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FI-561 - MERGERS

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ACQUISITIONS

WEEK 6 HOMEWORK ANSWER KEY


Problem 16-1 (Chapter 16, pp. 434-435)
P16.1.1
Based on the value drivers in Table P16.1.1 we obtain an intrinsic value per share for Coleman of
$10.87 as shown in Table PA16.1.1.
P16.1.2
After the turnaround by a new management group or by the previous management group
energized by new compensation arrangements in which they achieve a substantial ownership
position, the value drivers improve as shown in Table PA16.1.2. The new intrinsic value per
share has become $31.18. So the management buyout group could offer a substantial premium
over the pre-buyout intrinsic value and yet earn substantial returns over a 3 to 7 year holding
period.

Table PA16.1.1 - Capital Cash Flow Model - Coleman Textiles

Table PA16.1.2 - Capital Cash Flow Model - Coleman Textiles LBO

P16.1.3
The value of Coleman textiles had greatly increased. This represents the nature of an LBO.
Capable management accomplishes a turnaround. Sometimes new management is installed with
a substantial ownership stake. But sometimes old management given the opportunity to obtain a

large ownership position and support (financial as well as for policy changes) can achieve a
turnaround. The improved performance increases share value.
Note that we use a cost of capital of 11% in the pre-buyout situation and 13% for the post-buyout
firm. An argument can be made for a higher cost of capital in the pre-buyout situation since the
firm was not performing well and therefore carried risk of financial distress. Also in the
postbuyout situation we use 13% to reflect the high initial debt situation. However, since the
debt is paid down rapidly from internal cash flows, a lower discount factor might be employed.
In the capital cash flow method we are using, in theory the discount factor should be the required
asset return, independent of leverage. The required asset return therefore might be lower than
13%. Some might argue that the cash tax rate would be lower during the time that debt levels
and tax deductions are high. However if all aspects of taxes to the corporation and to holders of
the debt are taken into account some studies show that taxes are not reduced by leveraged
buyouts (citation).
This illustrates that there are rich opportunities for discussing alternative characteristics of both
the pre-buyout and post-buyout term characteristics and value drivers.

Questions 19.1 & 19.2 (Chapter 19, p. 549)


19.1: What are three types of antitakeover amendments, and how do they work to defend a
target from an unwelcome takeover?
Types of Antitakeover Amendments
Antitakeover amendments generally impose new conditions on the transfer of managerial control
of the firm through a merger, tender offer, or by replacement of the board of directors. There are
four major types of antitakeover amendments.
a.

Supermajority Amendments. These


amendments require shareholder approval by at least two-thirds and sometimes as much as
90% of the voting power of the outstanding capital stock for all transactions involving
change of control. In most existing cases, however, the supermajority provisions have a
"board-out" clause which provides the board with the power to determine when and if the
supermajority provisions will be in effect.

b. Fair Price Amendments. These are supermajority provisions with a "board-out" clause and
an additional clause waiving the supermajority requirement if a fair price is paid for all
purchased shares. The fair price is commonly defined as the highest price paid by the bidder
during a specified period and is sometimes required to exceed an amount determined relative
to accounting earnings or book value of the target. Fair price amendments are a defense in
particular against two-tier tender offers that are not approved by the target's board.
c. Classified Boards. Another major type of antitakeover amendment provides for staggered, or
classified, boards of directors to delay the effective transfer of control in a takeover.
Management's purported rationale in proposing a staggered board is to assure continuity of
policy and experience.

d. Authorization of Preferred Stock. The board of directors is authorized to create a new class
of securities with special voting rights. This security, typically preferred stock, may be issued
to friendly parties in a control contest.
19.2 : What is the effect of the passage of antitakeover amendments on stock price?
Effects of Antitakeover Amendments
In general, a problem of confounding effects in that antitakeover amendments may be associated
with information that the firm has become a takeover target which has positive effects on returns
to shareholders. DeAngelo and Rice found an insignificant negative effect. Linn and McConnell
found significant positive effects. Jarrell and Poulsen found very small negative effects.
McWilliams found a small positive effect and indicated that the market did not view the
amendments as effective defense.

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