Understanding Management Buyouts, Stock Issuance, Mergers, and Tax Shields

Management Buyouts Explained

Q: Management Buyouts are a form of buyouts. Explain this term.

Management buyouts (MBOs) are acquisitions where the company's existing management team purchases the company. While legally similar to other acquisitions, MBOs differ because the buyers are also the company's managers. This often means a limited due diligence process, as the buyers already possess in-depth knowledge of the company. Sellers are also likely to provide minimal warranties, assuming the management team is more familiar with the company's state than they are.

Stock Issuance and Dividend Calculation

Q: Company XYZ wants to issue more Common Stock of Face Value Rs 12. Next Year the Dividend is expected to be Rs. 3 per share assuming a Dividend Growth Rate of 10% pa.

Calculations:

• DIV1 = 3
• Po = 18
• g = 10%
• r = (DIV1/Po) + g
• r = 3/18 + 0.10
• r = 0.1666 + 0.1
• r = 0.2666 * 100

r = 26.67%

Net Proceeds = Flotation Price - Flotation Costs

Net Proceeds = 18 – 1

Net Proceeds = 17

• DIV1 = 3
• NP = 17
• g = 10%
• r = (DIV1/NP) + g
• r = 3/17 + 0.10
• r = 0.176 + 0.1
• r = 0.276 * 100

r = 27.64%

Types of Mergers

Q: Economists categorize mergers into four types. Explain these types with examples.

Four Specific Types of Mergers:

• Horizontal Merger: Merger of two competitors. This can potentially lead to a monopoly.
• Vertical Merger: Merger of a supplier with a buyer within the same supply chain.
• Congeneric Merger: Merger of firms within the same industry but not direct competitors.
• Conglomerate Merger: Merger of firms in unrelated industries.

Tax Shields and Leverage

Q: If interest tax shields are valuable, why don't all taxpaying firms borrow as much as possible?

While tax shields provide benefits, excessive leverage increases a firm's risk. Lenders and banks will charge higher interest rates, and the chance of bankruptcy increases. Therefore, firms must balance the benefits of tax shields with the risks of high debt levels.

Investing Excess Funds

Q: Where do firms invest excess funds until they are needed to pay bills?

Firms often invest idle cash in the money market, which deals with short-term financial assets. These assets are typically short-term, low-risk, and highly liquid, making them suitable for temporary investments before the cash is needed.