Financial Management - Chapter 23

• Economies of Scaleex: reduce administrative expensesas a percentage of sales.• Tax Benefitsex: target firm has tax credits fromoperating losses, and lacks theincome to use the credits.• Unused Debt Potentialex: merging with a firm that haslittle debt increases debt capacity.
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Financial Management - Chapter 23Ch. 23 - Corporate Restructuring: Combinations and Divestitures © 2002, Prentice Hall, Inc. Corporate Restructuring1960s - Mergers of unrelated firms formed huge conglomerates.1980s - Investors purchased conglomerates and sold off the pieces as independent companies.1990s - Strategic mergers of related firms to create synergies. Possible Benefits of Mergers• Economies of Scale ex: reduce administrative expenses as a percentage of sales.• Tax Benefits ex: target firm has tax credits from operating losses, and lacks the income to use the credits.• Unused Debt Potential ex: merging with a firm that has little debt increases debt capacity. Possible Benefits of Mergers• Complementarity in Financial Slack ex: a cash-poor firm merging with a cash-rich firm will be able to accept more positive NPV projects.• Removal of Ineffective Managers ex: ineffective target firm managers may be replaced, increasing the value of the target firm. Possible Benefits of Mergers• Increased Market Power ex: merging may increase monopoly power, but too much may be illegal.• Reduction in Bankruptcy Costs ex: merger may improve financial condition of the combined firm, reducing direct and indirect costs of financial distress. Determination of Firm Value1) Book value: assets minus liabilities on the balance sheet. Book value is based on historical cost minus accumulated depreciation.2) Appraisal value: firm value is estimated by an independent appraiser. This estimate is often based on the firm’s replacement cost. Determination of Firm Value3) Chop-shop or Break-up value: determines if multi-industry firms would be worth more if separated into their parts.Firms are valued by their business segments. Determination of Firm Value4) Free Cash Flow or “Going Concern” value steps:• Estimate the target firm’s free cash flows.• Estimate the target firm’s after-tax risk- adjusted discount rate.• Calculate the present value of the target firm’s free cash flows.• Estimate the initial outflow of the acquisition.• Calculate the NPV of the acquisition. DivestituresDivestiture - Eliminating a division or subsidiary that does not fit strategically with the rest of the company. Divestitures• Sell-off: selling a firm’s subsidiary or division to another company.• Spin-off: separating a subsidiary from its parent company, with no change in equity ownership. The parent firm no longer has control over the subsidiary. Divestitures• Liquidation: Selling assets to another company and distributing the proceeds from the sale to shareholders.• Going Private: A group of private investors buys all of a firm’s publicly- traded stock. The firm is now private, and its shares are no longer traded in the secondary market.