Chapter 11 Chapter 11
Mergers and Acquisitions
Discussion Questions
1. Since the year 2000, there has been a noticeable increase in mergers and acquisitions among firms in
different countries (termed cross-border acquisitions). What factors could explain this increase? What
special issues can arise in executing a cross-border acquisition and in ultimately meeting one’s objectives
for a successful combination?
Several factors could help explain the increase in merger and acquisition activity between firms in
Expansion of regional free trade areas. Once a regional trading block is implemented, it can
become more difficult for foreign firms to export its products to countries within the block. As a
Globalization of certain industries. Once a company has reached the maximum production in its
Search for new markets. Once domestic markets for a specific product have matured, a domestic
International mergers will create special issues that will ultimately affect the success of the merger.
reports under different accounting rules. Differences in accounting rules may include:
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• Treatment of intangibles, such as research and development expenses, brand names, goodwill,
patents, etc.
• Regulatory considerations.
• Foreign government investment approvals.
• Foreign government antitrust approvals.
2. Private equity firms have become an important player in the acquisition market. These private
investment groups offer to buy a target firm, often with the cooperation of management, and then take the
firm private. Private equity buyouts rose from just 2 percent of U.S. merger and acquisition activity in
2000 to 15 percent as of December 2005. Private equity buyers tend to finance a significant portion of the
acquisition with debt.
a. What types of firms would make ideal candidates for a private equity buyout? Why?
b. How might the buyout firm add sufficient value to the target to justify a high buyout premium?
a. Ideal private equity firms are those that
b. The acquirer might provide opportunities for better management of the firm’s operations. The
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3. Kim Silverman, CFO of the First Public Bank Company, notes: “We are fortunate to have a cost of
capital of only 7 percent. We want to leverage this advantage by acquiring other banks that have a higher
cost of funds. I believe that we can add significant value to these banks by using our lower cost
financing.” Do you agree with Silverman’s analysis? Why or why not?
Disagree. In general, a company’s cost of capital is related to the riskiness of its underlying assets.
As long as the risk of the assets does not change, then the cost of capital related to those assets will
It is unlikely that the First Public Bank Company will be able to find any other banks with a higher
cost of capital, due to capital market imperfections. Banks are not typically newly formed, high-
4. The Boston Tea Company plans to acquire Hi Flavor Soda Co. for $60 per share, a 50 percent
premium over current market price. John E. Grey, the CFO of Boston Tea, argues that this valuation can
easily be justified, using a price-earnings analysis. “Boston Tea has a price-earnings ratio of 15, and we
expect that we will be able to generate long-term earnings for Hi Flavor Soda of $5 per share. This implies
that Hi Flavor is worth $75 to us, well above our $60 offer price.” Do you agree with this analysis? What
are Grey’s key assumptions?
Disagree. Grey has made two key assumptions, each of which is questionable and could lead to the
Boston Tea Company paying too much for Hi Flavor. First, he assumes that Hi Flavor will have
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5. You have been hired by GT Investment Bank to work in the merger department. The analysis required
for all potential acquisitions includes an examination of the target for any off-balance-sheet assets or
liabilities that have to be factored into the valuation. Prepare a checklist for your examination.
Off-Balance-Sheet Liabilities
• Executory contracts
Off-Balance-Sheet Assets
Depending on the specific circumstance, these assets may already be included on the balance sheet.
6. A target company is currently valued at $50 in the market. A potential acquirer believes that it can add
value in two ways: $15 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 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?
There are two sources of value in Firm A’s bid for Company T. One source of value is $15 per
share due to improved working capital management. Firm A, however, is not the only firm that can
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7. In 2011 Comcast acquired a majority stake in NBC Universal in a deal that valued the
company at more than $30 billion. Analysts at the time tended to define the rationale for the
acquisition as being one of “conduit” acquiring “content”. Evaluate the potential strategic
merits of this rationale.
Comcast is viewing NBC Universal as a complementary resource. NBC Universal’s product,
entertainment “content”, can be distributed through Comcast’s distribution network. If it does not
control NBC Universal, Comcast will have to acquire additional content to fill its expanding cable,
The merits of Comcast’s argument depend upon the implicit assumption that the market for content
is uncompetitive. At the time of the merger, Comcast had many possible choices for sourcing
content. Each content producer can choose to sell their content to the highest bidder, including
Comcast. In a competitive marketplace, a content producer would not knowingly sell content to
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8. A leading oil exploration company decides to acquire an Internet company at a 50 percent premium.
The acquirer argues that this move creates value for its own stockholders because it can use its excess
cash flows from the oil business to help finance growth in the new Internet segment. Evaluate the
economic merits of this claim.
The oil company is arguing that a merger could create value by providing low-cost financing to a
financially constrained electronics firm. This argument is based on the idea that capital market
The merits of the oil company’s argument for buying the electronics company depend on two
conditions. First, financial constraints must be preventing the electronics firm from undertaking
some profitable projects. If the electronics firm is not financially constrained or does not have a set
However, there should be some doubts about the value of this acquisition by the oil firm. First, why
does an oil company have a comparative advantage assessing the merits of future investments in the
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9. Under current U.S. accounting standards, acquirers are required to capitalize goodwill and report any
subsequent declines in value as an impairment charge. What performance metrics would you use to judge
whether goodwill is impaired?
One way to assess whether goodwill is impaired is to examine the firm’s net operating return on
assets (NOPAT to Net Operating Assets). If this return is below the firm’s weighted average cost of
It may also be possible to judge whether goodwill has become impaired by estimating at the time of
the acquisition what types of performance benchmarks (return on sales, sales turnover, working
10. As an external adviser to the U.S. government’s interagency committee that vets foreign
takeovers, you have been asked to provide expert testimony on the proposed takeover of a major
US airport by a Dutch airport management services company. Would you recommend that the
acquisition be granted regulatory approval? What are the different issues you will examine and
present to the committee?
Several issues are likely to be pertinent to the regulatory approval:
i. Effect on Competition. One question that arises in large acquisitions is whether the deal
ii. Impact of Airport Safety and Security. A second issue that is likely to be important for
maintaining security once the acquisition is approved. Questions would be asked about
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