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Mergers and
Acquisitions and
Financial Distress
Introduction
Mergers and acquisitions
Firms combine
Assets
Liabilities
Equity
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larger firm
Acquisition one firm purchases another
Consolidation newly-created firm
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Horizontal Mergers
A horizontal merger is the combination of
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Vertical Merger
Combines a firm with a supplier or
distributor
Avoids fixed costs
Eliminates contracting, payment collection,
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Conglomerate Merger
Two companies merge that have no related
products or markets
Popular in 1960s and 1970s, but dismantled in
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conglomerate mergers
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Revenue Enhancement
Acquisition of firm in growing area may
enhance revenues
The acquiring firms revenues may become
more stable
Acquisition of new markets
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Cost Reduction
Economies of scale
Reduce or eliminate redundancies in firm
Cost of producing goods falls as size of firm
increases
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Cost Reduction
Economies of Scope
Refers to merged firms abilities to generate
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X-Efficiencies
Not directly due to economies of scope or
scale
Due to superior management as result of
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Tax Considerations
Tax gains from an acquisition can result
from
Net operating losses
Unused debt capacity
Surplus funds
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Valuing a Merger
Net present value (NPV) or discounted
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Financial Distress
Economic Failure
Return on assets less than cost of capital
Business Failure
Most extreme type -- firm out of business
Technical Insolvency
Operating cash flows are not sufficient to pay
liabilities
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management depended
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be temporary
Creditors and firm restructure debt
agreements in a workout
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creditors
Assignment passes liquidation of the firms
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Chapter 7
Generally used if reorganization under Chapter
11 not feasible
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120 days
Creditor committees appointed
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Predicting Bankruptcy
Broad types of credit scoring models
Linear discriminant models
Linear probability models
Logit models
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