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Unformatted text preview: Special Topics in Managerial Finance breakup value The value of a firm measured as the sum of the values of its operating units if each were sold separately. Regardless of the method used to divest a firm of an unwanted operating unit, the goal typically is to create a more lean and focused operation that will enhance the efficiency as well as the profitability of the enterprise and create maximum value for shareholders. Recent divestitures seem to suggest that many operating units are worth much more to others than to the firm itself. Comparisons of postdivestiture and predivestiture market values have shown that the breakup value—the sum of the values of a firm’s operating units if each were sold separately—of many firms is significantly greater than their combined value. As a result of market valuations, divestiture often creates value in excess of the cash or stock received in the transaction. Although these outcomes frequently occur, financial theory has been unable to explain them fully and satisfactorily.6 Review Questions 17–4 What is a leveraged buyout (LBO)? What are the three key attributes of an attractive candidate for acquisition via an LBO? 17–5 What is an operating unit? What is a divestiture? What are four common methods used by firms to divest themselves of operating units? What is breakup value? LG3 LG4 17.3 Analyzing and Negotiating Mergers We now turn to the procedures that are used to analyze and negotiate mergers. Initially, we will consider how to value the target company and how to use stock swap transactions to acquire companies. Next we will look at the merger negotiation process. Then we will review the major advantages and disadvantages of holding companies. Finally, we will discuss international mergers. Valuing the Target Company Once the acquiring company isolates a target company that it wishes to acquire, it must estimate the target’s value. The value is then used, along with a proposed financing scheme, to negotiate the transaction—on a friendly or hostile basis. The value of the target is estimated by using the valuation techniques presented in Chapter 7 and applied to long-term investment decisions in Chapters 8, 9, and 10. Similar capital budgeting techniques are applied whether the target firm is being acquired for its assets or as a going concern. Acquisitions of Assets Occasionally, a firm is acquired not for its income-earning potential but as a collection of assets (generally fixed assets) that the acquiring company needs. The price paid for this type of acquisition depends largely on which assets are being 6. For an excellent discussion and theoretical explanation of breakup value, see Edward M. Miller, “Why the Breakup of Conglomerate Business Enterprises Often Increases Value,” The Journal of Social, Political & Economic Studies (Fall 1995), pp. 317–341. CHAPTER 17 Mergers, LBOs, Divestitures, and Business Failure 721 acquired; consideration must also be given to the value of any tax losses. To determine whether the purchase of assets is financially justified, the acquirer must estimate both the costs and the benefits of the target as...
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This document was uploaded on 01/19/2014.

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