Question

Question 5 (15 marks)

1) A target company T is currently valued at $70 in the market. A potential acquirer, Firm A, believes that it can add value in two ways through the acquisition: $25 of value can be added through better working capital management, and an additional $10 of value can be generated by making available a unique technology only for firm A to expand the target’s new product offerings. In a competitive bidding contest, how much of this additional value will the acquirer have to pay out to the target’s shareholders to emerge as the winner? (Hints: You have to identify Company T’s value to Firm A and Company T’s value for any other firms that would bid)

2) Please IDENTIFY, DESCRIBE, and EXPLAIN FOUR potential PROBLEMS from which FIRM VALUE can be destroyed by an acquisition.

Answer 1

Value of Company T to Firm A = 70 + 25 + 10

= $105

Hence the maximum bid by Firm A for company T will be $105, Whereas the maximum bid by any other firm will be restricted to $70. hence the company would need to pay atleast $1 to the target company over and above themarket price to win the bid.

Four Problems of Acquisition which can destroy Firm Value are:

1. Lack of proper Due Diligence: During the process of acquisition it is very important to do proper due diligence of the company to ascertain the correct value of the company and satisy that the price paid to acquire them is fair and is of value to the acquirer.

2. Over-estimation of value of Synergy: Synergy means that the performance of the combined firm will be more than the combined value of two seperate firms. In most of the acquisitions Acquirer estimates synergy value to be so high that they end up paying much more than the market value of the Acquired company, which leads to overpayment nd financial problems to the company.

3. Loss of Key Managerial Personnel(KMP): In the most of the acquisition the Top management of the acquired company is asked to leave to cut costs and the top level of acquirer takes over both the companies. Sometimes it is quality of personnel which is the driving force of the company and since the new management may not understand the acquired company that well, the financial performance of the acquired company falls below the estimation.

4. Poor post-acquisition itegration: Lack of proper planning wrt to post acquisiton. Sometims integration process can be slow and expensive. It is important to understand what you have to put in to make the acquisition successful not just what you have to pay.