Mergers and Acquisition Paper

Mergers and Acquisition Paper

In recent years the number and speed of merger activity has been incredible. During this period of intense merger activity financial managers must spend a considerable amount of time either searching for firms to acquire or trying to prevent some other firm from taking over their corporation. When dealing with the concept of mergers and acquisitions, a financial manager must have an understanding of how mergers and acquisitions impact a business, both the “sensible” and “dubious” reasons for mergers, the benefits and cost of mergers, and the costs of mergers on cash and stock transactions. Managers must also examine the financial risks of merging with or acquiring a corporation in another country and how to mitigate these risks.

The Impact of Mergers and Acquisitions

In general terms, mergers and acquisitions are performed in “the hopes of realizing an economic gain.” If such a transaction is to be justified, the two companies involved must be worth more together than they are apart. This concept is known as synergies. There are a number of potential advantages of mergers and acquisition, such as achieving economies of scale, combining complementary resources, garnering tax advantages, and eliminating inefficiencies. Some other advantages for growth through acquisitions include obtaining proprietary rights to products or services, increasing market power by purchasing competitors, correcting weaknesses in key business areas, penetrating new geographic regions, or providing managers with new opportunities for career growth and advancement. All of these factors impact a corporation in a huge way. However, financial managers must remember that mergers and acquisitions are very complex and it can be difficult to evaluate the transaction, define the associated costs and benefits, and handle the resulting tax and legal issues (E-notes, 2007).

Sensible and Dubious Reason

A financial manager must understand that the key feature that distinguishes sensible from dubious reasons is that sensible reasons affect the firm by resulting in the value of the corporation increasing. Sensible reasons for mergers include economies that are expected to arise as a result of the merger and various tax benefits. Dubious reasons include risk reduction, growth for growth’s sake, and EPS illusion effect. Risk reduction, by itself, is not a sensible factor for merging. All the corporation is doing is providing a service that is already available to investors; the diversification is redundant. In addition, investors can affect any desired diversification themselves more efficiently and quickly than a corporation can provide it (Finance, 2007).

Benefits and Costs

When a small corporation chooses to merger with or sells out to another company, it is called “harvesting” the small business. In this scenario, the transaction is intended to release the value locked up in the small business for the benefits of its owners and investors. The impetus for a small organization to pursue a sale or merger may involve estate planning, a need to diversify, an inability to finance growth independently, or simple need for change. Moreover, some corporations find that the best way to grow and compete against larger corporations is to merger with or acquire other small businesses. In theory, the decision to merge with or acquire another corporation is a capital budgeting decision much like any other. However, mergers differ from ordinary investment decisions in at least five ways. First, the value of a merger depends on such things as strategic fits that are difficult to measure. Next, the accounting, tax, and legal aspects of a merger are often very complex. Thirdly, mergers may involve issues or corporate control and are a means of replacing existing management. Fourthly, mergers obviously affect the value of the company; in addition, they also affect the relative value of the stocks and bonds. Finally, mergers are often “unfriendly” takeovers (E-notes, 2007).

Cash and Stock Transactions

One way to differentiate mergers from acquisitions is partly by the way in which they are financed and partly by the relative size of the companies. There are numerous methods of financing an M&A deal. One method is payment by cash. These transactions are usually termed acquisitions rather than mergers because the shareholders of the target company and are removed from the picture and the target comes under the indirect control of the bidder’s shareholders alone. Another