Corporate Financial Management: Concepts, Techniques And Analysis

Corporate Financial Management

Part a.

Particulars	Amount
Capital Investment	220000 Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper
Salvage Value	40000
Life of the Machine (years)	3
Sale units	6000
Growth in sale unit	10%
Sale Price	60
Growth in Sale Price	5%
Variable Cost	36
Growth in Variable Cost	3%
One time Fixed Overhead Cost	60000
Inspection Charges incurred at the end of year 2	3000
Working Capital Invested	30000
Recoverable Working capital	80%
Cost of Capital	12%
Tax Rate	15%

CALCULATION OF NET PRESENT VALUE
Particulars	0	1	2	3
No. of Units	–	6,000	6,600	7,260
INITIAL CASH FLOWS
Capital Investment	-2,20,000	–	–	–
Working Capital Invested	-30,000	–	–	–
Net Initial Cash Flows (a)	-2,50,000	–	–	–
OPERATING CASH FLOWS
Sales	–	3,60,000	4,15,800	4,80,249
Variable Cost	–	-2,16,000	-2,44,728	-2,77,277
Depreciation	–	-60,000	-60,000	-60,000
Fixed Overhead Paid	–	-60,000	–	–
Inspection Charges	–	–	-3,000	–
Profit Before Tax	–	24,000	1,08,072	1,42,972
Tax @ 15%	–	3,600	16,211	21,446
Profit After Tax	–	20,400	91,861	1,21,526
Cash Flow after Tax (PAT + Depreciation)	–	80,400	1,51,861	1,81,526
Net Operating Cash Flows (b)	–	80,400	1,51,861	1,81,526
TERMINAL CASH FLOWS
Salvage of Machine	–	–	–	40,000
Working Capital Recovered	–	–	–	24,000
Net Terminal Cash Flows (c )	–	–	–	64,000
Net Cash Flows (a+b+c)	-2,50,000	80,400	1,51,861	2,45,526
PV Factor @ 12%	1	0.892857	0.797194	0.711780
PV of Cash Flows	-2,50,000	71,786	1,21,063	1,74,761
Net Present Value	1,17,609

Therefore, the net present value of the project is $117609.

Part b.

As we know Capital Asset Pricing Model is a Single factor model and Arbitrage Pricing Model is a multi-factor model (Sherman, 2011). The APT model incorporates various non-corporate factors in its analysis, whereas CAPM involves only the difference between the market and actual return. The factors involved in APT model are not defined; they can be anything, any element which can affect the price of the security. APT has a broad set of factors whose affect can be incorporated while calculating the price, whereas CAPM ignores the affects of these factors. This is why multivariate models are used to overcome the CAPM. (Rosenbaum et al., 2013)

Part a:

Mergers and acquisition is an organic growth strategy which is opted by the corporate. The organic growth strategies such as internal expansion are a tad complicated procedure, but merger takes less time (Snow, 2011). Though the process of merger is less time consuming, it is expensive, as the acquirer firm is required to pay a premium to the acquired firm. The management of the acquired firm is responsible to justify and explain the need for premium. Mostly, the premium involved in mergers is due to synergies created.

As discussed the process of merger is expensive, but still people go for it because it has many advantages. The process of merger brings together the strengths of entities promoting higher growth. It also helps to create monopoly, which results in decreased competition and better bargaining position. There are a lot of rules and regulations which in some cases can be fulfilled by collaborations only, therefore mergers helps to satisfy these also. In the process of merger one non-branded partner may get recognition by merging with a branded entity, creating recognition of the former entity. Last but not the least the process of merger helps to create synergy. Synergy is the extra value which is created by merging of two or more entities. Merger helps to strengthen the entity by utilising the positive attributes and reducing the negative. This results in better operating and financial environment for the entity to work in and hence results in synergy creation.

Synergy is the potential or additional value that is expected to be generated as a result of the merger. It is the most used rationale for the purpose of analysing a merger plan. But lack of information and improper application of synergy calculations may lead to wrong conclusions. (Bainbridge, 2012)

Working Capital and Capital Investments

Few of the major reasons why synergy is generated are listed below:

• Economies of Scale:Due to large scale production as a result of merger, the cost per unit declines, resulting in economies of scale.
• Better Pricing Power: Since the merged entity now has more resources and more market share, it will be in a better position to enjoy the pricing power in the market.
• Complimentary Resources: where a big innovative firm with ample of resources merges with a small firm with very limited resources, then the small firm enjoys the resources which was not yet available to them.
• Utilisation of surplus funds:the funds which are idle and not being used can be used to complete the buy-out in a merger, providing greater returns,
• Tax Benefits: whereby in the process of merger a profit making company acquires a loss making company in order to generate tax shield, then the tax benefits can be availed by the merger entity.
• Managerial Efficiency: there is a probability that the acquired firm would have been mismanaged, after the completion of merger, better expertise and managerial efficiency of the acquiring company, helps to manage the acquired company.(Filippell, 2011)

• Horizontal Merger: These types of merger take between the companies which belonh to same industry and are at the same stage.
• Vertical Merger:this type of merger takes place between the companies which belong to same industry but different stages. For example, an oil refilling company merging with a company involved in the business of oil marketing.
• Concentric Merger:this type of merger takes place between companies belonging to related industries. For example, a banking company merging with a insurance company.
• Conglomerate Merger: this type of merger takes place between companies of totally different industries.

