Revise Lecture 29

Mergers and Acquisitions 1.Merger & Consolidation ? 2.Four ways of merger ? 3.Three types of merger? 4.Resisting in acquisition?

Mergers and Acquisitions 1.Mergers 2.Consolidations External growth may be achieved by the purchase of the assets or common stock of another firm, paid for with cash or the issuance of shares.

Mergers and Acquisitions Mergers A merger is a combination of two or more businesses in which only one of the corporation survives. The other corporation ceases to exist, and its assets and possibly, debts are taken over by the surviving corporation.

Mergers and Acquisitions The merger may occur in four ways: 1.Purchase of assets 2.Purchase of common stock 3.Exchange of stock for assets 4.Exchange of stock for stock

Mergers and Acquisitions Consolidations A consolidation is a combination of two or more businesses into a third, entirely new corporation. The new corporation absorbs the assets, and possibly liabilities, of both original corporations, which cease to exist. The legal and financial characteristics of a consolidation are basically the same as those for a merger.

Mergers and Acquisitions Three major types of mergers have been important in the development of large American corporations: 1.Horizontal Merger 2.Vertical Merger 3.Conglomerate Merger

Mergers and Acquisitions In many cases, the management of a firm decides that the firm should not be acquired by another firm. Many reasons may be given to explain the management’s feelings: 1.Failure to understand target firm’s problems 2.Future plans not in the interest of target firm’s shareholders 3.Tender price or exchange ratio to low 4.Acquiring firm’s plan for new management

Dividend Policies and Decisions

Dividend Policy Dividend policy is largely a matter of common sense and is a reflection of the investment decision and the financing decision

Dividend Policy Investment decision If the company is going through a growth phase, it is unlikely to have sufficient liquidity to pay dividends. In this case shareholder expectations may well be for the dividend to remain low or 0. This will not be a problem as long as the share price is rising.

Dividend Policy Financing decision If a company can borrow to finance its investments, it can still pay dividends. This is sometimes called borrowing to pay dividend. There are legal constraints over company’s ability to do this, it is only legal if a company has accumulated realised profits

Dividend Policy

Nature of Dividend Decisions A firm’s dividend policies have the effect of dividing the firm’s after tax profit into two categories: 1.Funds to finance long-term growth 2.Funds to be distributed to shareholders

Dividend Policy 1.Funds to finance long-term growth These are represented on the balance sheet by the retained earnings account. Earnings retained by the firm have traditionally accounted for one- half to two-thirds of the firm’s long-term financing. The remaining one-third has been provided by debt and by new issues of preferred and common stock.

Dividend Policy 2. Funds to be distributed to shareholders These are represented by cash dividends declared by the board of directors and paid to the common shareholders

Factors Affecting Dividend Decisions

Factors Affecting Dividend Decision Once we accept the premises that the level of dividends affects the value of a firm’s common share. We need to consider the factors that define the dividend decision.

Factors Affecting Dividend Decision Why Investors Want Dividends Most investors expect two forms of return from the purchase of common share: 1.Capital Gains 2.Dividends

Factors Affecting Dividend Decision 1.Capital gain The investor expects an increase in the market value of the common share over time. If for example, the share is purchased at Rs40 and sold for Rs60, the investor realizes a capital gain of Rs20. Capital gain may be defined as the profit resulting from the sale of capital investments, in this case common share.

Factors Affecting Dividend Decision 2. Dividends The investor expects, at some point, a distribution of the firm’s earnings. From mature and stable corporations, most investors expect regular dividends to be declared and paid on the common share. This expectation takes priority over the desire to retain earnings to finance expansion and growth.

Factors Affecting Dividend Decision A number of factors may be analyzed to help explain the investor’s expectation of dividends over capital gains. Perhaps the three major factors are: 1.Reduction of uncertainty 2.Indication of strength 3.Need for current income

Factors Affecting Dividend Decision 1.Reduction of uncertainty The promise of future capital gains or a future distribution of earnings involves more uncertainty than a distribution of current earnings. A current dividend represents a present value cash inflow to the investor that cannot be lost if the firm later experiences operating or financing difficulties. This reduction of uncertainty in one factor explaining investor preference for current dividends.

Factors Affecting Dividend Decision 2. Indication of strength The declaration and payment of cash dividends carry an information content that the firm is reasonably strong and healthy. The dividend declaration reveals liquidity since cash is needed to make the dividend payment and this cash must be taken away from the firm’s operations.

Factors Affecting Dividend Decision 3. Need for current income Many shareholders require income from their investments to pay for their current living expenses. These investors may be reluctant to sell their shares in order to gain cash. Cash dividends provide current income to these investors without affecting their principal or capital.

Constraints on Paying Dividends

While most firms recognize the investor’s demand for dividends, several factors may restrict the firm’s ability to declare and pay dividends. These are: 1.Insufficient cash 2.Contractual restrictions 3.Legal restrictions

Constraints on Paying Dividends 1.Insufficient cash Although a firm may have adequate income to declare dividends, the firm may not have sufficient cash to pay the dividends. The firm’s liquid funds may be tied up in receivables or stock or the firm may be short on liquid funds due to commitments to fixed assets.

Constraints on Paying Dividends 2. Contractual restrictions If a firm is experiencing liquidity or profitability difficulties, creditors may require restrictions on dividends as part of any new loan arrangements. In this situation, the firm agrees as part of a contract with a creditor to restrict dividend payments.

Constraints on Paying Dividends Example A loan agreement may prohibit dividends as long as the firm’s debt-equity ratio exceeds 1.2 / 1. The firm would be forced to retain earnings to increase equity and thus reduce the debt-equity ratio. A second example would be a loan agreement that restricts the dividend payout to 20% of earnings during the life of the loan.

Constraints on Paying Dividends 3. Legal restrictions Occasionally a firm is legally restricted from declaring and paying dividends. The most common example is found in those states where the law requires that all dividends must be paid from current or past income. Firms incorporated in these states must have adequate retained earnings to declare dividends. In the absence of retained earnings, the firms are barred from declaring dividends even though they may have sufficient cash to make the payment.