UGB363
UGB363
Student Name & ID: SHOFAYZIEV MUSTAFO Module Name/Code: UGB363 Strategic Corporate
B1400114 Finance
Assessment Title:
Learning Feedback relating learning outcomes assessed and assessment criteria given to
Outcomes students:
Assessed:
General Comments:
Students Signature: (you must sign this declaring that it is all your own work and all sources
of information have been referenced)
ASSESSMENT COVER SHEET / FEEDBACK FORM......................................1
PART A..........................................................................................................................3
a).................................................................................................................................3
Capital structure and its meaning...........................................................................3
Theories of capital structure...................................................................................3
Approach based on net income (ni)...............................................................4
Traditional approach......................................................................................4
Approach of net operating income.................................................................4
Approach of Modigliani and Miller (MM)....................................................5
Factors that influence the capital structure.............................................................6
b)................................................................................................................................7
c).................................................................................................................................8
PART B..........................................................................................................................9
a).................................................................................................................................9
Merger....................................................................................................................9
Takeover.................................................................................................................9
Rapid economic justification................................................................................10
Scale economies of management.........................................................................10
Financial economies of scale...............................................................................10
Empirical research on acquisitions.......................................................................10
b)..............................................................................................................................11
Calculations..........................................................................................................11
Reference......................................................................................................................14
PART A
a)
2. In order to keep the company's financial risk under control, the capital
structure must be designed.
3. Cost: The total cost of capital stays low.
The overall cost of capital and the firm's worth will be determined by the
weight of debt and equity in the company's capital structure. In order to
increase business value and reduce capital expenditures, a sound capital
structure is essential.
The capital structure must be taken into account when a company needs
money to invest. Financing decisions need the development of an entirely
new capital structure when it is necessary to raise money. The decision-
making process for finance or capital structure is shown in the diagram below.
Capital structure, cost of capital, and firm value can be explained using the
following approaches:
Approach based on net income (ni)
Traditional approach
This strategy is based on the premise that the cost of capital will decrease
and the company's value will rise as a result of increased financial leverage.
Beyond this point, the patterns begin to reverse. An ideal capital structure
decreases the cost of money.
This strategy entails:
The firm's capital structure and total valuation should be optimized by careful
use of both debt and equity in the capital structure. Capital costs will be lowest
and company value highest in the optimal capital structure.
"NOI" stands for "before interest and taxes" (EBIT). According to this
approach, the firm's capital structure decisions are insignificant.
Leverage has no effect on the value of a firm or its stock price since the
overall cost of capital is unaffected by changes in leverage. As a result, the
distinction between debt and equity has lost its significance.
If the capital market is perfect, with no transaction costs or taxes, then the
value and cost of a company's capital will not vary no matter how its capital
structure shifts. Additional assumptions include: • Capital markets are
perfectly functioning. There are no transaction fees, and all information is
publicly available.
Companies can be classified into 'Equivalent risk classes' based on the level
of risk they experience in their company.
Investors in the higher-valued company will unload their holdings and switch
to the lower-valued company's stock. They will be able to get the same return
for less money with the same or lower risk. As a result, they would benefit.
According to this viewpoint, the value of a levered firm cannot be larger or
lower than that of an unlevered firm. Two things have to be equal. A
company's capital structure does not benefit or harm from employing debt.
A company's capital structure is considered as a complete pie., with stock,
debt, and other securities being divided into equal parts. Regardless of how a
company's capital structure is divided (e.g., between debt, equity, etc.),
investment value is preserved. Because a company's total investment value is
based on its underlying profitability and risk, it is unaffected by changes in the
relative capitalization of the company.
Two factors that affect the company's capital structure are growth and stability
in sales. It is possible for a company to raise more debt if its sales are
predicted to remain consistent. Stability in sales means that the company will
be able to meet its established commitments to repay loan interest without
problem. Capital structure decisions are also influenced by the rise in sales. In
most cases, the bigger the sales growth rate, the greater the company's
capacity for taking on debt to fund operations.
Risk Concept: According to this principle, the use of common equity rather
than excessive use of debt is preferred in financing capital requirements.
