DEPARTMENT OF POSTGRADUATE STUDIES

MAF AND MA -2022/2023

FINANCIAL MANAGEMENT (AFG 09103)

MERGER AND ACQUISITION

MERGER
The term merger refers to combination of two or more companies in to single company and this
combination may be through absorption or consolidation. When one company absorbs another
company, it is called absorption whereas when two or more companies combine to form a new
company, it is known as consolidation. From law point of view, merger is also referred to
amalgamation.
FORMS OF MERGER
Horizontal merger
When two firms engaged in the same business line merge together, it is known as horizontal
merger. This form, of merger results in the expansion of business of firms operations in a given
product line and the same time eliminates competitor.
Vertical merger:
When two firms working in different stages of production or distribution of the same product
join together, it is called vertical merger. The economic benefits of this type of merger comes
from firms increased control over the acquisition of raw material or distribution of finished
goods.
Conglomerate merger:
It relates to merger of two firms engaged in totally unrelated business i.e. business are not related
to each other horizontally or vertically. A Conglomerate may have operations in manufacturing,
banking, fast food restaurant etc. This form of merger results in expansion of business in
different unrelated lines with a aim to diversify the business.

ACQUISITION
Acquisition refers to acquisition of effective control by one company over another. This control
may be attained through purchase of majority of shares carrying voting rights exercisable at
general meeting or controlling the composition of board of directors of the company. The control
over management of another company can be acquired through either a friendly takeover or
through forced or unwilling acquisition. This mergers and acquisitions is resorted by many
companies which are seeking to;

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  Enter into a new market
 Acquire and consolidate strength
 Expand customer base and enhance revenue
 Cut competition.
 Cost saving or reduction

MODES OF FINANCING ACQUISITION

ACQUISITION BY CASH
When one company acquires another for cash, capital budgeting may be used to examine the
financial feasibility of the acquisition. To ascertain whether the purchase of assets is financially
justifiable, the company must predict the costs and benefits of the assets.
Example one
The management of NJORO Ltd proposed to buy HIMBA Ltd a smaller company engaged in
Bricks Making. HIMBA ltd wants to be paid shs64, 000,000 for the entire business. It is
anticipated that the after-tax cash inflows from the business after acquisition of HIMBA ltd will
increase by shs30, 000,000 per year for the next 8 years. The cost of capital is 12 percent.
Required (i) Calculate the initial net cash outlay/initial investment? (ii)Calculate the net
present value from assets taken (ii) should the acquisition be made? (If the present value annuity
factor for 8 years and interest rate of 12% is 4.968)
Statement of financial position of HIMBA Ltd as at 31st December 2021

Assets Tshs Liabilities and stockholders’ Tshs

equity
Accounts receivable 8,000,000 Total liabilities 80,000,000
Inventories 20,000,000 Total stockholders’ equity 105,000,000
Plant 10,000,000
Machinery 20,000,000
Equipment 35,000,000
Building 92,000,000
Total assets 185,000,000 Total liabilities and stockholders’ 185,000,000
equity
. Solution
Computations of initial investment Calculations Present Value
Amount paid to Year 0- shs144,000 x 1= -144,000,000
Liabilities shs 80,000,000
Years 1-8 (30,000X 4.968 = 149,040,000
Owners 64,000,000
Net present value 5,040,000
Initial net cash outlay shs 144,000,000
Recommendation
Since the net present value is positive, the acquisition should be implemented.

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ACQUISITION BY EXCHANGING ORDINARY SHARES
A company is often acquired by exchanging common stock. The exchange will be in accordance
with a predetermined ratio. The amount the acquiring firm offers for each share of the acquired
business is usually more than the current market price of the traded shares. The ratio of exchange
is equal to:
Amount paid per share of the acquired company
Market price of the acquiring company’s shares
Example two
Company A wants to acquire company B. Company As stock sells for shs80 per share.
Company
B’s stock sells for shs55 per share. Because of the merger negotiations, company A offers shs60
per share. The acquisition is made through an exchange of securities.
Ratio of exchange = Amount paid per share of the acquired company 60 = 0.75
Market price of the acquiring company’s shares 80
Company A must exchange 0.75 share of its stock for one share of company B’s stock.
Example three
The management of Instant Bakery is considering a takeover of Doughnuts Bakery. Both
companies are financed totally by equity and it has been estimated by the management of Instant
Bakery that the merger will produce a benefits with the net present value of Tshs 100,000,000.
On the advice of its merchant banker it has been decided that four ordinary shares of Instant
Bakery should be offered for every five shares of Doughnuts Bakery. Relevant stock market
data are given in the table below;
Share price Number of share Market value(Tshs)
(Tshs) outstanding
Instant bakery 100 7,000,000 700,000,000
Doughnuts Bakery 60 4,000,000 240,000,000
.
Required to calculate
(i)Gross premium received by members of Doughnut Bakery per each share
(ii)Premium per received by members of Doughnut Bakery per each share
(iii) Calculate the percentage of premium to members of Doughnut Bakery
(iv)Number of shares issued by Instant Bakery to members of Doughnut Bakery in exchange for
their company
(v) Number of shares of Instant Bakery after acquisition of Doughnut Bakery
Solution shs
(i) 4 shares of IB 4 x 100 = 400
5 shares of DB 5 x 60 = 300

