Q.1 Give the meaning of merger and acquisition.

What are the key motives behind the merger and acquisitions? Ans. Mergers or amalgamation:- 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. Merger is also defined as Amalgamation, especially in Indian law. For example section 2 (1A) of the Income tax Act, 1961 defines amalgamation as the merger of one or more companies (called amalgamating company or companies) with another company (called amalgamated company) or the merger of two or more companies to form a new company in such a way that all assets and liabilities of the amalgamated company or companies become assets and liabilities of the amalgamating company and shareholders holding not less than nine-tenths in the value of the shares in the amalgamating company or companies become shareholders of the amalgamated company. Merger or Amalgamation may take two forms i.e. Merger through Absorption and Merger through Consolidation. Acquisitions:- The term “acquisition” refers to the acquisition of assets by one company form another company. In an acquisition, both companies may continue to exist. We will hereafter use the word mergers & acquisitions interchangeably and will refer to these as a business transaction where one company acquires another company. An acquisition, also known as a takeover, is the buying of one company (the „target‟) by another. An acquisition may be friendly or hostile. In the former case, the companies cooperate in negotiations; in the latter case, the takeover target is unwilling to be bought or the target‟s board has no prior knowledge of the offer. Acquisition usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. This is known as a reverse takeover. Motives behind the mergers and acquisitionsThere 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. Plausible reasons- The most plausible reasons: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 enables a firm to „leap frog‟ several stages in the process of expansion. It may entail less risk and even less cost.

increase growth or both. Merger of HDFC bank with Centurian bank of Punjab can be taken as an example of cost reducing operating synergy. There are two main types of synergy: 1. This may occur if the existing management team. allowing the combined firm to become more cost-efficient and profitable. Managerial effectiveness:.One of the potential gains of merger is an increase in managerial effectiveness. Tax shield:. Economies of scale: It may arise from the merger. For example. Operating synergy 2. the merger of a company engaged in oil exploration and production with a company engaged in refining and marketing may improve coordination and control.When a firm with accumulated losses and/or unabsorbed depreciation merges with a profit making firm. Thus. With the merger of the two firms it may be possible to successfully manufacture and market the innovative product. . it may make sense for them to merge. Q. a small firm with an innovative product may need the engineering capability and marketing reach of a big firm.A firm in a mature industry may generate a lot of cash but may not have opportunities for profitable investment. For example. economies of vertical integration may be realized. Complementary resources:.When companies engaged at different stages of production or value chain merge.It two firms have complementary resources.In a „saturated‟ market. which is performing poorly. Ans. to the same is possible. Financial synergy Operating Synergy: Operating synergies are those synergies that allow firms to increase their operating income. Economics of scales can be seen in mergers of firms in the same business. Economies of vertical integration:. We would categorize operating synergies into four types: 1. Both the banks after combination can expect to cut costs considerably on account of sharing of their resources and thus avoiding duplication of facilities available. 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. the two firms thanks to their complementary resources are worth more together than they are separately. The firm with accumulated losses and/or unabsorbed depreciation may not be able to drive tax advantages for long time. Utilization of surplus funds:.2 Explain the different types of synergy. simultaneous expansion and replacement makes more sense than creation of additional capacity through internal expansion. is replaced by a more effective management. Such a firm ought to distribute generous dividends and even buy back its shares. For example : Two banks combining together to create a larger bank. tax shields are utilized better.

This synergy is likely to show up most often when large firms acquire smaller firms.2. Firm A is having substantial amount of financial resources (having enough surplus cash that can be invested somewhere) while firm B is having profitable investment opportunities ( but is lacking surplus cash). 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. the benefits can take the form of either higher cash flows or a lower cost of capital (discount rate) or both. Combination of different functional strengths: Combination of different functional strengths may enhance the revenues of each merger partner thereby enabling each company to expand its revenues. (and limited project opportunities) and a firm with high-return projects (and limited cash) can yield a payoff in terms of higher value for the combined firm. After the acquisition blow past acquired a strong hold on the market and operated under near monopoly situation. Synergy results from complementary activities. or cash slack. A combination of a firm with excess cash. An example of limiting competition to increase pricing power is the acquisition of universal luggage by Blow Plast. 4. which should result in higher margins and operating income. Operating synergies can affect margins and growth. 3. The phenomenon can be understood in cases where one company with an established brand name lends its reputation to a company with upcoming product line or a company. with an established distribution network and brand name recognition. Another example is the acquisition of Tomco by Hindustan Lever. Financial Synergy: With financial synergies. Higher growth: Higher growth in new or existing markets. This can be understood with the following example. The increase in value comes from the projects that were taken with the excess cash that otherwise would not have been taken. In other words the two companies should get the advantage of the combination of their complimentary functional strengths. for example here A can invest its resource in the opportunities available to B. or when publicly traded firms acquire private businesses. If A and B combine with each other both can utilize each other strengths. The two companies were in the same line of business and were in direct competition with each other leading to a severe price war and increased marketing costs. arising from the combination of the two firms. A company with strong distribution network merges with a firm that has products of great potential but is unable to reach the market before its competitors can do so. Example: Consider a situation where there are two firms A and B. and uses these strengths to increase sales of its products. Greater pricing power: It from reduced competition and higher market share. and through these the value of the firms involved in the merger or acquisition. Financial synergies can be present in the following cases: 1. . 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. This would be case when a US consumer products firm acquires an emerging market firm. note that this can happen only when the two firms are combined with each other or in other words they must act in a way as if they are one.

