Financial Management: Mergers and Acquisitions Basics - Coursework Example

Financial Management Financial Management Operating lease is a short-term contract that allows the lesseeuse of an asset for a period lesser than its economic life but does not provide ownership of the asset. With operating lease, office equipments and computers are leased (Needles & Powers, 2012). On the other hand, financial lease is a long-term contract that allows for usage of an asset and at the end of payment contract allows ownership of the asset. In this case machineries, land and buildings are considered financial leases. However, operating leases can be canceled before the expiry of the contract while financial leases are not cancelable. Financial leases are referred to as long-term debts and are included in the balance sheet while operating leases are referred as operating expenses and can be excluded from the balance sheet (Needles & Powers, 2012). II). Capitalizing of leases and related assets have several benefits. Use of long-term leases ensures that payment is paid in full as agreed since there is no cancelation of the agreement. In addition, the payment period is almost the same with the useful life of the asset. It also provides the lessee with the option of buying the asset at a nominal value at end period due to the agreement (Needles, & Powers, 2012). A long-term lease costs less than a short-term lease and does not require immediate payment as rental payment is deducted in full for tax purposes. Use of short-term lease however allows the risk of ownership to remain with the lesser and the lease period is shorter than the useful life of the asset (Needles, & Powers, 2012). Leases however have various disadvantages which include the following. There must be payment of interest regardless of the economic position of the company. Secondly the interest rates are fixed and do not consider the economic condition of the firm. However, excessive lease increase the risk of shareholders hence reducing the share prices (Needles, & Powers, 2012). 2). E= B (rf- rm) + RF Where B is beta, E is expected rate of return, RF is the risk free rate, and rm is return of the market. Ford Under= 1.3(11-3) + 11 14.3 – 3.9= 10.4 10.4+11 =21.4 =21.4% Expected rate of return = 21.4% Amount= 0.7(11- 3) +11 7.7 – 2.1 = 5.6 5.6 +11 =16.6% Expected rate of return = 16.6 % Face book =0.9(11- 3) + 11 9.9 -2.7 = 7.2 7.2 + 11= 18.2% Expected rate of return = 18.2 % Pfizer = 0.5(11 – 3) +11 5.5 -1.3 = 4.2 +11 =15.2% Expected return =15.2% 3). Interest expense should be deducted from the operating cash flows. The University of Le Verne M.B.A is right. According to Brigham & Earnhardt (2013), interests should not be included in calculating cash flows of a project. This is because the project cash flows are discounted by risk involved in the cost of capital interest being expenditure. The cost of financing a project may either be in the form of interest expense, debt financing, or dividends from shareholders. Excluding cost such as interest expense in the calculation of cash flows may seem to be illogical but it is important because they accounted for in the process of calculating future cash flows (Brigham, & Ehrhardt, 2013). 4). Cost of debt and equity = ke =RF + B (Rm – RF) Where; ke is the cost of equity capital B is beta, (Rm-Rf) is the expected market risk premium, and RF is expected return on risk free securities Ke = RF + B (Rm – RF) Rate of Dustvac equity= 0.06 + 1.36 (0.04) = 0.06 +0.0544= 0.1144 After tax rate of debt = (1 – 40%) = 0.1144(1- 0.4) = 0.1144-0.04576= 0.06864 Weight of debt = 5/15 = 0.3333 Weight of equity= 1- 0.3333 = 0.6667 Dustvac WACC = (0.3333*0.0686) + (0.6667*0.1144) 0.02286 + 0.0763= 0.09916 = 9.916% Pre-merger WACC = 9.916% b). New debt would be issued to finance the acquisition. Therefore, eight percent (8%) discount rate will be used to discount Dustvac’s free cash flows and interest tax savings. c).Value of Dustvac equity to magi clean = sum of discounted future cash flows and tax savings = 4000000/1.08 + 4000000/1.082 + 4000000/1.083 +4000000/1.084 + 15000000/1.084 =24,273,955.15 – 5,000,000 =19,273,955.15 = $ 19,273,955 5). The market share of the company has considerably decreased during the years. Management of the company should consider rebranding their products to improve on the market share. Innovative ways should also be used to capture new market for the product in order to increase the market share. Advertising of the product can be useful tools to create product awareness which will help the company improve its market share. Reducing the cost of production will help reduce the price of the product which will result in increase in the market share and capture more customers (Brigham, & Ehrhardt, 2013). Financial restructuring is done to avoid bankruptcy liquidation. The company is already bankrupt since the liabilities exceeds the assets of the company hence financial restructuring will be impossible in this situation. The most likely occurrence in this case is acquisition or takeover. To avoid hostile takeovers, the company can merge with another company willing to acquire them and this can help maintain its product, customers and management (Brigham, & Ehrhardt, 2013). The organization is a public company since it is listed and the shareholders own seventy percent of the shares. According to (Frankel, 2013) the board of directors is unique and important to the company. They act as the intermediaries between the shareholders and the employees. Management of the company can decide on splitting of shares which is a way of generating income and attract more investors. Frankel, (2013) acknowledges that a business entity may grow over time and the product market share may grow. Mergers involves two companies joining together to form a single company where one ceases to exist. Several factors may lead a company to contemplate on whether to merge with another. A company may decide to merger so that it can expand its customer base, handle competition, or enter into a new venture. According to the facts presented for this particular company, the decrease in market share gradually indicates that the company is on the verge of collapsing. It will be advisable to recommend for a merge for this company to survive in the market (Frankel, 2013). References Brigham, E. F., & Ehrhardt, M. C. (2013). Financial management: Theory and practice. Mason Ohio: Southwestern. Frankel, M. E. S. (2013). Mergers and acquisitions basics: The key steps of acquisitions, divestitures, and investments. Hoboken, N.J: Wiley. Needles, B. E., & Powers, M. (2012). Financial accounting. Mason, OH: Southwestern Cengage Learning. Read More