Chapter 22, Problem 1Q

a.

Summary Introduction

To determine: Definition of synergy; merger

Explanation of Solution

Synergy is the motivation to merger. It means that after merger companies are able to reduce cost and gain from merger. It results in economies of scale in management, marketing and production and increases efficiency. Merger is bring business of two companies under one business and increasing the value of shares.

b.

Summary Introduction

To determine: Definition of horizontal merger, vertical merger, Congeneric merger, conglomerate merger

Explanation of Solution

Horizontal merger means joining business of having same line of business. Vertical merger means joining business with its supplier or customer. Congeneric merger happens between related industries. Conglomerate merger happens when one business decides to enter into another industry and join with company in another industry.

c.   

Summary Introduction

To determine: Definition of friendly merger, hostile merger, defensive merger, tender offer, Target Company, breakup value, acquiring company

Explanation of Solution

A merger in which merger is approved by both the companies is called friendly merger. A situation where merger offer is resisted by the target company, it is called hostile merger. When one company is acquired by another company but Target Company tries to avoid acquisition by initial acquisition company is defensive merger.

A tender offer is a friendly merger where merger takes place with the approval of management of both companies and shareholders tender the shares. Target Company is the firm which is acquired by another company under merger. Breakup value is the value of company which is acquired by another company. Acquiring company is the company which purchase the another company under merger.

d.

Summary Introduction

To determine: Definition of operating merger, financial merger

Explanation of Solution

Operating merger is merger in which operations in the firm involved are integrated and generate operating synergy. Financial merger is where operations of two companies are not integrated and does not generate operating synergy.

e.

Summary Introduction

To determine: Free cash flow to equity.

Explanation of Solution

The free cash flow to the equity model is also known as the residual dividend model, first the calculations of the FCFE, that refers to the free cash flow that are payable to the shareholders. FCFE is calculated by subtracting the interest expenses from the free cash flow and adding the interest tax shield.

After this the FCFE is discounted at the levered cost of the equity in order to arrive at the equity value operations. It is essential to add the value of the non-operating assets and the equity value is obtained. The debt value is added after for obtaining the operations value.

f.

Summary Introduction

To determine: Definition of purchase accounting

Explanation of Solution

Purchase accounting is a method of accounting in which assets and liabilities of the firm are valued at fair price when merger is taking place to record in the books of acquiring company.

g.

Summary Introduction

To determine: Definition of white knight, proxy fight

Explanation of Solution

White knight is the situation under merger where friendly investor invests in the company and acquires it with the support of management. The merger takes place at the fair value or fair consideration of assets and liabilities. Proxy fight is situation that arises when shareholders send their representatives as proxy and they form a group and try to win corporate vote.

h.

Summary Introduction

To determine: Definition of joint venture, corporate alliance

Explanation of Solution

Joint venture is a creation of new entity by two or more parties to acquire new market, to gain from enhanced operations by acquiring skills and capabilities and sharing the risk of investment. Corporate alliance is a relationship build with the motive to reduce cost and improve efficiency.

i.

Summary Introduction

To determine: Definition of divestiture, spin-off

Explanation of Solution

Divestiture means divestment. It means withdrawing or cutting-off the investments done by company into another company. Spin-off of corporate means that company splits its one part business as a separate business.

j.

Summary Introduction

To determine: Definition of holding company, operating company, parent company

Explanation of Solution

Holding company is the company which has ownership interest in another company and runs the business of these companies. An operating company is the company which runs operations and provides with goods and services to customers. Parent company is the company which holds sufficient power in another company to influence the operations of the company. Sometimes holding company is also known as parent company.

k.

Summary Introduction

To determine: Definition of arbitrage, risk arbitrage

Explanation of Solution

Arbitrage is the advantage of difference in price in the two or more different markets and has no negative cash-flows as commodities are simultaneously bought and sold in two different markets at different prices striking the imbalance. Risk arbitrage means that stocks are purchased of the companies which may become takeover targets in some near future.