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Mergers Acquisitions and Other Restructuring Activities 9th Edition DePamphilis Solution Manual

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Mergers Acquisitions and Other Restructuring Activities 9th Edition DePamphilis Solution Manual

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  • January 27, 2025
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  • 2024/2025
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SOLUTIONS MANUAL:
MERGERS ACQUISITIONS AND
OTHER RESTRUCTURING ACTIVITIES
9TH EDITION DEPAMPHILIS

, Chapter 1: Introduction to Mergers, Acquisitions, and Other Restructuring Activities

Answers to End of Chapter Discussion Questions

1.1 Discuss why mergers and acquisitions occur.

Answer: The primary motivations for M&As include an attempt to realize synergy by combining the acquiring
and target firms, diversification, market power, strategic realignment, hubris, buying what are believed to be
undervalued assets, so-called agency problems, managerialism, and tax considerations. Synergy is the notion
that combining two firms results in a valuation of the combined firms that exceeds the sum of the two firms
valued on a standalone basis. Synergy represents the incremental cash flows only achievable by combining the
acquirer and target firms. Synergy is often realized by achieving economies of scale, the spreading of fixed
costs over increasing levels of production, or economies of scope, the utilization of a specific set of skills or an
asset currently employed to produce a specific product to produce related products. Financial synergy
represents another source of increased value that may be realized by lowering the combined firm’s cost of
capital if the new firm experiences lower overall transaction costs in raising capital and a better matching of
investment opportunities with internally generated funds. Diversification may be either related or unrelated.
Both forms represent an effort by the acquirer to shift assets away from a lower growth, less profitable focus to
a higher growth, potentially more profitable area. Strategic realignment represents a radical departure from a
firm’s primary business to another area of focus often because of changes in regulations or technology, which
makes obsolete the firm’s primary business.

Hubris is often the motivation for M&As even if the market correctly values a firm, since the acquiring
firm’s management may believe that there is value in the target firm that investors do not see. Firms may also
be motivated to buy another firm if the firm’s market value is less than what it would cost to replace such
assets. Agency problems arise when there is a difference between the interest of incumbent managers and the
firm’s shareholders. By acquiring the firm, value is created when managers whose interests are more aligned
with shareholders replace current management; and, as such, these new managers are more inclined to make
value enhancing investments rather than those intended to entrench management or contribute to their overall
compensation. Firms may acquire another firm to achieve greater market share in an effort to be able to gain
more control over pricing. Managerialism is a situation in which a firm’s managers acquire other firms simply
to increase the acquiring firm’s size and their own compensation. Finally, an acquirer with substantial taxable
income may wish to acquire a target firm with significant loss carryforwards and investment tax credits in
order to shelter more of their taxable income.

1.2 What is the role of the investment banker in the M&A process?

Answer: Investment bankers serve as advisors to firms developing business strategies. They also recommend
M&As and other types of restructuring activities intended to build shareholder value, screen potential buyers
and sellers, make initial contact with a seller or buyer, and provide negotiating support, valuation, and deal
structuring. Investment bankers may also assist in arranging M&A financing.

1.3 In your opinion, what are the motivations for two mergers or acquisitions in the news?

Answer: In 2002, Hewlett Packard announced its interest in acquiring Compaq Computer, a major competitor.
The justification was to achieve cost savings by eliminating duplicate overhead and by closing under-utilized
manufacturing facilities and to move the two firms increasingly into selling such services as maintenance and
consulting. Northrop Grumman announced its desire to purchase TRW in 2003, primarily for its strong
position in satellites and surveillance technologies. The HP acquisition represents an effort to realize operating
synergy by combining two highly related firms. In contrast, the Northrop attempt to takeover TRW is driven
more by a desire to diversify into a related market that is expected to exhibit high growth due to the “war of
terrorism.”

1.4 What are the arguments for and against corporate diversification through acquisition? Which do you support
and why?



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, Answer: In discussing diversification, it is important to distinguish between unrelated and related
diversification. Firms often justify unrelated diversification if they believe their current core business is
maturing or is too “cyclical.” By shifting their focus to higher growth areas, management argues they can
improve shareholder value. Moreover, by moving into an industry whose cash flows are uncorrelated with
those in the core business, it is argued that the firm’s earnings growth will become more predictable and hence
less risky, thereby boosting the share price. Related diversification reflects an effort to sell the firm’s current
products into new markets or to sell new products into current markets. Such efforts are often less risky,
because the firm is either familiar with how to produce the current products being sold into the new markets or
is familiar enough with the needs of the customers in its current markets to know which new products they are
likely to want. Empirical studies show that unrelated diversification tends to destroy shareholder value.
Moreover, an investor is always able to more cheaply diversify their own portfolio by buying a minimum of
12-15 stocks in distinctly different industries than by buying the stock of a highly diversified firm. In 2002, a
number of highly diversified companies such as Tyco were severely punished by investors because of the
complexity of their business portfolios and the inability of investors to see the value added by the holding
company structure.

1.5 What are the primary differences between operating and financial synergy? Give examples to illustrate your
statements.

Answer: Operating synergy includes economies of scale and scope. Economies of scale may be realized when
two firms with manufacturing facilities operating well below their capacity merge. If such facilities are
combined, the average operating rate is increased and fixed expense per unit of output is reduced. Significant
savings may be realized if two firms merge and combine their data centers such that all operations in the future
are supported by one rather than two or more such centers. Financial synergy may be realized in a holding
company if the holding company can more cheaply raise capital for its subsidiaries than they could do on their
own.

