Current Share Price and the Earnings Yield - Assignment Example

FINANCIAL STRATEGY Name: Instructor: Institution: City: Date: QUESTION (a) Synergy may be defined as the strong hope of there being a lot of financial benefit when two or more firms either merge or one firm takes over the other(s). This belief has always led to the misconception that any two firms merging or one taking over the other leads to an almost automatic financial performance of the resultant merger. The existence of synergy in a merger or takeover can be attributed to quite a number of factors. Some of these factors include the possibility of reducing costs collectively, the combination of both skills and capabilities, and the likelihood of increased revenues. It is indeed a fact that when two or more firms merge or when one acquires the other; the revenues of the resultant outfit have higher chances of behind high. This tendency explains why there may be synergy when one company merges with another or one firm acquires another. In actual sense, when companies merge, their revenue streams are combined so as to make the resultant revenue stream higher than the original. The other reason for synergy existence in mergers and takeovers is the tendency of technology and skills to be combined in mergers and acquisitions. In these resultant firms, the skills of the resources in the respective former firms are in most cases transferred to the merger and acquisition. This boosts the skills available in the merge and acquisition. Similarly, the technologies employed in the former individual firms are easily transferrable into the resultant company outfit thereby making the processes there more technologically efficient. This definitely boosts the productivity of the company. Finally, in mergers and takeovers there is the obvious benefit of redundant processes and resources being ironed out so that significant reduction of costs is achieved by the merger and acquisition. The ultimate result is an efficient company that can give value to shareholders. QUESTION (b) i. In estimating the value of Mallard using the comparative P/E Ratios, it is important to consider the Current Share Price and the Earnings Yield. These two parameters are critical in understanding the P/E ratio, and, therefore, the approximate value of any firm – Mallard, in this case. The bigger the Earnings per share for Mallard against the price per share, the smaller the value of the P/E ratio. Consequently, this implies better performance of a given company. In the case of Mallard and Oakton, the P/E ratios are 7:1 and 10:1 for Mallard and Oakton respectively. Going by the analogy of the P/E ratio in terms of valuation, it is evident that Mallard is indeed a performing company, however small it might be. The disadvantage with this method of P/E ratios is that in times of inflation, the values of inventory and depreciation are highly likely to be exaggerated. During such times, the P/E ratios are usually made to look lower pegged on the belief that the earnings per share rises abnormally. This might not make the use of P/E ratio prudent as a method of valuing Mallard, for example. The advantage, however, is that this method is one of the most accurate in determining the value of a company. ii. When using the Dividend Valuation Model to value a firm, it is essential to calculate the value of payments of dividend for which the stock is expected to throw – off in the coming times. Technically, Oakton will first of all calculate the value of the so-called preferred stock – Mallard, in this case. Mallard’s preferred stock, therefore, can be calculated by dividing the annual dividend per share by the rate of return of investments. In Mallard’s case, its value will be calculated as: Hence insinuating that the value of Mallard as at now is $14,033333.33. The biggest problem with this model is its overdependence on many assumptions in its calculations. This overdependence on assumptions has always caused this method to be less accurate in its valuation in comparison to other models such as the use of P/E ratios. Its advantage, however, is its ease of calculation. iii. The Asset Valuation Method uses the net asset value of the company in question to value its net worth – Mallard, in this case. This could also mean subtracting the total liabilities of Mallard from its total assets. This may be calculated as follows: This value would help Oakton to understand the exact cost it would take it to bring Mallard into future success. Based on this value, Oakton can then decide to either go ahead with the acquisition or not. In conclusion, therefore, even though all the three valuation models have ended up estimating the value of Mallard to be slightly lower than the stated $22 million, there are all indications that Mallard has indeed been a profitable company. There are equally all indications that this profitability is also likely to last even into the future. Moving forward, therefore, Oakton would be recommended to go ahead and takeover Mallard, in which case there is definitely some room for negotiation. Because Mallard is little known, it may have little of brand name to brag of. In view of this, therefore, not so much goodwill would be appropriate for it. I suggest an amount of, say, $900,000 for the goodwill. QUESTION (c) In making payments for Mallard, Oakton may or may not use cash balances rather than bonds. This, however, is dependent on several factors as discussed below. For the buyout to be considered, therefore, the firm to be taken over has to exhibit certain features as preferred by the firm taking over its acquisition. First, the burdens of debt in the target company should be significantly low. It is important to note that once an acquisition is done, the debt burden for both the acquired and the acquirer are put together to end up with a combined debt kind of. What this technically means is that the higher the debt level of the target firm, the greater the debt burden for the acquiring firm. Consequently, most financial institutions such as banks would be less willing to give loans to such firms with high debt burden. Secondly, the history of cash flows for the target company has to be stable and with an increasing trend, if possible, exponentially. Technically speaking, it is the target company’s cash flow that will be used to apply, process, and pay for the loan. The decision made by the lending institutions regarding whether to lend or not is highly dependent on this cash flow history. It is, therefore, prudent that the cash flows of the target company remain as stable as possible for Oakton to acquire it using cash. The other factor that will determine whether Oakton uses cash to pay for Mallard is the latter company’s ownership of collateral assets. Assets are an important factor too in supporting the lender when borrowing money from the lending institutions such as the banks. The lower the collateral assets, the lower the chances of being advanced a loan, and, therefore, the lower the chances of Oakton using cash payments to takeover Mallard. Finally, most acquirers are also looking for companies whose management is “analogue”, so to speak. Such old management means the company has not invested in technology as much as it should be. This, therefore, means that Oakton can then bring in newer technologies which will definitely bring in good flow of cash. QUESTION (d) In a merger or takeover, a financial post – audit is usually very important in a number of respects. This kind of audit is usually synonymous with internal auditors since this type of audit is mainly aimed at providing an understanding to the firm’s shareholders. One reason for carrying out a financial post-audit is to point out the various loopholes that may exist in the control of the merger or takeover. Once these loopholes have been found out, they are then documented properly by the internal auditors of the firm. Technically, this audit is aimed at critiquing the policies and regulations of the former individual firms with a view of stabilizing the resultant merger or takeover. The other parameter to be established at this stage is the passage of information and communication. These are all important in ensuring a proper and functional control system in the merger or takeover. Secondly, financial post-audits in a merger or takeover are necessary in providing a clear picture of the acquired or merged firm especially to the board of directors and other top management team. This information is necessary in helping this team to establish whether indeed the merging or acquisition of this firm is indeed worth carrying out. The financial post-audit is also a factor to consider in ascertaining whether the original goals of the merger or takeover were actually met. Usually, these goals and objectives of the merger or takeover are set by the top management of the respective former individual companies. In most cases, these objectives have to be met somehow. The post-audit is crucial in achieving this. The ultimate goal of doing this is so as to harmonize the objectives for these two separate companies into one merger or takeover. Conflicts are, therefore, avoided in the future running of the merger or takeover. In conclusion, therefore, the results of the financial post-audit in a merger or takeover are majorly used by the board of directors as a tool for setting and attaining the corporate objectives for the merger or takeover. Reference Peirson, G., et al, Business Finance(12th Edition), McGraw-Hill Australia. Read More