These transactions could result in a higher cashflow

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company with limited cash and excess project opportunities. These transactions could result in a higher Cashflow or a lower WACC – possibly both The increased value is the ability to invest in high-yield projects that would otherwise not have been available. The earnings and cash flows of both companies become more stable and predictable Increase the company’s ability to borrow and benefit from the associated tax benefits (due to a larger debt capacity) More debt = tax benefit, because interest payments and tax-deductable If a profit making company acquires a loss making company – use loss to offset the tax burden 3 – Diversification - By diversifying into different industries - reduce the firms exposure to firm-specific risk - Reduce the earnings volatility and risk, while increasing potential value - Advantages include “ the coinsurance effect ’’ – if the earnings of the merger parties are negatively correlated, (likely if in different industries), earnings volatility can be reduced, leading to stable dividends and an increase in firm value. - Often use conglomerates to achieve diversification – can see that its very challenging to get it to be a success - Negative correlation – offsetting returns – when one industry does badly, the other does well = balance out * Virgin has utilised diversification successfully - have a presence in many industries, offset any losses. 4 – Horizontal Integration - Horizontal integration increases the firms market size and power - Acquire a company in a highly related industry . - Same characteristics make the chance of success greater - Increase company’s market power by exploiting cost-based and revenue-based synergies 5 – Vertical Integration - A company acquires a supplier or a distributor that is placed either forward or backward from the firms cost, activity or value chain. 6 | P a g e
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6 – Turning around struggling companies - Companies always looking for struggling, undervalued companies. - By “turning the company around” the acquirer can benefit from the increased value in company - Potential for success is dependent on the following : The poor performance of the target company should be attributable to the incumbent management of the company, rather than to market or industry factors that are not under management’s control. Acquisition must be followed by a change in management, and thus an increase in value. The market price of acquisition should reflect the status quo (current management & poor practices) - Undervalued companies can create significant returns for investors if they noted this early enough - Share is undervalued if its intrinsic value exceeds its market value. - Acquirer can benefit from positive different between fair value and purchase price if: The acquirer has the capacity to find companies that trade at less than fair value , better information Acquirer has access to the funds necessary to complete the acquisition – this is dependent on the personal funds of the company as well as their track records with undervalued companies
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