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The value of a target company can be estimated by

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Unformatted text preview: another firm or existing management; the spin-off of assets into an independent company; or the liquidation of assets. Motives for divestiture include cash generation and corporate restructuring. LG2 LG3 Demonstrate the procedures used to value the target company, and discuss the effect of stock swap transactions on earnings per share. The value of a target company can be estimated by applying capital budgeting techniques to the relevant cash flows. All proposed mergers with positive net present values are considered acceptable. In a stock swap transaction in which an acquisition is paid for by an exchange of common stock, a ratio of exchange must be established to measure the amount paid per share of the target company relative to the per-share market price of the acquiring firm. The resulting relationship between the price/earnings (P/E) ratio paid by the acquiring firm and its initial P/E affects the merged firm’s earnings per share (EPS) and market price. If the P/E paid is greater than the P/E of the acquiring company, the EPS of the acquiring company decreases and the EPS of the target company increases. Discuss the merger negotiation process, the role of holding companies, and international mergers. Investment bankers are commonly hired by the acquirer to find a suitable target company and assist in negotiations. A merger can be negotiated with the target firm’s management or, in the case of a hostile merger, directly with the firm’s shareholders by using tender offers. When the management of the target firm does not favor the merger, it can employ various takeover defenses—a white knight, poison pill, greenmail, leveraged recapitalization, golden parachutes, and shark repellents. A holding company can be created by one firm gaining control of other companies, often by owning as little as 10 to 20 percent of their stock. The chief advantages of holding companies are the leverage effect, risk protection, tax benefits, protection against lawsuits, and the ease of gaining control of a subsidiary. Disadvantages include increased risk due to the LG4 744 PART 6 Special Topics in Managerial Finance magnification of losses, double taxation, difficulty of analysis, and the high cost of administration. In recent years, mergers of companies in Western Europe have moved toward the U.S.-style approach to shareholder value and public capital market financing. Both European and Japanese companies have become active acquirers of U.S. firms. Understand the types and major causes of business failure and the use of voluntary settlements to sustain or liquidate the failed firm. A firm may fail because it has negative or low returns, because it is technically insolvent, or because it is bankrupt. The major causes of business failure are mismanagement, downturns in economic activity, and corporate maturity. Voluntary settlements are initiated by the debtor and can result in sustaining the firm via an extension, a composition, creditor control of the firm, or a...
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