AIMST UNIVERSITY

FACULTY OF BUSINESS AND MANAGEMENT

MERGERS, ACQUISITIONS AND CORPORATE RESTUCTURING

CLASSROOM EXERCISE 2:
1. Compare and contrast economies of scale, specialization, and economies of scope.
Economics of scale – cost reduction due to larger size of customer base and
higher number of production.

Specialization – the business that only focus on one type of product or service.

Economics of scope – cost reduction due to capability to produce variety types of

products.
2. Describe the reasons why a merger can increase value.
Synergy – when companies merged, they are able to increase market power
(share), their capital has increased (due to the combined earnings), larger
customer base, wider area of marketing, shared expertise and knowledge,
diversification of business.

Economics of scale - cost reduction due to larger size of customer base, increase
in production and size of company, greater efficiency in the operation of the
business, rise in the revenue (earning or income).

3. Briefly explain each of the major merger movement that have occurred in the
United States, indicating the major forces involved.
First wave- Horizontal merger (1895 – 1904)
Motivation –
a. Changes in economic infrastructure and production technologies,
transcontinental railroads resulted in national market and innovations like
electricity have created the opportunities to expand the area of marketing and
reduction of costs from the operation of business.
b. The M&A activities enable the companies to reach economic of scale and
increase their market power. Thus, the problem of monopolized market
happens during this era – price of goods was high.
Ended – Anti-competitive law was created and it restricted the number of
horizontal merge activities. But some are due to failure in management (failure to
modernize equipment, lack of flexibility due to larger size and abilities (aka,
expertise) of management teams.
Second wave – Vertival merger (1922-1929)
Motivation –
An alternative to horizontal merger. The opportunity to expand the product and
market through business of similar product lines but different products, increasing
the efficiency of supply-chain management by the innovation of transportation
and communications. Also known as the era of consolidation of fragmented
industries – oligopoly.
Ended – economic slowdown
Third wave – Conglomerate mergers (1960s)
Motivation –
Booming economy. Merging to diversify their business outside of their traditional
activities. To avoid sales/profit instability, poor growth prospects, industry
uncertainty, adverse competitive shifts an technological obsolescence.
Ended – Decline of stock prices and introduction of the 1969 Tax Reform Act that
limited use of convertible debt to finance acquisitions and EPS calculation on
fully diluted basis.
Fourth wave – The Deal Decade (1981-1989)
Motivation –
Investment banks were losing profits. As the results, hostile (unfriendly)
takeover/acquisition was accepted by the banks as a move to increase their profits.
Surge in the economy (rise in firm’s profits) but stock price decline in response to
a generally declining stock market. It becomes an opportunity to acquire trouble
firms by established companies.
 Ended – Rise of wide range of defensive measures against hostile takeovers.
Fifth wave – Strategic mergers (1992-2000)
Motivation – (power point in good enough)

 Technological innovations (ex. Impact of computers and internet – resulted in

new industries and firms)

 Globalization
- Technological developments in transportation and communications
- Europe and other regions moving toward common markets

 Economic environment
- Rising stock prices and P/E ratios
- Low interest rate levels

 Deregulation of numerous industries caused reorganization (telecom, energy,

airlines, etc.)
Method of payment
- Wide use of stock for stock transactions
- Less reliance on highly leveraged transactions

 Share repurchases – widely used by firms as a credible signal of future

success

 Stock options – used both to compensate talented executives and as an

incentive for employees throughout organizations
Ended – Weak economic recovery. Corporate fraud and dismal record of active
acquirers.

