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Financial

Management
II: NERO’s
Pasta, Inc.
Case Analysis

We understand that plagiarism is the severest form of academic fraud. For all the other material references and citations are mentioned. Section: 1 Group number: 2 Group Members: ADARSH S ARPIT TYAGI GAUTAM SANKAR MOHIT WADHWANI PRASHUN KUMAR JHA SHASHIRAJ R TANVI BANSAL FT161007 FT161022 FT161036 FT161053 FT161067 FT161082 FT161096 Page | 1 . If any copying is detected in this assignment. we bear the complete responsibility and the consequences that might follow.Financial Management II Statement of Academic Integrity We declare that all the material presented and submitted as part of this assignment is our original work.

Thus reducing the risk of being only in a particular market. ICI will have tax benefits. and immediately shelter its current and future income. Diversification. For example.Financial Management II Answer 1: The important rationales for merging are Tax consideration. Mergers allow for increased debt-The target has too little debt and acquirer can infuse the target with the missing debt.Understanding these avenues of value creation during a merger will help ICI to take a decision on determining the maximum price for the acquisition. Control.) A merger by Diversification provides a steady flow of income for a company which is in the industry with cyclicality. It becomes unjustifiable if it is aimed at exploiting the Market. The maximum price of the merger will be the sum of all the value created due to merger in Tax consideration. synergy is also referred to as the “1 + 1 = 11” effect. It also provides an opportunity to cash rich companies to venture into markets with high growth potential but lack of capital and boost growth of the market. Another valid rationale behind mergers is Tax considerations. Page | 2 . that is not used to its full potential in one company is purchased and used at its full potential by another company. However. This merger is an asset. Relevance . It increases the efficiency in utilization of resources in a society. (So. Diversification. Purchase of assets below replacement cost and Synergy at the discounted rate of the capital. By acquiring Nero’s Pizza. Synergy is said to occur whenever the value of the combined firm is greater than the sum of the values of firms taken separately. a firm that is highly profitable and consequently in the highest corporate tax bracket can acquire a company with large accumulated tax losses. Control. Mergers that lead to Operating and financial economies are socially desirable. In second case both the target and acquirer have optimal debt levels. A merger to gain Control over the competitive forces of market is justifiable only if it is used as a defense to exploitation of the market by any one entity. mergers that reduce competition are both undesirable and at times. Purchase of assets below replacement cost adds value to the society as a whole. provided it ventures into a new market with comparatively lower risk. diversification advantages in terms of increase in profit and purchase of assets. A merger leads to risk reduction. Calculating the monetary value of these factors will help ICI decide the maximum price for Nero. illegal. Purchase of assets below replacement cost and Synergy. as these mergers increase the managerial efficiency.

This takes the form of a tender offer. Of course. bonds. if it chooses to. or some combination of the three. Page | 3 . Now the acquirer. In a friendly merger. competing. the management may also ask shareholders to tender their shares at the agreed price. whereby the target firm’s shareholders are asked to “tender” their shares to the acquiring firm in exchange for cash. the target initiates it. In this case. acquiring firms. If 51% or more of the target firm’s shareholders tender their shares. and the rest of the time. The managements of both the firms would together work out terms that they believe to be beneficial to both sets of shareholders. then the acquiring firm’s advances are said to be hostile rather than friendly. At times. An important point to note is that the management of the target company discourages the tendering of stockholders shares. there is a mutual agreement between the management of the acquiring firm and the management of the target firm. they issue statements to their stockholders recommending that they should agree for the merger. the shareholders of the target firm must normally vote on the merger. then the merger will be completed despite the management’s objection to it. a premium generally detracts other prospective.Financial Management II Answer 2: There exist two types of mergers Hostile and Friendly. but management’s support generally assures that the votes will be favorable. Additionally. stock. the acquiring firm initiates the action. must make a direct appeal to the target firm’s shareholders. or if there is disagreement between the acquiring firm and the target firm. In case a target firm’s management resists the merger. Hostile takeovers generally end up in the acquiring company offering (and sometimes winning) a premium price for the price of a share. In most cases.