1.6 At a time when natural gas and oil prices were at record levels, oil and natural gas producer, Andarko
Petroleum, announced on June 23, 2006 the acquisition of two competitors, Kerr-McGee Corp. and Western
Gas Resources, for $16.4 billion and $4.7 billion in cash, respectively. These purchase prices represent a
substantial 40 percent premium for Kerr-McGee and a 49 percent premium for Western Gas. The acquired
assets strongly complement Andarko’s existing operations, providing the scale and focus necessary to cut
overlapping expenses and to concentrate resources in adjacent properties. What do you believe were the
primary forces driving Andarko’s acquisition? How will greater scale and focus help Andarko to reduce its
costs? Be specific. What are the key assumptions implicit in your argument?

Answer: Given the escalation in oil prices and the increasing difficulty in finding new reserves, Andarko
concluded that it would be cheaper to buy reserves rather than to explore and develop new reserves.
Recovering the substantial premium it paid assumed that oil prices would remain high. Declining oil prices
would make it difficult for the firm to recover the premium without very aggressive cost cutting. The firm also
expects to achieve significant cost savings from combining overhead functions such as human resources and
finance. Increasing operational scale will enable the firm to obtain savings from bulk purchases of supplies and
services. Moreover, the adjacency of the properties will enable better utilization of production equipment and
distribution pipelines. Achieving these savings assumes that the simultaneous integration of two companies can
be handled smoothly without disruption to the firm’s existing operations. Furthermore, the ability to recover
the large premiums paid assumes that energy prices will continue to escalate into the foreseeable future.

1.7 On September 30, 2000, Mattel, a major toy manufacturer, virtually gave away The Learning Company, a
maker of software for toys, to rid itself of a disastrous foray into software publishing that had cost the firm
literally hundreds of millions of dollars. Mattel, which had paid $3.5 billion for the firm in 1999, sold the unit
to an affiliate of Gores Technology Group for rights to a share of future profits. Was this related or unrelated
diversification for Mattel? How might this have influenced the outcome?

Answer: The Learning Company represented the application of software to the toy industry; however, The
Learning Company was still a software company. Mattel was in a highly unrelated business. Perhaps propelled



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, by hubris, Mattel acquired a business that it did not really understand, casting doubt on its ability to make
informed decisions

1.8 In 2000, AOL acquired Time Warner in a deal valued at $160 billion, excluding assumed debt. Time Warner is
the world’s largest media and entertainment company, whose major business segments include cable networks,
magazine publishing, book publishing and direct marketing, recorded music and music publishing, and film and
TV production and broadcasting. AOL viewed itself as the world leader in providing interactive services, Web
brands, Internet technologies, and electronic commerce services. Would you classify this business combination
as a vertical, horizontal, or conglomerate transaction? Explain your answer.

Answer: If one defines the industry broadly as media and entertainment, this transaction could be described as a
vertical transaction in which AOL is backward integrating along the value chain to gain access to Time Warner’s
proprietary content and broadband technology. However, a case could be made that it also has many of the
characteristics of a conglomerate. If industries are defined more narrowly as magazine and book publishing,
cable TV, film production, and music recording, the new company could be viewed as a conglomerate.

1.9 Pfizer, a leading pharmaceutical company, acquired drug maker Pharmacia for $60 billion. The purchase price
represented a 34 percent premium to Pharmacia’s pre-announcement price. Pfizer is betting that size is what
matters in the new millennium. As the market leader, Pfizer was finding it increasingly difficult to sustain the
double-digit earnings growth demanded by investors. Such growth meant the firm needed to grow revenue by $3-
$5 billion annually while maintaining or improving profit margins. This became more difficult due to the
skyrocketing costs of developing and commercializing new drugs. Expiring patents on a number of so-called
blockbuster drugs intensified pressure to bring new drugs to market. In your judgment, what were the primary
motivations for Pfizer wanting to acquire Pharmacia? Categorize these in terms of the primary motivations for
mergers and acquisitions discussed in this chapter.

Answer: The deal was an attempt to generate cost savings from being able to operate manufacturing facilities at a
higher average rate (economies of scale), to share common resources such as R&D and staff/overhead activities
(economies of scope), gain access to new drugs in the Pharmacia pipeline (related diversification), gain pricing
power (market power), and a sense that Pfizer could operate the Pharmacia assets better (hubris). Pfizer seems to
believe that “bigger is better” in this high fixed cost industry. Also, with many patents on existing drugs
expiring, the firm is hopeful of gaining access to what could be future “blockbuster” drugs.


1.10 Dow Chemical, a leading chemical manufacturer, announced that it had reached an agreement to acquire in late
2008 Rohm and Haas Company for $15.3 billion. While Dow has competed profitably in the plastics business for
years, this business has proven to have thin margins and to be highly cyclical. By acquiring Rohm and Haas,
Dow will be able to offer less cyclical and higher margin products such as paints, coatings, and electronic
materials. Would you consider this related or unrelated diversification? Explain your answer. Would you
consider this a cost effective way for the Dow shareholders to achieve better diversification of their investment
portfolios?

Answer: This acquisition should be viewed as related to Dow’s core competence in producing chemicals and
chemical-based products. It does not represent an efficient way for individual investors to achieve portfolio
diversification. Individuals could more cost effectively diversify among different firms in different industries
without having to shoulder a pro rata share of the Dow overhead that exists to manage the firm’s portfolio.

Solutions to End of Chapter Case Study Questions
Charter Communications Acquires Time Warner Cable Amid Industry Turmoil

Discussion Questions:

1. Using the motives for mergers and acquisitions described in Chapter 1, which do you think apply to Charter’s
acquisition of Time Warner Cable? Discuss the logic underlying each motive you identify. Be specific.




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