Spring 2022 Corporate Acquisition Final Exam Solutions – Columbia University

The following are 100% accurate corporate acquisition exam questions and solutions for an assessment done at Columbia university in spring 2022. Please go through them for your revision for free. In case you’re also looking for help with your corporate finance exams for similar results, our competent finance test-takers are available to serve you at any time.

Exam question:

Discuss How Financial Bargain Can Affect the Choice of An Acquisition

Few people can resist a real or perceived bargain. This is as true of companies as anything else. When bargains occur in the corporate field, it is usually due to some element of weakness. The weakness may be in the company itself because of declining profitability or liquidity problems. The weakness may lie with a controlling shareholder under pressure to sell. In the case of a public company. the market rating may be poor for some reason not directly connected with the company, for example the sector being out of fashion with investors.

Potential acquirors may have identified a company as an opportunity and be patiently waiting for the right moment. Bargain prices are often dependent on opportunism. A company which is ready to strike holds a distinct advantage. A popular moment to bid for a public company is after disappointing results have just been announced and before a recovery can be forecast.

Exam question:

How Does Discount to Asset Value Affect the Choice of An Acquisition?

This is probably the most popular and most reliable financial basis for an acquisition. Aggressive individuals or organizations have been labelled 'asset strippers' because they make no disguise that this is their primary motivation. However, eminently respectable companies may also make asset backing the primary focus of their analysis.

Analysis will be concentrated on the balance sheet of the target company. Book values will not be accepted as accurate assessments of present market value but each item will be scrutinized for potential appreciation and for losses. Liabilities and contingent liabilities will be examined. Many sources of information will be tapped. Some figures may be rough estimates or even guesses, so a considerable margin for error must be allowed. Allowing room for negotiation, a situation may not be of real interest unless the estimate of revised net asset value is, in the case of a public company, at least 50% higher than the prevailing market price.

The type of company which tends to attract most attention is one with substantial fixed assets and yet a lackluster profit and dividend record. Over a period of time the company may come to be valued principally in relation to its profits and dividends rather than its asset backing. This situation is likely to reflect uninspired management in general.

It sometimes happens that assets become more valuable if put to some alternative use in an area in which the current management may have no expertise. Management may be adequate as regards the traditional business but not alert to some change in the outside environment. A classic example is a business operating a department store on a site which becomes ripe for redevelopment. Acquirors with expertise in a relevant area may be able to derive more benefit from a particular asset than its existing controllers, however well they run their traditional business. Certain intangible factors such as tax losses may only be valuable in the hands of someone capable of ensuring profits are earned in the relevant entity.

Exam question:

How Does Increase in Earnings Per Share Impact Acquisitions?

A company may increase its earnings per share by issuing shares to acquire another company rated at a lower price earnings multiple. A simplified example would be as follows:

Assume:

An all-share offer by the acquiror for 100% of the shares of the target company.
The terms are based on the market prices of the shares of the two companies.

	Acquiror	Target
Latest Earnings	100	50
Number of shares in issue	1000	1000
Earnings per share	0.10	0.05
Multiple on which shares are related	12 times	8 times
Share Price	1.20	0.40
Market Capitalisation	1200	400
Terms of offer (based on respective market prices)	1 new share	3 existing shares

Combined Group

Enlarged issued share capital	1000+333	--	1333
Combines earnings	100	50	150
New earnings per share	(150 divided by 1333) assume acquiror’s rating unchanged		0.1125
Multiple on which shares are related	(150 divided by 1333) assume acquiror’s rating unchanged		12
New share price	0.1125 x	12	1.35
New market capitalisation	1333 x	1.35	1800

The increase in earnings per share, from 0.10 to 0.1125, is a simple question of mathematics, following from the assumption that the terms of the share exchange are based on respective market prices. (This is in fact an over-simplification, as normally a premium over market would have to be paid for the target.) The increase in the market price of the acquiror after the offer from $1.20 to $1.35 depends on whether the combined group remains rated at the multiple of the acquiror prior to the offer, that is 12 times. If it does, or at least holds at above the weighted average multiple of the acquiror and the target (weighted by size of earnings), the market capitalisation of the combined group will be higher than that of the two companies separately.

An aggressive company may have gained for itself a high market rating on the expectation of rapid growth in profits. These expectations can be fulfilled, at least in the short term, be acquisitions on terms such as those illustrated in the example. Indeed, they may be self-fulfilling for the moment in that the ability to grow by acquisition (apparently proved) may be part of the reason for the premium rating.