000 17.00.16.000 22.50.000 10.0 00 1.55.32.70.72.00.92.000.62.000 3.000 17.00.50.32.250.500 3.000 1998 $31.50.50.00.000 11.000 4.000 13.50.625 2.83.000 16.000 13. and hence including again interest expenses in financing flows for capital budgeting would lead to "double counting.00.51.625 8.50.19.32.51.00.000 2.50.375 7.000 6.000 7.30.000 3.000.50 0 2.50.50.96.50.000 14.500 36.59.00.000 3.32. Page | 4 .000 3.000 13.50 0 3.53 9 2.000 12.000 5.00.60.00.5 00 1999 $39." Retained earnings are also deduced to as that money is accounted for reinvesting in the company business & it should not be included in the free cash flow of the company.00.69.00 0 2.000 26.500 2.60.000 13.35.00.50.625 4.60.000 3.500 7.000 10.000 10.000 4.65.000 8.50.12.79.000 20. for capital budgeting cash flow analysis.16 4 Interest Expenses are deducted in the merger cash flow statements to deduce the actual free cash flow available to the company.000 10. However.80.000 2.00 0 1997 $25.87.0 00 2.062.000 9.00.750 22.20.62.000 9.000 28.Financial Management II Answer 3: Net Sales Variable Operating Costs Depreciation Fixed Operating Costs Interest Expense Earnings Before taxes Taxes Net Income Plus Depreciation Cash Flow Required Addition to Equity Available Cash Flow Expected Terminal Value Free Cash Flow 1996 $20. the return required by investors who furnish the capital is accounted cost of capital discount rate.72.500 24.87.

Financial Management II Answer 4: Beta Unlevering: Beta of Nero Debt Equity D/E Tax Unlevered Beta Value s 1.85 % 50% 50% 10. due to the merger the market risk premium does not change more than 1%.667 30% 0.82 50% 50% 40% 1 1. Page | 5 . The error for the discount rate can only be 1% or so because the market premium is the only factor that is assumed from the market. Change in hurdle rates even by 1% can have huge impact on the Discounting of cash flows of a going concern.2 40% 60% 0.82 Beta Relevering Unlevered Beta Debt Equity Tax D/E Relevered Beta Value s 0.43 % The Discount rate to be used for cash flow discounting is 10. Market premium for other pure play companies in the industry is 6%.43%. A going concern will have infinite cash flows and NPV calculation would be hugely impacted by even 1% change in Discount rates.31 Column1 Cost of Capital (WACC) Constant Growth rate Rf Market Risk Premium Cost of Debt Cost of Equity Re= (Rf+β(Rm-Rf)) Equity Debt WACC Value s 5% 7% 6% 10% 14. all other factors used in calculating the Discount rate are constants.

To avoid these services of external agency could be used for negotiation. different firms have different beta values.Financial Management II Answer 5: Terminal Value = Final year CashFlow * (1 + Long term growth rate)/ (Discount rate Long term growth rate) = $23. Nero's managers must work on increasing competition by bringing more and more firms for bidding. b. Since. Answer 6: a. They need to negotiate with the firms bidding to get the maximum bug for their share.532.574 Suppose if any other firm tries to acquire Nero. then they would obtain same value only if their WACC is same as that of ICI. In case they fail to do so. therefore there WACC is different due to which the value that they can offer to acquire Nero differs. they should aggressively advertise their value and invite other companies for bidding. and different debt/equity ratio. Higher management involved in negotiation is interested in reaping benefits and maximizing their share in the process of merger. To get the maximum price for their stock and have some bargaining power. They are also concerned about their job security. This may prove disadvantageous to Nero's stockholders as managers are losing their negotiation power due to conflict of interests. Nero's must collaborate with other stock holders with substantive amount of shares so as to discourage any hostile takeover. c. Page | 6 . d.