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Chapter 5: Q.5 (page 648)

What is synergy? What might cause this result? Is there a tendency for management to over- or underestimate the potential synergistic benefits of a merger?

Short Answer

Expert verified

Synergy refers to the situation in which whole is more than the sum of parts.

This result is achieved by the elimination of overlapping functions of production and marketing, as well as combining various engineering capabilities.

There is often tendency for management to over or underestimate the benefit.

Step by step solution

01

Explanation on Merger

Under merger, one business entity combines with other business entities, and continues to operate in the name of acquiring company.

02

Synergy Effect

Under the synergy effect, “2+2=5”, which indicates that sum of two numbers is less than the whole numbers. Synergy effect indicates that when two or more process companies combine, it provides higher cumulative effect, as compared to individual effect.

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Most popular questions from this chapter

If a firm wishes to achieve immediate appreciation in earnings per share as a result of a merger, how can this be best accomplished in terms of exchange variables? What is a possible drawback to this approach in terms of long-range considerations?

The Clark Corporation desires to expand. It is considering a cash purchase of Kent Enterprises for \(3 million. Kent has a \)700,000 tax loss carryforward that could be used immediately by the Clark Corporation, which is paying taxes at the rate of 30 percent. Kent will provide $420,000 per year in cash flow (aftertax income plus depreciation) for the next 20 years. If the Clark Corporation has a cost of capital of 13 percent, should the merger be undertaken?

Chicago Savings Corp. is planning to make an offer for Ernie’s Bank & Trust. The stock of Ernie’s Bank & Trust is currently selling for \(44 a share.

a.If the tender offer is planned at a premium of 50 percent over market price, what will be the value offered per share for Ernie’s Bank & Trust?

b.Suppose before the offer is actually announced, the stock price of Ernie’s Bank & Trust goes to \)60 because of strong merger rumors. If you buy the stock at that price and the merger goes through (at the price computed in part a), what will be your percentage gain?

c.Because there is always the possibility that the merger could be called off after it is announced, you also want to consider your percentage loss if that happens. Assume you buy the stock at \(60 and it falls back to its original value after the merger cancellation, what will be your percentage loss?

d. If there is an 80 percent probability that the merger will go through when you buy the stock at \)60, and only a 20 percent chance that it will be called off, does this appear to be a good investment? Compute the expected value of the return on the investment.

What procedures would you recommend for a multinational company in studying exposure to political risk? What actual strategies can be used to guard against such risk?

Assume that Western Exploration Corp. is considering the acquisition of Ogden Drilling Company. The latter has a \(470,000 tax loss carryforward. Projected earnings for the Western Exploration Corp. are as follows: 20X1 20X2 20X3 Total Values Before-tax income ................................. \)185,000 \(250,000 \)370,000 \(805,000 Taxes (35%) ........................................... 64,750 87,500 129,500 281,750 Income available to stockholders .......... \)120,250 \(162,500 \)240,500 $523,250. How much will the total taxes of Western Exploration Corp. be reduced as a result of the tax loss carryforward? b. How much will the total income available to stockholders be for the three years if the acquisition occurs? Use the same format as that in the text.
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