1. MERGERS & ACQUISITIONS • One company absorbs another entire company • Analyzing a merger is an application of our capital budgeting techniques but because of scale and complexity, we need to bring all of our financial tools to bear

2. Financial statement analysis and financial planning Capital budgeting and cost of capital Capital market efficiency Do current prices capture true value? Capital structure Agency problems and corporate control Merger financing Medium of exchange Valuation: WACC, APV, Flows to equity Risk management Does corporate diversification pay? M & A AND COURSE TOPICS

3. NET ADVANTAGE TO MERGING • VA, VB = prior values of A, B • VAB = value of combined firm • PB = premium over market value paid to B • E = merger expenses

4. Possible: Operating efficiencies and economies of scale Tax benefits Release of surplus cash Grow more cheaply and quickly Doubtful: Diversification Financial Synergy Enhanced EPS when high-PE firm acquires low-PE firm WHEN CAN MERGERS CREATE VALUE?

5. TRANSACTION FORMS • Merger • Negotiated with management - requires shareholder approval • Often involves tax-free exchange of shares • Acquisition of stock • Can make offer directly to shareholders • Acquisition of assets • no liabilities assumed

6. Comparables PE Price-Book Price-EBITDA Price-Replacement Value Liquidation values Difficulty of finding true comparables DCF approaches WACC APV Flows to Equity Essentially, a variation on the comparables approach VALUATION METHODS

7. WACC APPROACH:THINGS TO WATCH OUT FOR • Acquiree excess cash or other assets • Assumption of acquiree debt • Financing of transaction • Operating assumptions • Terminal value • Appropriate cost of capital

8. WACC VS. APV • WACC assumes constant financing proportions • Will the company continually rebalance its capital structure to maintain these? • APV requires assumed dollar amounts of debt outstanding • Possible advantage in LBO analysis, where debt is paid down according to schedule

9. Firm A: 2M shares Currently $20 per share Total Value = $40M Offer 1 share in A for every 2 shares in B Firm B: 2M shares Currently $10 per share Total Value = $20M Firm A issues 1M new shares so Firm B shareholders have 1/3 of combined firm EXCHANGE OF SHARES

10. If combined firm is worth $90M, Firm B shareholders own 1/3, so acquisition has cost $30M If combined firm is worth $30M, Firm B shareholders own 1/3, so acquisition has cost $10M With a cash offer of $20M, cost is $20M no matter what COST OF ACQUISITION