A.
A merger of two companies can be looked in either ways. Some of the economically justifiable reasons for mergers include:
Acquiring intangible assets such as trademarks, patents, etc
Economies of scale can be justified with the merged entity
Sum of the parts is greater than the individual as a whole
Gaining a dominant market share in markets where anti-competitive rules are not very strong
Offsetting taxes by using accumulated losses
Temporary distress in the target firm but with better future prospects
Some of the doubtful or illogical reasons for mergers include:
Diversification in an entirely unrelated line of business
Poison pill, or to load the company in so much debt that it becomes unattractive for hostile takeovers.
Current Case – In the current case, the reason for merger is expansion. By acquiring Hill’s Hardware, Smitty’s Home repair company can extend its reach to another state
B.
Hostile Merger – A hostile merger or a hostile takeover is the acquisition of a company which is done without amicable terms. In this type of merger, the acquirer reaches out to the shareholders of the target company by offering higher value of share price and proposes to replace the management of the target firm. In a hostile takeover, the Board of Directors of the target company rejects the offer for merger, but the bidder pursues the acquisition by circumventing the board and the top management.
Friendly merger – A friendly merger is carried out by agreeing to amicable terms by the management of both the firms. In this type of arrangement, the bidder will propose an offer and the target firm will approve the buyout terms in public.
C.
Please refer to calculations in excel for the cash flow calculations.
In a normal capital budgeting cash flow, all debt to fund the asset purchase is the new debt and this cost is accounted for by using the firm’s weighted average cost of capital (WACC). However, in a merger scenario, the bidder takes up two types of debt. One is the existing debt which is running in the target firm, while the other is the new debt taken to finance the purchase. Hence, these debts have different costs and cannot be considered as a single cost for firm’s weighted average cost of capital. So the interest expense is deducted in cash flow statement. Earnings retention are deducted in the cash flow statement because they are not available for use to the bidder company.
D.
The estimated cash flows are residual and belong to the firm which has bid for the target company. Due to the fixed interest, these cash flows must be discounted using the cost of equity. Hence, using the CAPM Model, the discount rate is determined.
Please refer to the excel sheet for calculations
E.
Please refer to excel sheet for calculations. Another firm evaluating Hill for acquisition will obtain a different value due to differing tax rates, financing options, which will lead to a different discount rate
F.
Please refer to excel sheet for calculations. The offer price should be between $9 per share to $16.39 per share. At $9 per share, shareholders of Smitty’s Home Repair Company would have struck a bargain whereas at $16.39, the shareholders of Hill’s Hardware would have derived a premium to recently traded share price
G.
Merger related activities taken by investment bankers include:
Identifying targets of acquisition for potential bidders
Identifying synergies as a result of mergers
Arranging suitable financing for the mergers
Help in valuation of the companies
