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Financial Management Degree - Case Study Example

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I. In a takeover bid, a business may wish to adopt methods such as cash, loan or share exchange. Discuss the merits and demerits of each of these methods from the viewpoint of (a) the bidding business shareholders, and (b) the target business shareholders.
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Financial Management Degree Case Study
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Financial Management Degree

As the acquirer buys another company and pays cash to the target's shareholders, the bidding shareholders would be able to retain the same level of control in the company because their equity proportion is not diluted. To some shareholders, retaining the level of control over the whole entity after the target company has been acquired is one of the major considerations (McDougall & Chenhall). Another advantage of cash purchase to the bidding shareholders is that is is simple and straightforward. A cash offer would be more likely attractive to the target's shareholders especially when economic times are not so predictable, therefore the acquisition deal would prove to have higher success.
A major disadvantage to the acquirer would be the huge sum of cash that it has to raise in order to fulfil the deal. While it is less likely for a company to raise such a huge amount of cash from its retained earnings, it is necessary for the company to raise it through other means, such as by incurring debt. The dilution of the capital structure of the company through higher debt, which affects its risk and credit rating, is a major disadvantage. If the company already has a high amount of debt, the acquirer's shareholders would find that the huge amount of debt to raise cash and pay for the acquisition would erode the company's credit rating, and would increase the risk of each share that they hold.
From the point of view of the target's ...
B. Shares exchange

Another form of merger financing is shares exchange. Instead of paying cash, the acquiring company can issue more shares for the target's shareholders in exchange for the shares that they hold in the target company. From the point of view of the acquirer's shareholders, shares exchange is beneficial in such that the company would not have to be burdened to raise a huge amount of cash through other financing means such as debt, which could put pressure and increased risk on each of the shares they hold. The company's liquidity position would not be compromised in the process (McDougall & Chenhall).

Shares exchange have been so attractive during the past decades because of its impact on the acquirer's price/earning ratio. If the target has a low p/e ratio, the acquirer can take advantage of it by issuing one share equivalent to more than one share of the target's. This can have a significant impact on the acquirer's own p/e ratio. However, one major disadvantage of shares exchange to the acquirer's shareholders is the dilution of equity due to the issue of more shares, which leads to the dilution of position and lower level of control over the company.

With shares exchange, the target's shareholders will not incur capital gains tax because no immediate sale of shares has taken place. If the target's shareholders sell their new shares in the acquiring company, that is when they pay the capital gains tax. This is one of the advantages. Another advantage is that the target's shareholders will be able to maintain a position in the new combined entity. One disadvantage to the target's shareholders would be that, if the acquiring company fails to generate ... Read More
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