Question

List and describe some of the more important financial factors, as opposed to operational factors, that you would take into account when considering acquiring another company? 10 marks

Answer 1

Answer:-

Some of the important financial factors taken into account when acquiring a company are

1) Mode of payment

There are two methods of financing an acquisition
a) Securities offering (Stock offering)and
b) Cash offering

In securities offering the target company shareholders receive shares of the acquirers common stock in exchange for their shares in the target company.The number of acquirer's share received for each target company share depends on the exchange ratio. Given an illustration shareholders in the target company may receive 1.4 shares of the acquirer's stock for every one share they own in the target company.

In Cash offering the acquirer simply pays an agreed upon amount of cash for the target company's shares.

In many cases there will be a combination of the above two referred to as mixed offering.

The three main factors to be considered when the acquiring company is negotiating with the target over the method of payment:-

I) Relative valuations of companies involved
II) Changes in capital structure, and
III) Distribution of risk and reward for the acquirer and target shareholders.

2) Evaluation of the Bid

It involves whether the post merger value of the combined firm is worth more than the sum of the two separate firms.

The post merger value of the combined company is:-
V(c) = V(a) + V(t) +S -C

V(c)= post merger value of the combined company
V(a)= pre merger value of the acquirer
V(t)= pre merger value of the target
S = synergies created by the merger
C= cash paid to target shareholders

Gains Accrued to Target G(t):-

G(t) = TP = P(t)- V(t)
G(t) = gains accrued to target shareholders
TP = takeover premium
P(t) = price paid for target
V(t) = pre merger value of target

Gains Accrued to Acquirer G(a):-

G(a) = S - TP = S - [P(t) - V(t)]
G(a) = gains accrued to the acquirers shareholders
S= synergies created by the merger
TP = takeover premium
P(t) = price paid for target
V(t) = pre merger value of target.

Note:-
1) In cash offering the cash paid to the target shareholders (C) is equal to the price paid for the target [P(t)]
2) In stock offering P(t)= N X P(at) where
N = number of new shares the target receives
P(at)= price per share of the combined firm after the merger announcement.