BFN3104

Mergers and Acquisitions

1.

Define the following terms:

a. Merger
A merger is absorption of a firm, the acquired by another firm, the
acquirer.
b. Consolidation
A consolidation is the combination of two or more firms into an entirely
new entity.
c. Horizontal Merger
A horizontal merger is merger of two firms in the same line of business.
d. Vertical Merger
A vertical merger is a merger of two firms involved in the same industry
but operating at different points in the supply chain.
e. Conglomerate Merger
A conglomerate merger is a merger of two firms in unrelated business.

2.

Describe the valid motives that two firms may have for merging.
Valid reasons for firms merging are to achieve operating efficiency, to achieve
economies of scale, to realize tax benefits, to capture surplus cash, and to grow
quickly and cheaply.

3.

Diversification is one of the main justifications managers give when undertaking

conglomerate mergers. Explain why the justification is usually invalid
notwithstanding the Diversification Principle.
Diversification is a questionable motive for merging because shareholders of the
acquirer can usually achieve diversification more cheaply on their own.

4.

How can a merger create financial synergy? How can it create business synergy?
What is the difference between these two types of synergy?
Financial synergy results when the merged firm is able to make larger securities
issues and thus, reduce its transactions costs relative to the unmerged firms.
Business synergy results from eliminating duplicate facilities, operations, or
departments and form achieving economies of scale in the operations of the merged
firm. Financial synergy is a function of the way the firm is financed, and business
synergy is likely to be much more important than financial synergy in creating
value through a merger.

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5.

Define the term tender offer, explain how a firm can acquire another firm through
a tender offer. What are the main advantages of a tender offer relative to other
acquisition methods?
A tender offer is an offer made by the acquirer to purchase stock from the
shareholders of the acquiree. The acquirer can gain control of the acquiree by
purchasing enough of the outstanding shares. The main advantages are that it is fast,
flexible, simple and allows the original acquirer to profit even if another bidder
emerges.

6.

Explain how a merger can expropriate wealth from shareholders to bondholders.

A merger can expropriate wealth from the shareholders to the bondholders because
the earnings of each firm can effectively insure the debt of the other firm. This is
making the debt less risky. Since, shareholders now have to service the debt of the
both companies, the value of their equity may decrease.

Problems
7.

Lucite Co. is acquiring Mt. Gear Co. Prior to the merger, Lucites equity has a total
value of $600 million and that of Mt. Gear was worth $220 million. After the
merger, Lucite is expected to have a market value of $900 million. Lucite is giving
Mt. Gear shareholders a $100 million premium for their shares. In addition, Lucite
incurred $3 million if acquisition costs.
a. What is the net advantage to merging for Lucite?
NAM = [VAB (VA + VB)] PB Expense
NAM = -$23million
b. What is the total synergistic effect in this merger? By how much did the synergy
exceed the premium and other acquisition costs.
Synergy = $900million ($600million + $220million) = $80million
The synergy is $23million below the premium and the other acquisition costs.

8.

Youhall has 4,000,000 shares outstanding that are trading at $25 each. Z-Rocks has
2,000,000 shares outstanding that are trading at $20 each. Youhall earns $2.00 per
share, and Z-Rocks earns $2.50 per share. If the firms merge, their total combined
earnings will be the same as before the merger.
a. Calculate each firms price earning ratio.
PE ratio - Youhall: $25/$2 = 12.5
Z-Rocks: $20/$2.50 = 8

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b. Suppose Youhall acquires Z-Rocks in a stock-for-stock swap based on current

market values. What is the exchange ratio? What happens to Youhalls earnings
per share?

Youhall earnings = (4000000 shares * $2) + (2000000 shares * $2.5)

= $13million
Outstanding share = 4000000 shares + (2000000 shares*0.8) = 5.6million shares
EPS = $13million/5.6million shares = $2.32 per share
c. Suppose that Youhalls managers believe that Youhall is profiting as long as its
earnings per share do not decline as a result of the merger. What is the
maximum number of shares offered to Z-Rocks stockholders that they can issue
and achieve this? What is the exchange ratio?
EPS = $2 = $13million/outstanding shares
Outstanding shares = $13million/ $2 = 6.5million shares
Shares offered to Z-Rocks = 6.5million shares 4million shares
= 2.5million shares
Exchange ratio = 2.5million Youshall shares/2million Z-Rocks shares =1.25

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