Synergy can be of various types too. In a merger, benefit generated in any area will be termed as synergy. Synergies can be of following types:

• Cost savings synergy: we have already discussed above how economies of scale can be achieved form the process of merger. Due to economies of scale the cost per unit declines. Decrease in the cost results in higher revenue and profits which then results in higher market value of the company. Hence generating synergy for the newly formed entity.
• Revenue Synergies: revenue synergies are increase in revenue for the merged entities. The revenue generated by the merged entity is more than the revenue individually generated the participating entities. In our discussion below we will see a practical example of how two merged entities have resulted in revenue synergies. The merged entities have more resources which are put to use more efficiently which results in these types of synergies.(Harrison, n.d.)
• Market value synergies: this is due to boot strap effect. Under this type of synergies the market capitalization of merged entities is much more than the market cap of individual participating entities. Difference between these figures is the amount of synergy created form merger.

In the following discussion we have discussed the real life merger of two major food companies Heinz and Kraft food groups. After the merger the merged company Kraft Heinz, became the world’s fifth largest food and Beverage Company. This was one of the biggest mergers which resulted in generation of high synergies for the resultant company. We have shown below the revenue synergy created by the merger.

		(All Figures in million $)
Sales Kraft
Particulars	2014	2013	2012	Total Sales	Average Sales
Sales	18,205	18,218	18,271	54,694	18,231
Sales Heinz
Particulars	2014	2013	2012	Total Sales	Average Sales
Sales	11	12	12	34	11
Sales Kraft Heinz
Particulars		2017	2016	Total Sales	Average Sales
Sales	–	19,355	26,487	45,842	26,195
Synergy= Sales Kraft Heinz-Sales Kraft-Sales Heinz
Synergy	=	26195-18231-11
	=	7953

Therefore, we see that the merger resulted in synergy amounting to $7,953 million.

Before the merger, 605 of the revenue of Heinz was generated from sales from regions other the North America, whereas 98% of Kraft revenue was generated from North America. Therefore merger gave Kraft the scope for expansion in international markets (Galpin and Herndon, 2014). Also, when the merger was about to take place it was estimated that it would result in cost savings of $1.5 billion per year. The cost synergies were expected to realise from economies of scale. The economies of scale would help them have better bargaining power which will provide them higher operating margin. Also, other cost reducing strategies were to be implemented in order to achieve cost synergies such as closing down of inefficient units, reduction in headcount, etc. Therefore, we see that the expected plan of the management of Kraft came through and helped them realise the revenue synergy of $ 795 million.

We have already discussed that the merger of these two companies resulted in generation of high synergies for the resulting company. We will now show calculations which will support the above statement. Also we will prove that the equation of PV (Acquirer) + PV (Target) < PV (Combined Firm) is being satisfied by the said merger (Halibozek and Kovacich, n.d.). Below are the figures stating the market price per share of the companies and the number of shares of the companies before and after merger. The market capitalisations of the companies are calculated in order to arrive at the present value of the companies before and after acquisition. All the figures below are in million $ except for share price, which are per unit.

Share price of Kraft
Year	Share Price	No. of Share
2012	44.15	592.76
2013	53.91	596.23
2014	62.66	587.33
Average Share Price	53.57
Average Number of Shares	592.11
Share price of Heinz
Year	Share Price	No. of Share
2012	57.68	110.87
2013	72.50	109.83
Average Share Price	65.09
Average Number of Shares	110.35
Share price of Kraft Heinz
Year	Share Price	No. of Share
2016	87.32	1,216.48
2017	77.76	1,216.48
Average Share Price	82.54
Average Number of Shares	1,216.48

Calculation of Market Capitalisation
Particulars	Heinz	Kraft	Kraft Heinz
No of shares	110.35	592.11	1,216.48
Share price	65.09	53.57	82.54
Market Capitalization	7,183	31,721	1,00,408

Therefore we can see that market cap of Heinz was $7183 million and that of Kraft was $ 31721 million before merger. After merger, the market cap of the merger entity resulted in $ 100408 million. The equation PV (Acquirer) + PV (Target) < PV (Combined Firm) is hence satisfied.

The present values of the entities are calculated by taking into consideration the market price of the shares and the number of shares outstanding at the year end. The value of the firm is then calculated and compared.

References

Bainbridge, S. (2012). Mergers and acquisitions. New York: Foundation Press.

Filippell, M. (2011). Mergers and Acquisitions Playbook: Lessons from the Middle-Market Trenches. John Wiley & Sons.

Galpin, T. and Herndon, M. (2014). The complete guide to mergers and acquisitions. San Francisco, Calif.: Jossey-Bass.

Halibozek, E. and Kovacich, G. (n.d.). Mergers and Acquisitions Security. Burlington: Elsevier.

Harrison, C. (n.d.). Make the deal.

Rosenbaum, J., Pearl, J., Perella, J. and Harri. (2013). Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisition. John Wiley & Sons.

Sherman, A. (2011). Mergers & acquisitions from A to Z. New York: Amacom.

Snow, W. (2011). Mergers & Acquisitions For Dummies. John Wiley & Sons.