Chapter 31 Principles of Corporate Finance Tenth Edition Mergers Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

31-2 Topics Covered  Sensible Motives for Mergers  Some Dubious Reasons for Mergers  Estimating Merger Gains and Costs  The Mechanics of a Merger  Proxy Fights, Takeovers, and the Market for Corporate Control  Mergers and the Economy

31-3 Sensible Reasons for Mergers Economies of Scale A larger firm may be able to reduce its per unit cost by using excess capacity or spreading fixed costs across more units. $ $ $ Reduces costs

31-4 Sensible Reasons for Mergers Economies of Vertical Integration –Control over suppliers “may” reduce costs. –Over integration can cause the opposite effect. Pre-integration (less efficient) Company S S S S S S S Post-integration (more efficient) Company S

31-5 Sensible Reasons for Mergers Combining Complementary Resources Merging may results in each firm filling in the “missing pieces” of their firm with pieces from the other firm. Firm A Firm B

31-6 Sensible Reasons for Mergers Mergers as a Use for Surplus Funds If your firm is in a mature industry with few, if any, positive NPV projects available, acquisition may be the best use of your funds.

31-7 Dubious Reasons for Mergers  Diversification –Investors should not pay a premium for diversification since they can do it themselves.

31-8 Dubious Reasons for Mergers The Bootstrap Game Acquiring Firm has high P/E ratio Selling firm has low P/E ratio (due to low earnings growth) After merger, acquiring firm has short-term EPS rise Long term, acquirer will have slower than normal EPS growth due to share dilution.

31-9 Dubious Reasons for Mergers The Bootstrap Game

31-10 Dubious Reasons for Mergers Earnings per dollar invested (log scale) Now Time Muck & Slurry World Enterprises (before merger) World Enterprises (after merger)

31-11 Estimating Merger Gains  Questions –Is there an overall economic gain to the merger? –Do the terms of the merger make the company and its shareholders better off? ????

31-12 Estimating Merger Gains

31-13 Estimating Merger Gains Example – Two firms merge creating $25 million in synergies. If A buys B for $65 million, the cost is $15 million.

31-14 Estimating Merger Gains Example – The NPV to A will be the difference between the gain and the cost.

31-15 Estimating Merger Gains  Economic Gain

31-16 Accounting for a Merger Accounting for the merger of A Corp and B Corp assuming that A Corp pays $18 million for B Corp.

31-17 Takeover Methods Tools Used To Acquire Companies Proxy Contest Acquisition Leveraged Buy-Out Management Buy-Out Merger Tender Offer

31-18 Mergers ( ) Number of Deals

31-19 Web Resources Click to access web sites Internet connection required