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 Gross premium 100
(ii)Premium per share = 100/ 5 shares = 20
(iii)Percentage of premium = 20/60 =33 percent
(iv)To acquire Doughnuts Bakery it will be necessary to issue 4/5 x 4,000,000 shares =
3,200,000 ordinary shares
(v) Following the acquisition of DB Instant Bakery will have 7,000,000 + 3,000,000 shares =
10,200,000 ordinary shares.
Example four
The management of Menstrie product, a medium sized food processing company is considering a
takeover bid for Alva Dairy products, a smaller company in the same industry. A study had been
commissioned by on the cost savings which such takeover would generate. It has been estimated
that annual cost savings of shs 20,000,000 will be possible if Alva Dairy Product is acquired.
The net present value of these savings is put at shs120,000,000. Both companies are financed
entirely by equity: Menstrie products has 14 million shares outstanding and these are currently
valued at shs330 each, while Alva Diary products has 3 million outstanding shares outstanding
which are currently valued at shs240 each. Some preliminary discussion suggests that the board
of directors of Alva Diary Products would support a bid which offered a premium of 20% on the
current value of the companies’ shares. Menstries Product has been building up its cash position
to allow it to take over of this nature.
Required
(i)Calculate the value of Menstrie products before acquisition of Alva Dairy products
(ii) Calculate the value of Alva Dairy products before the proposed takeover bid
(iii) Calculate the value of Menstrie products after acquisition of Alva Dairy products
(iv) Calculate the capital outlay by Menstrie products to acquire Alva Dairy products
(v) Net cost of acquisition of Alva Dairy products
(vi)Evaluate the proposed takeover from the position of Menstrie product’s shareholders.
(vii) )Evaluate the proposed takeover from the position of Alva Diary product’s shareholders.
Solution
Name of company Number of Market price of each Market value of the
outstanding shares share firm(Shs)
Menstrie products 14,000,000 Shs 330 4, 620,000,000
Alva Diary product 3,000,000 Shs 240 720,000,000
Gain (present value of cost savings) 120,000,000
Value of Menstrie products Ltd after acquisitions of Alva Diary product 5,460,000,000

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Ltd will be
(i)Value of Menstrie products before acquisition of Alva Dairy products is shs4, 620,000,000
(ii) Value of Alva Dairy products before the proposed takeover bid is shs 720,000,000
(iii) PV (MP + ADP) = PV (MP) + PV (ADP) + GAIN
=4,620,000,000+ 720,000,000+120,000,000
= shs5,460,000,000
Value of Menstrie products after acquisition of Alva Dairy products will be shs 5,460,000,000
(iv) Cash out lay = 240(1+ 0.2) x 3,000,000
= 288 x 3,000,000
= shs 864,000,000
The capital outlay by Menstrie products to acquire Alva Dairy products is shs 864,000,000
(v) Net cost of acquisition of Alva Dairy products
Net cost = Cash outlay – Market value of Alva Dairy products
=shs864,000,000 -shs 720,000,000
=shs 144,000,000
(vi) NPV = NPV of cost savings – NET COST
=shs120,000,000 - shs 144,000,000
= - shs 24,000,000
The shareholders of Menstrie products will loose shs 24,000,000 as a result of such take over,
therefore the takeover should not be implemented
(vii) ) Gain = Amount received by member of ADP – Market value of ADP
=shs864,000,000 -shs 720,000,000
=shs 144,000,000
The shareholders of Alva Diary product will gain shs 144,000,000 as a result of such take over
by Menstrie products; therefore the takeover should be implemented

REASONS FOR MERGERS

There are several reasons why a company would prefer external growth through merger rather
than internal growth:
(i)Exploitation of economies of scale
Mergers and acquisition of firms in the same industry make opportunities for the firm to
exploit the economies of scale, in many industries cost fall with the size of plant being

