In other cases firms attempt to improve value by

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Unformatted text preview: lding companies. A variety of motives, such as synergy, increasing managerial skill or technology, and defense against takeover, could drive a firm toward a merger, but the overriding goal should be maximization of the owners’ wealth. Occasionally, merger transactions are heavily debt-financed leveraged buyouts (LBOs). In other cases, firms attempt to improve value by divesting themselves of certain operating units that are believed to constrain the firm’s value, particularly when the breakup value is believed to be greater than the firm’s current value. Regardless of whether the firm makes a cash purchase or uses a stock swap to acquire another firm, the analysis should center on making sure that the risk-adjusted net present value of the transaction is positive. In stock swap transactions, the long-run impact on the firm’s earnings and risk can be evaluated in order to estimate the acquiring firm’s postacquisition value. Only in cases where additional value is created should the transaction be made. CHAPTER 17 Mergers, LBOs, Divestitures, and Business Failure 743 Business failure, though unpleasant, must be treated similarly; a failing firm should be reorganized only when such an act will maximize the owners’ wealth. Otherwise, liquidation should be pursued in a fashion that allows the owners the greatest amount of recovery. Regardless of whether the firm is growing, contracting, or being reorganized or liquidated in bankruptcy, the firm should take action only when that action is believed to result in a positive contribution to the maximization of the owners’ wealth. REVIEW OF LEARNING GOALS Understand merger fundamentals, including basic terminology, motives for merging, and types of mergers. Mergers result from the combining of firms. Typically, the acquiring company pursues and attempts to merge with the target company, on either a friendly or a hostile basis. Mergers are undertaken either for strategic reasons to achieve economies of scale or for financial reasons to restructure the firm to improve its cash flow. The overriding goal of merging is maximization of owners’ wealth (share price). Other specific merger motives include growth or diversification, synergy, fund raising, increased managerial skill or technology, tax considerations, increased ownership liquidity, and defense against takeover. The four basic types of mergers are horizontal (the merger of two firms in the same line of business); vertical (acquisition of a supplier or customer); congeneric (acquisition of a firm in the same general industry but neither in the same business nor a supplier or customer); and conglomerate (merger between unrelated businesses). LG1 Describe the objectives and procedures used in leveraged buyouts (LBOs) and divestitures. Leveraged buyouts (LBOs) involve use of a large amount of debt to purchase a firm. LBOs are generally used to finance management buyouts. Divestiture involves the sale of a firm’s assets, typically an operating unit, to...
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