Question one
World enterprises would have to issue 162,172 shares in order to achieve an EPS of $2.67. Since there are no improvements in earnings, the total earnings of the merged firm will be equivalent to the sum of the current sum of the earnings of the two firms. In some cases, synergies may give rise to savings that would make the earnings of the merged firm to exceed the simple sum of the two firms before they merged (Gaughan, 2007).
Axle company shares = 100,000
Shares exchanged = 162,172
Therefore the exchange ratio = 162,172/100,000 = 1.62 shares of World enterprises for each share of Axle company.
The cost of the merger to World enterprises is calculated as follows:
Shares issued 162,172
Share price $40
Cost of the merger $6,486,880
The Change in the market value of World enterprises shares that were outstanding before the merger is calculated as follows:
(53.4-40) *100,000 = $1,340,000
The calculation indicates that World enterprises shareholders experienced an increase in their wealth by $1,340,000. This shows that investors who acquire companies with a low Price Earnings ratio are able to increase their wealth (Gaughan, 2007).
Question two
Given the free cash flows and the required discount rate the maximum price of Craftworks Inc share, can be calculated as follows:
Present value of cash flows $72.52 million
Maximum value per share $18.13
Discounting the free cash flows of a firm at the investors required rate of return generates the present value of the firm’s free cash flows and represents the maximum price an investor would be willing to pay in an arm’s length transaction (Gaughan, 2007). In this case, Investors require a return of 16%, which is used as the relevant discount factor to discount the cash flows of Craftworks Inc. since, Craft Inc. does not have any debt, the present value of the free cash flows represent the total value of equity (Gaughan, 2007).
Question Three
Some of the reasons for mergers can be justified economically while others cannot. Some of those that can be justified economically are:
Tax considerations, mergers tend to trigger capital gains tax especially when shareholders sell their shares for cash at a substantially higher price than what they had paid for (Saunders, 2015). However, shareholders can reduce their tax bill by transferring their shares to someone else in a lower tax brackets or if they did a share exchange, they can hold on to their share until death. Shareholders would not have to pay capital gains tax on shares whose prices have gone up if they hold their shares until they die (Saunders, 2015). Alternatively, shareholders who receive a share exchange have better control over the timing of when they will pay their capital gains tax (Saunders, 2015)
Purchase of assets below the market value is viable when a company share price is trading below the liquidation value of its assets. However, buying a company simply to liquidate its assets may have the greatest appeal to companies that buy companies in distress with a view of liquidating their assets and making a gain.
Synergies can also arise in mergers through rationalization of operations, savings on cost of capital due to the increased size and the ability to negotiate for lower cost of credit, and the enjoyment of economies of scale (Gaughan, 2007).
Risk reduction through diversification makes an economic case because investors are able smooth earnings or prevent their earnings from declining (Gaughan, 2007). For instance, a mature company in a declining industry may decide to merge with a high technology company that is in the growth stage and has bright prospects. Such a merger will smooth the earnings of the investors who would have otherwise experienced a decline in their fortunes (Gaughan, 2007).
The other reason for a merger such as control and globalization may not be justifiable economically but are carried out for strategic reasons. A firm may be interested in acquiring a particular firm if they believe the firm posses a valuable resource such as a natural resource, patent, a network, or any other resource of value that the firm would want to acquire control.
Many firms that would want to go global may decide to acquire targets in the markets they wish to enter (Gaughan, 2007). For instance, Kraft acquired Cadbury so that they could increase their presence in UK and other emerging markets. Firms that prefer to acquire target companies do so to reduce the risks associated with investing internationally by acquiring a company that is successful in the market of their interest.
Reference list
Gaughan, P. A. (2007). Mergers, acquisitions, and corporate restructurings. Hoboken, NJ:
Wiley.
Saunders, L. (2015, July 24). Three Mergers, But One Isn't Tax Free. Retrieved March 07, 2016,