Interest payments increase as more and more debt is taken out. In a poor
business climate, this would lead to a decrease in the value of the stock held
by shareholders. Financial risk rises in direct proportion to an increase in debt.
Additionally, nature of the industry, its timing, and the competitiveness in the
industry should all be taken into account. Industries that face fierce
competition are also more likely to rely on equity rather than debt to fund
operations.
Thus, a finance manager must find a balance between the above concepts
while developing a suitable capital structure. To find a middle ground,
consider how important each of these principles is to the business, and then
assign a numerical value to each of them.
b)
WD D/S BL RS
0% 0.00 1.000 12.00
%
20% 0.25 1.150 12.90
%
30% 0.43 1.257 13.54
%
40% 0.67 1.400 14.40
%
50% 1.00 1.600 15.60
%
Afterwards, repeat the process for each of the potential capital arrangements.
wd rd rs WACC
0% 0.0% 12.00% 12.00%
20 8.0% 12.90% 11.28%
%
30 8.5% 13.54% 11.01%
%
40 10.0% 14.40% 11.04%
%
50 12.0% 15.60% 11.40%
%
c)
For example, the corporate value for wd = 20% is:
V = FCF / (WACC-G)
G=0, so investment in capital is zero; so FCF = NOPAT = EBIT
(1-T). In this example, NOPAT = ($500,000)(1-0.40) =
$300,000.
PART B
a)
Merger
It's common for two companies to merge in order to create a new company
that is more valuable than its parts. This is called a "typical merger."
Smaller companies often reject hostile takeovers because they don't want to
give up control of their businesses. When a company buys another, instead of
merging with it, the acquiring company often provides the target company's
shareholders a cash price per share or the shares of the acquiring company
to the target company's owners according to a stipulated conversion ratio.
However, either method, the purchasing corporation buys the target company
for its stockholders outright, financing its purchase. The acquisition of Pixar
Animation Studios by Walt Disney in 2006 is an example of this. Due to
unanimous shareholder approval, the acquisition of Pixar was a friendly
takeover. In the event of an unwelcome hostile takeover, target corporations
might deploy a variety of techniques, including the inclusion of covenants in
their bond offerings that demand early debt payback at higher premiums if the
firm is taken over.
However, due to the global economic downturn and a decline in mergers and
acquisitions (M&A) activity, several empirical studies have looked at how
acquisitions affect various stakeholder groups' financial well-being. More than
130 of this research were conducted between 1971 and 2001. However,
determining whether an acquisition was a success or a failure sometimes
necessitates making a series of subjective judgments. Theoretically,
organizations engaging in acquisitions can reap the benefits of economies of
scale and synergy. Post-merger planning and management will play a major
role in determining whether or not these prospective gains can be realized in
practice. Only 20% of mergers actually succeed, say Grubb and Lamb (2000),
despite their optimism about the advantages of purchases. The majority of
mergers tend to reduce the wealth of shareholders. Studies of post-merger
integration and ways to boost acquisition performance are also well-
documented in the academic literature. Many lessons can be learned from De
Noble et al. (1988. Stakeholder groups affected by acquisitions should be
identified and the information pertaining to their impact on acquisitions should
be considered. This is the best approach to get an overall picture of whether
acquisitions are helpful.
b)
Calculations
WACC(Target) = 10.84%
CF0 0
CF1 11.7 F1= 1
CF2 10.5 F2 = 1
CF3 16.5 F3= 1
CF4 20.7 + 453.3 = 474.0 F4= 1
I = 10.84%
Cpt NPV = 345.26
g = 6% r sL= 12.2%
22.1(1.06)
=377.84
0.122−0.06
CF0 0
CF1 8.7 F1= 1
CF2 23.8 F2 = 1
CF3 12.6 F3= 1
CF4 22.1 + 377.8 = 399.9 F4= 1
I = 12.2%
Cpt NPV = 287.9
g = 6% r sL= 11.56%
Tax Shield from interest $2.0 $2.6 $2.6 $2.8
20.7(1.06) =394.6
0.1156−0.06
TS2018 (1+ g)
Horizon value (tax shield) =
r sU −g
g = 6% r sU = 11.56%
2.8(1.06)
=53.4
0.1156−0.06
Reference