However, unless the acquisitions are very skillful ones, the rating of the acquiror will in due course suffer as the proportion of earnings contributed by lowly-rated companies increases. In addition, the size and number of acquisitions at low ratings needed to maintain this strategy over a period of time becomes ever larger, leading to its collapse unless the acquiror and/or the companies acquired are also capable of achieving organic growth.

In the case of a cash offer, a similar effect will be achieved if the return from the business acquired at the purchase price is higher than the funding cost. The funding cost in the short term (as it will affect the reported earnings) could be considered either to be the cost of debt incurred to finance the purchase or, if surplus cash is used, the interest foregone on the cash deposits. In the longer term, if acquisitions are funded purely by cash or borrowings, the increased gearing is likely to require further equity issues.

Exam question:

What Is the Role of Financial Gearing in Acquisitions?

An acquisition by means of a share exchange of a company which has low borrowings or surplus cash is likely to reduce the financial gearing of the enlarged group. In an extreme form, the acquiring company may issue shares to purchase an investment trust or other company with highly liquid assets. This type of transaction may be seen more as a disguised equity issue than a true acquisition.

An acquiror may take the opportunity to change the balance of its capital structure. The terms of an acquisition may include the issue of unsecured loan stock or convertible securities in addition to ordinary shares and cash. By juggling with the proportions of such elements in the total consideration, the acquiring group can increase or decrease the proportion of long-term debt in its balance sheet and adjust its overall gearing.

Exam question:

How Does Ambition Affect the Occurrence of An Acquisition?

Prestige and compensation in an organization may depend more on size than results. Acquisitions are the quickest way of building up the size of the group. An element of small-town boy makes good' may come into play. An individual who has built up his company reaches a stage where he seeks to acquire more established and well-known organizations. Sometimes these are companies he has admired in the past or had to ask for help during his rise.

A successful acquisition often brings with it extensive publicity. Certain noted corporate raiders and their advisers have become national figures for a time. The exposure may mainly be a matter of ego. However, it can also be justified in terms of increased corporate and management visibility. This may lead to improved ratings in the stock market and a larger number of acquisition opportunities being presented by brokers. A high degree of determination on the part of an individual or group is usually necessary to bring an acquisition to a successful conclusion, particularly if it is contested. During the course of an acquisition, occasions almost always arise where the parties concerned are ready to call it off. In these circumstances, the motivation and drive of a particular individual can be a critical factor.

Exam question:

Explain How Defense Can Lead to An Acquisition

It is commonly believed that the bigger the group is, the harder it is to swallow. Companies therefore sometimes attempt acquisitions principally in order to grow too big to be taken over by a feared rival. In addition, the more complex a group is, the greater is the likelihood that regulatory authorities or some other interested parties will find grounds to raise objections to a takeover. A company in a sensitive area, for example communications and broadcasting, may be particularly favoured as an acquisition partly for this reason.

Companies espousing this philosophy should be wary of creating their own downfall. Ill-conceived acquisitions can lead to criticisms and disaffection from shareholders. Weakening the financial position of the group through expensive purchases ultimately plays into an acquiror's hands.

Exam question:

Can Good Management Ignite an Acquisition?

Some acquisitions are made primarily to the of a manager or management team who have proved themselves competent at running a particular type of company or handling a particular type of crisis. Sometimes the specialized professional expertise or contacts of individuals are what is sought. An example would be the purchase of a stockbroker or insurance agency by a bank. In such cases, an important task is for groups of people with a different approach to conducting business to learn to work together effectively.

Exam question:

Explain How Tax Losses Can Lead to An Acquisition

Companies which have been unsuccessful may have accumulated considerable losses for taxation purposes which may in certain circumstances be utilized by an acquiring group. Usually, the company is valued on the basis of a discount to the amount of tax which will be saved. The feasibility of such an acquisition depends critically on the tax regulations in the country concerned and the current interpretation of them.

Exam question:

How Can the Ease to Obtain a License Facilitate an Acquisition?

A license, for example to conduct a banking business or operate a TV station may be more easily obtained by acquiring a company which already holds such a license than by a fresh application. Care must be taken to ensure that a change of control in the company acquired does not jeopardize the continuity or validity of the license. If it is practical, this matter should be cleared in advance with the authority responsible for granting the license or regulating companies which hold it. This may not always be possible for tactical reasons; in which case any agreement should be conditional on the appropriate clearance being obtained

This chapter has discussed the main motives for making takeovers. The motives are divided into commercial, financial and customized. An acquisition which is undertaken for a specialized purpose may also have a commercial basis and be capable of justification in financial terms.