It is commonly argued that the NPV of a merger depends on the method of payment...

It is commonly argued that the NPV of a merger depends on the method of payment used. Cash offers seem to yield a higher NPV than stock offers. Thus, acquiring firms need to be very careful in setting the exchange ratio in a stock offer deal. Explain in DETAIL why?

Solutions

Expert Solution

Selection of Methods of payment with Mergers & Acquisition(M&A), is the key of a successful M&A. Methods of payment includes cash payment, security payment, stock payments, bond payments and leveraged buyout.

CASH PAYMENT is a simple purchasing action, which means the purchasing corporation purchases a certain amount of assets or stocks from the target company by paying a certain amount of cash. It is the most popular payment method with Mergers & Acquisition on Chinese Capital Market.

Firms have to take many factors into consideration( such as the potential presence of other bidders, tax implications etc.)

STOCK PAYMENT, while stock payment, the purchasing companies issues new stocks to buy the stocks or assets of the target companies. Among which the most popular form is stock exchange, which means the purchasing company pays the stock of its company directly to the target company to buy out the stocks or assets of the target companies.

FOR EXAMPLE :

X ltd is considering the proposal to acquire Y ltd. and their assumed financial information is given below:

Particulars	X ltd.	Y ltd.
No of Equity Shares	10,00,000	6,00,000
Market price per share(Rs.)	30	18
Market Capitalization (Rs.)	3,00,00,000	1,08,00,000

i) Cost of Merger, when Merger is Financed by Cash = (Cash-MVY)+(MVY-PVY)

where, MVY = Market Value of Y ltd. PVY = True/Intrinsic Value of Y ltd.

Then, = (1,40,00,000 - 1,08,00,000) + (1,08,00,000 - 1,08,00,000) = Rs. 32,00,000

If cost of merger becomes negative then shareholders of X ltd. will get benefited by acquiring Y ltd. in terms of market value.

ii) Cost of Merger, when Merger is Financed by Stock :

Cost of Merger = PVXY - PVY

Where, PVXY = Value in X ltd. that Y ltd.'s shareholders get.

Suppose X ltd. agrees to exchange 5,00,000 shares in exchange of shares in Y ltd., instead of payment in cash of Rs.1,40,00,000. Then the cost of merger is calculated as below:

=(5,00,000 x Rs.30)

= Rs.1,08,00,000

= Rs.42,00,000

PVXY = PVX + PVY = 3,00,00,000 + 1,08,00,000 = 4,08,00,000

Proportion that Y ltd's shareholders get in X ltd's Capital Structure will be :

= 5,00,000 / (10,00,000+5,00,000)

= 0.333

True cost of merger = PVXY - PVY

= (0.333 x 4,08,00,000) - 1,08,00,000

= Rs. 28,00,000

As we can see that the values are different in cash merger and stock merger. Thus, acquiring firms need to be very careful in setting the exchange ratio in a stock offer deal.

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

It is commonly argued that the NPV of a merger depends on the method of payment...

It is commonly argued that fewer risk factors (as compared to the stock market) explain expected...

It is commonly argued that fewer risk factors (as compared to the stock market) explain expected returns in bonds. Indicate the main risk factors that empirical studies on the performance evaluation of bond funds consider and explain the risks they aim to capture.

It is commonly argued that complex and sophisticated technologies have created problems for society because they...

It is commonly argued that complex and sophisticated technologies have created problems for society because they have outstripped the human ability to control them; the naked ape is not able to act responsibly with the god-like powers of advanced technologies. Is this a fair assessment or not, and why?

a)What weakness does the NPV method have that is not present in the payback method? -The...

a)What weakness does the NPV method have that is not present in the payback method? -The NPV method is easier to understand. -Initial cash flows are ignored. -It requires estimating the cost of capital. -It takes into account the time value of money. b)A dealer offers you financing to purchase a car priced at $11,000. Under the finance plan, you would pay $2,500 now and $2,500 at the end of each year for 5 years. The finance plan has an...

Why is the NPV method considered by finance specialists to be the best method for capital...

Why is the NPV method considered by finance specialists to be the best method for capital budgeting? What does the NPV of a project tell managers?

What control procedures would firms commonly use for the acquisition and payment activities?

Evaluating cash flows with the NPV method The net present value (NPV) rule is considered one...

Evaluating cash flows with the NPV method The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decisions. Consider this case: Suppose Happy Dog Soap Company is evaluating a proposed capital budgeting project (project Alpha) that will require an initial investment of $600,000. The project is expected to generate the following net cash flows: Year Cash Flow Year 1 $350,000 Year 2 $475,000 Year 3 $425,000 Year 4...

The Basics of Capital Budgeting: NPV The net present value (NPV) method estimates how much a...

The Basics of Capital Budgeting: NPV The net present value (NPV) method estimates how much a potential project will contribute to -Select-business ethicsshareholders' wealthemployee benefitsCorrect 1 of Item 1, and it is the best selection criterion. The -Select-smallerlargerCorrect 2 of Item 1 the NPV, the more value the project adds; and added value means a -Select-higherlowerCorrect 3 of Item 1 stock price. In equation form, the NPV is defined as: CFt is the expected cash flow at Time t, r...

What accounting method was used to account for the merger of Continental and United? What are...

What accounting method was used to account for the merger of Continental and United? What are the reporting implications? In your opinion was this a successful merger? Which company do you think gained the most benefit? Why.

1. Net present value (NPV) Evaluating cash flows with the NPV method The net present value...

1. Net present value (NPV) Evaluating cash flows with the NPV method The net present value (NPV) rule is considered one of the most common and preferred criteria that generally lead to good investment decisions. Consider this case: Suppose Cold Goose Metal Works Inc. is evaluating a proposed capital budgeting project (project Alpha) that will require an initial investment of $450,000. The project is expected to generate the following net cash flows: Year Cash Flow Year 1 $325,000 Year 2...

Subjects