4. Discuss the effect of the following variables on merger activity:

a. The growth rate of GDP.
The opportunity to growth the business due to increase in consumption. M&A
activities will increase to get higher profits and expansion of marketing
areas/products.
b. Interest rate levels.
 Interest rate is related to the cost of borrowing. Higher rate will result in a more
expensive loans available for the firms. Thus, M&A activities are expected to
reduce due to higher costs.
c. Interest rate risk premiums.
Risk premium is related to the uncertainty of return from stock investment.
Higher risk premium, higher cost for the firm and M&A activities are likely to
reduce.
d. Monetary stringency.
Reduction in money supply will cause an increase in interest rate, thus, the cost of
borrowing. Since M&A activities are mainly financed by debt, it will experience a
reduction in its activities.
5. How are target stock returns affected by the use of (a) cash or (b) stock as the
method of payment? (only look at the target firm perspective!!)
Target firm’s stock returns will not be affected by cash payment method. As for
the stock method, their return will be based on the performance of the market (i.e.,
the demand of the investors). This means that the target firm’s shareholders have
a chance to gain a premium profit if the stock price rises.

6. How do bidder returns vary with (a) the mode of payment and (b) the presence of
single versus multiple bidders? (only look at the acquire firm perspective!!)
If the method of payment is cash, the host is fully bear by the acquiring firm. If
the method of payment is stock, the risk is shared by the both the target and
acquiring firm.
If there is only one single bidder, the acquiring firm will have the full power to
decide the offering price. However, its power will reduce when the number of
bidders increases. It is because the winner of the bidding is the one offering the
highest price. Thus, it will increase costs and reduce the return for the acquiring
firm’s return.

7. Describe SIX (6) advantages and disadvantages of holding company structure.

ANS:
Disadvantages: Advantages:
1.There is a possibility of fraudulent 1.Subsidiary company maintained their
manipulation of accounts. separate identity.
2.Intercompany transaction may not be at 2.The public may not be aware the
a fair price. existence of combination among the
various company.
 3.Monority shareholders interest may not 3.Holding company need not to be invest
be properly protected. entire amount in the share capital in
subsidiary company still enjoy controlling
power in such company.
4.The accounts of various companies may 4.It would be possible to carry forward
be made upon different dates to losses for income tax purposes.
manipulate profit or financial position of
Group companies.
5.The shareholders in the holding 5.Each subsidiary company prepares its
company may not be aware of true own accounts and therefore financial
financial position of subsidiary company. position and profitability of each
undertaking is known.
6.Creditors and outsider’s shareholder in 6.Holding company may additionally
the subsidiary company may not be aware acquire or disposed of and the shares in
of true financial position of subsidiary subsidiary company in market whenever if
company. desired.

8. Provide an illustration of the same transaction using the two accounting methods, a)
pooling of interests accounting and b) purchase accounting. The assumptions are as
following:

 Company A acquires Company B for RM200,000

 Property, plant & equipment (PP&E) is written up by RM7,000 to reflect fair

(market) value

 Inventory increases in value by RM2,000.

 Market value of debt increase to RM282,000

Company A (RM Company B (RM

thousand) thousand)

Assets
Cash 450 135
Accounts Receivables 300 100
Inventory 200 65
Property, Plant & Equipment 400 150

Total Assets 1350 450

Liabilities and Shareholder's

Equity
Account Payable 600 150
Total Debt 500 250

Total Liability 1100 400

Shareholder's Equity 250 50

Total Liabilities and

Shareholder's Equity 1350 450

ANS:
Purchase method

Company A (RM Company B (RM

thousand) thousand)

Assets
Cash 450 135
Accounts Receivables 300 100
Inventory 200 67
Property, Plant & Equipment 400 157

Total Assets 1350 459

Liabilities and Shareholder's

Equity
Account Payable 600 150
Total Debt 500 282

Total Liability 1100 432

Shareholder's Equity 250 27

Total Liabilities and

Shareholder's Equity 1350 459
 Company A&B (RM thousand)

Assets
Cash 385
Accounts Receivables 400
Inventory 267
Property, Plant & Equipment 557
Goodwill 173

Total Assets 1782

Liabilities and Shareholder's Equity

Account Payable 750
Total Debt 782

Total Liability 1532

Shareholder's Equity 250

Total Liabilities and Shareholder's

Equity 1782