spin-off & so on or General term for divestiture of part/all of a firm by any one of a no. new shares are issued. Sell-off: Selling a part or all the firm by any one of means: sale. (b). A stronger test of synergy is to evaluate whether merged firms improve their performance (profitability and growth) relative to their competitors. The existence of synergy generally implies that the combined firm will become more profitable or grow at a faster rate after the merger than will the firms operating separately. Partial Sell-off Spin-off Sell-off Equity carve out LBO ESOP . 3. liquidation. spin-off and so on. as we show later in this chapter. Although the stockholders are initially the same the spun-off firm has its own management and is run as a separate company. or take the form of a lower cost of capital for the combined firm. Thus. This result has to be interpreted with caution. which creates a tax benefit for the combined firm. As a result of the proportional distribution of shares. (c). allows them to borrow more than they could have as individual entities. Once again. after takeovers. how to value it. (b). and increase its value. however.2. but here they are distributed to stockholders on a pro rata basis. Ans. Clearly. because when two firms combine. (d). a profitable firm that acquires a money-losing firm may be able to use the net operating losses of the latter to reduce its tax burden. in turn.4 Explain the following: (a). This. Debt capacity can increase. there is potential for synergy in many mergers. Tax benefits can arise either from the acquisition taking advantage of tax laws or from the use of net operating losses to shelter income. including under valuation and a change in corporate control. the stockholder base in the new company is the same as that of the old company. their earnings and cash flows may become more stable and predictable. since the increase in the value of the combined firm after a merger is also consistent with a number of other hypotheses explaining acquisitions. Q. a firm that is able to increase its depreciation charges after an acquisition will save in taxes. The more important issues are whether that synergy can be valued and. On this test. liquidation. It is thus a weak test of the synergy hypothesis. Alternatively. if so. (e). This tax benefit can either be shown as higher cash flows. many mergers fail. Spin-off: In a spin-off new legal entity is created. of means: sale. (a).

Features:      Employee Stock Ownership Plan(ESOP) is an employee benefit plan.   A partial sell-off/slump sale. or organization buys a company or a controlling share in the stock of a company. and if the company fails to perform. Buyouts great and small occurs all over the world on a daily basis. using a establishing company as a base rather than trying to start from scratch. the selling shareholder and participants receive various tax benefits. Employers have the benefit to use the ESOP‟s as a tool to fetch loans from a financial institute. The new equity gives the investors shares of ownership in the portion of the selling company that is being divested. In fact. a new legal entity is created with a stockholder base that may be different from that of the parent selling company. It is one of the profit sharing plans. The scheme provides employee the ownership of stocks in the company. (e). as much of 90% of the purchase price can be borrowed. LBO(Leveraged Buy Outs): A buyout is a transaction in which a person. (c). It is the mirror image of a purchase of a business unit or plant. Buyouts can also be negotiated with people or companies on the outside. In an equity carve-out. involves the sale of a business unit or plant of one firm to another. employee never buy or hold the stock directly. With an ESOP. ESOP is a qualified. the company is purchased primarily with borrowed funds. In a leveraged buyout. group of people. This can be a risky decision. A company which makes widgets might decide to buy a company which makes thingamabobs in order to expand its operation. Equity carve-out became a popular financing technique in the late 1980‟s. This mode of restructuring creates a new publicly traded company with partial or complete autonomy from the parent firm. employee benefit plan designed to invest primarily in the stock of the sponsoring employer. The divested company has a different management team and is run as a separate firm. From the seller‟s perspective. from the buyer‟s point of view it is a form of expansion. as the assets of the company are usually used as collateral. 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. it is a form of contraction. (d). . ESOP(Employee Stock Ownership Plans): An Employee Stock Option is a type of defined contribution benefit plan that buys and hold stock. it can go bankrupt because the people involved in the buyout will not able to service their debt. It also provides for tax benefits to the employers. The sale may not necessarily leave the company in control of the subsidiary. Employee Stock option‟s are “qualified” in the sense that the ESOP‟s sponsoring company. defined contribute on.

Q. the legal form of a joint venture‟ is likely to be determined by a number of factors including the nature and size of enterprise. the identity and location of the ventures and the commercial and financial objectives of the participants. development or project rather than a long term relationship between the co-ventures. The JV is a collaborative extension of their commercial activities.The term „joint venture‟ is an umbrella term which describes the commercial arrangement between two or more economically independent entities.00.   The association between the participants is almost invariable regulated by a written agreement called a Joint Venture Agreement (JVA). 2 . JVs usually are not the major activity of the parties concerned. Presume the following data for an hypothetical target company: Outstanding shares Outstanding warrants Warrant exercise period Entitlement to holders 10. If they‟re individuals they‟ll have day jobs. Q.00. Generally the parties need to contribute skills as well as money. What area the characteristics of joint ventures? Ans.5 Explain the meaning of joint Venture. the anticipated length of the venture‟. In the business work they‟ll have a core business to which the JV is an adjunct typically.000 2.6 What is share warrant and convertible debentures? Calculate fully diluted EPS. JVs are typically for a single business. Ans. Characteristics of Joint VentureSome of the key features of a JV are:   JVs are typically not a passive investment. These characteristics will be present in all joint venture relationships regardless of the structure the parties adopt. Meaning of Joint Venture:.000 2 years 1 share of Rs. In practice.

11.000 Rs. Earnings per share before exercise or warrants was Rs. 2) Less: Tax Rs. 000 45% 121/2 % convertible Calculations of EPS: Earnings Add: Return form investment of proceeds from Warrants=(2.00.00.Earnings after Tax Corporation Tax Closing price stock on opening of the year= Rs. 00.259 = 0.000 = Rs.2592.000) . 0. 20.00 Rs.30 which has now diluted by 0.00. 25.000 3. 3.000 + 2. 3.3 (-) 0. 9.45 = Rs.11. 0.44 or 4% (10. Rs.000 11.000 ‟ = Rs.000 Fully diluted EPS =3.000 x 0.00.000 20.

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