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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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