choice to select optimal portfolio that maximize or personal portfolio that maximize managerial value. They always prefer to select personal portfolio. (Jrisy, 2007) In addition to the above discussed merger motives some other drivers deals why companies go to merger are following.
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To global expansion Obtaining new expertise To increase market share & market power. To enhance number of customer Cross sale also the driver of merger Fear of globalization and technological advancement

Impact of macro factors on merger activity:

Business cycle Empirical studies show that merger activities are strongly associated with business cycle. Sean, (1986), pointed out that there is large increase (18% per year) in merger activity during the period of expansion while this activity would decline with the same rate during recession period. Interest rate Credit available at low interest rate would also impact to enhance the occurrence of merger activity. On the other side when funds are available at high interest rate the graph of merger activity will decline. Advancement in technology The extent to which merger activity take place depend upon the extent of technological changes. Merger of Google and YouTube take place due to development in technology. Government policies As merger is clustered to specific industries thus changes in Govt- policies regarding those specific industries will impact on merger activity. Such as deregulation in banking sector in 1990 enhance the occurrence of merger activity.
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QC Does the corporate performance improve after the merger? Explain the merger impact on the operating cash flows, stock returns etc.
Paul, et all (1990), examine the performance of 50 mergers that take place in US during the period of 1979 to1983. They examine the cash flow performance of both acquiring and targeted firms that have been already merged. They collect accounting data from annual reports of the 50 merged companies for the purpose of measuring changes that take place regarding the operating cash flows. Industry performance was the benchmark to measure the performance of companies after the merger has been take place. Results of their study shows that the performance of merged companies improves significantly regarding asset productivity and operating cash flows. But the empirical study of Michial, et all (2006), shows that the profitability of 50 Greek firms that have been examine on the basis of both financial and non financial characteristic decrease due to activity of merger. Andrade, et all (2011), state that as result of merger operating performance of both acquired and target firm would be high as compare to industry. Robert (2002), pointed out that although the value of joint cash flow of both targeted and acquiring firm would increase after merger but when we talk about each firm individually, In case of acquiring firm the returns show a negative trend while in case of target firm positive returns are trending.

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Causes of merger failure:

Rita, (2006), pointed out that 60% - 80% merger failure are because of financial and market factors. His work shows that although financial and market factors are the cause of merger but other factor such as lack of synenergies, communication gap, lack of employee training, no strategic fit, cultural clash, and power politics between the merging organizations would also be the main cause of merger failure. Before further proceeding here are statistics regarding merger failure. Kearney study shows that 58% merger failing to achieve their stated goals Productivity of acquiring firm decrease up to 50% in first 6 8 month and 47% of senior management of acquiring firm leave their job within first year after the merger. Rita, (2006), indicated following factors that lead towards merger failure. Lack of communication Power politics Clash of culture Lack of employee training Loss of customer Human Resource involvement in merger process regarding USA, Asia Pacific and Brazil.

United State Initial Planning Investigative Negotiation 16% 41% 16%

Asia Pacific 19% 21% 16%

Brazil 8% 12% 24%

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Source: Raymond Noe; Merger and AcquisitionMHR860, Ohio State University, Fisher College of B.usiness, January 17,2002

QD Means of merger financing with respect to advantages and disadvantages.

There are two most common ways to finance a merger Cash offering Equity offering Cash offering This is the most effective and simplest way to acquire a targeted firm. But in order to pay a cash regarding all the outstanding shares of targeted firm, bidding firm may need a debt so in that case merger would be more risky. Paul, et all (1990), pointed out that bidding firm future returns remain positive if merger would be financed through cash offering. But most of the research finding shows that merger would be unprofitable regarding the bidding firm either they are financed with cash or equity. Bidding firm use cash offering option only when it believes that its cash is undervalued. In this type of
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merger financing transaction cost would be low as compare to issuing securities. Cash offering takes little time as compare to equity offering Equity offering Bidding firm can offer its securities to targeted firm for the purpose of takeover financing. Although it would be easy for biding firm to offer its own securities instead of taking debt but this method is time consuming because it is difficult for both acquired and target firm to reach a mutual agreed price regarding offering securities. Paul, et all (1990), indicated that the returns against equity financing regarding bidding firm would be negative due to decline in stock prices after the take place of merger. Bidding firm use equity offering option only when it believe that its stock is overvalued.

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[1] Andrade Gregor, Mark Mitchell, and Erik Stafford, (2001), 103 120. [2] Hirschleifer, David, (1995), "Mergers and acquisitions: Strategic and informational issues." Handbooks in Operations Research and Management Science 9, 839-885 [3] Jresy, S, (2007), Mergers and Acquisitions: Patterns, Motives, and Strategic Fit. [4] James D. Rosenfeld, 1984, Additional evidence on the relation between divestiture announcements and shareholder wealth, The Journal of Finance 39, 1437-1448. [5] Motis, J. (2007), Mergers and Acquisitions Motives (No. 0730). [6] Paul M. Healy, Krishna C. Palepu, Richard S. Rubak,(1992), Does Corporate Performance Improve After Mergers? Journal of financial economics 31,135-175. [7] Pazarskis, M., Vogiatzogloy, M., Christodoulou, P., & Drogalas, G. (2006). Exploring the improvement of corporate performance after mergersthe case of Greece. International Research Journal of Finance and Economics, 1(6), 184-192
[7] Rita Salame, (2006), Why Do Mergers Fail? What Can Be Done to Improve their Chances of Success?


evidence and perspectives on mergers." Journal of Economic perspectives 15,

[8] Robert F. Burner, (2002), Does Merger & Acquisition Pay? A Review of the Evidence for the Decision-Maker, Journal of Applied Finance 12, 4868.

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[9] Sean Becketti, (1986), Corporate mergers and the business cycle, Journal of Economic Review, 13-26. [10] Terjesen, S. (2007), Mergers and Acquisitions: Patterns, Motives, and Strategic Fit.

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