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employed, to access such economies of scale it is usually necessary to construct larger plants.
Through mergers and acquisition the new company can attain the size which justifies
investment in large scale operation in order to exploit economies of scale.
(ii) Creation of market power
Mergers between firms supplying in the market can increase the market power of the firms
involved. Value for shareholders may be increased at the expense of consumers. Mergers
between the non-dominant firms in an oligopolistic industry can in some circumstances
enhance the effective level of competition by providing the effective rival to the dominant
firm. However, it can also make it easier to reach and maintain collusive agreements.
(iii) More effective exploitation of joint resources
Acquisitions can be justified to the extent to which they add value, and one way in which
value may be added, or synergy created, is by the exploitation of firm’s distinctive
capabilities. Example an internationally well-known company may be able to use its brands
to effect in another country- capitalizing on goodwill and reputation built up in another
country. The company may merge with another company in order to use a well distribution
system and a strong marketing approach and skills.
(iv) Increased market share;
This motives assumes that the company will be absorbing a major competitor and thus
increase its power (by capturing increased market share) to set prices.
(v) Financial and taxes benefits:
Mergers and acquisitions may lead to financial efficiencies for example firms may
diversify their earnings by acquiring other firm or other assets with dissimilar earnings
stream. Earnings diversification within the firms may lessen their profitability, reducing
the risk of bankruptcy and attendant costs. Also a profitable company can buy a loss
maker to use the target’s tax write-offs. In the United States and many other countries,
rules are in place to limit the ability to profitable companies to ‘’shop’’ for loss making
companies, limiting the tax of an acquiring company.
(vi) Resources transfer: Resources are unevenly distributed across firms and the
interaction of target and acquiring firm resources can create value through either
overcoming in formations asymmetry or by combining scarce resources.

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REVISION QUESTIONS

Question one
The MBUNJU Company ltd is soap making firm in Tanzania selling its products in all east
Africa countries, the company has sustained a steady growth in sales over the past few years.
The management of MBUNJU Company ltd is proposing to acquire JAMAA Company ltd in
Kenya. A study had been commissioned by on the benefits which such takeover would generate.
Required
a. Identify and explain the type of business combination involved between the two
companies?
b. Evaluate the advantages to be obtained by MBUNJU Company ltd from the proposed
takeover of JAMAA Company ltd
c. Advice the percentage of shares of JAMAA Company ltd to be acquired by MBUNJU
Company ltd. Justify your recommendation.

Question two
Miles Corporation is thinking of acquiring Piston Corporation for 50,000. Piston has liabilities of
75,000. Piston has equipment that Miles desires. The remaining assets would be sold for 58,000.
By acquiring the equipment, Miles will have an increase in cash flow of 17,000 each year for the
next 12 years. The cost of capital is 10 percent.
The net cost of the equipment is:
50,000 + 75,000 - 58,000 = 67,000
Miles should make the acquisition since, as indicated below, the net present value is positive.
Calculations Present Value
Year 0 -67,000 X 1.000 - 67,000
Years 1-12 +17,000 X 6.814 +115,838
Net present value + 48,838

Question three
With example briefly explain the three types of business combinations, state one advantage on
each type of business combination
Question four
The management of NJORO Ltd proposed to buy HIMBA Ltd a smaller company engaged in
Bricks Making. HIMBA ltd wants to be paid shs54,000, 000 for the entire business. It is
anticipated that the after-tax cash inflows from the business after acquisition of HIMBA ltd will
increase by shs30, 000,000 per year for the next 8 years. The cost of capital is 12 percent.
Required (i) Calculate the initial net cash outlay/initial investment? (ii)Calculate the net
present value from assets taken (ii) should the acquisition be made? (If the present value annuity
factor for 8 years and interest rate of 12% is 4.968)
Statement of financial position of HIMBA Ltd as at 31st December 2021

Assets Tshs Liabilities and stockholders’ Tshs

equity
Cash 2,000,000

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Accounts receivable 8,000,000 Total liabilities 50,000,000
Inventories 20,000,000 Total stockholders’ equity 135,000,000
Plant 10,000,000
Machinery 20,000,000
Equipment 35,000,000
Building 90,000,000
Total assets 185,000,000 Total liabilities and stockholders’ 185,000,000
equity
.
Solution
(b)Total payment: tshs 000 tshs 000
Liabilities shs 54,000
Owners 48,000 102,000
Less Cash available ( 2,000)
Initial net cash outlay shs 100,000
Calculations Present Value
Year 0 - shs100,000 x 1 -shs 100,000
Years 1-8 +shs30,000X 4.968 + 149,040
Net present value 49,040
Since the net present value is positive, the acquisition should be implemented.