ADMS 4540 Final Review 1 A.T. XU Dec. 15.2015
1) Lease Payment
A. Operating Lease:
Lessor is responsible for insurance, taxes and maintenance
B. Longer-term lease
Lessee is responsible for insurance, taxes and maintenance
Generally not cancelable
Specific capital leases
Sale and leaseback
Formula – Lessee:
NPV(leasing)/ NAL = CF0 (i.e., purchasepricesavings)+PV(maintenancesavings)
– PV(foregone depreciation tax savings) – PV(foregone salvage value) – PV(after-
tax lease payments)
Should we lease or buy?
If NAL > 0, the firm should lease
If NAL < 0, the firm should buy
E.g. York finance plans to either purchase or lease a machine that costs $250,000 and is
subject to a 20 percent CCA rate using the declining balance method. The required lease
payments are $30,000 for 4 years and are paid at the beginning of the year. The
maintenance of the equipment will be provided by the lessor and included in the lease
contract. York has estimated it would incur $20,000 per year in maintenance expenses if
it decides to purchase the machine. It is estimated that the machine could be sold for its
UCC after four years. The firm’s before tax borrowing rate is 8%, and its effective tax
rate is 40%. Should York purchase or lease the machine, assuming the acquisition of the
machine has a positive NPV and that the lease would qualify as an operating lease? The
asset pool remains open and the half year rule is applicable. If the leasee can take advantage over the lease contract, let’s say the NAL is equal to
$30,000, that means the leaser will obtain the lease loss -$30,000.
Also, If NAL = 0, it means this is break-even lease payment, the lease payments have to
be for both the lessor and lessee to be indifferent for the lease.
2) Merge and Acquisition
A. Type of M&A:
• Proxy contest – Attempts to gain control of a firm by soliciting a sufficient number
of shareholder votes to replace existing management
• Going private – All publiclyowned stock in a firm is replaced with complete equity
ownership by a private group.
• Leveraged Buyouts(LBOs):Going-privatetransactionsinwhichalargepercentage
of the money used to buy the stock is borrowed. Often, incumbent management is
• Strategic Alliance – Agreementbetweenfirms to cooperatein pursuit ofajoint goal
• Joint Venture – Typically an agreement between firms to create a separate, co-
owned entity established to pursue a joint goal
B. How to M&A:
Friendly Merger Offer
It usually begins with the acquirer directly approaching the target’s mgt. If both
parties like the idea of a potential deal, they will negotiate the method of payment
and the terms of the transaction.
Both parties conduct due diligence.
Once the negotiation and due diligence process is complete, attorneys draft a
definitive merger agreement.
The transaction will be announced to public only when each party signs the
definitive merger agreement.
The target company’s shareholders are then given a proxy statement that outlines
all of the facts of the transaction.
Once it has been approved by shareholders and regulators, payment is made, and
the deal is complete.
Hostile Merger Offer
• If the target company’s management does not support the deal, the acquirer submits
a merger proposal directly to the target’s board of directors in a process called a
• If the bear hug is unsuccessful, the next step is to appeal directly to the target’s
shareholders using one of the following methods.
• Tender Offer: the acquirer offers to buy the shares directly from the target
shareholders, and each individual shareholder either accepts or rejects the offer. • Proxy Battle: the acquirer seeks to control the target by having shareholders
approve a new acquirer approved board of directors. A proxy solicitation is
approved by regulators and then sent to the target’s shareholders.
C. Motivation of M&A
• Cost Reduction
Personal Benefits for Managers
Mergers may create the appearance of growth in EPS
V AT = VA+ V T S – C
V AT = post-merger value of the combined company (acquirer + target)
V A = pre-merger value of acquirer
V T pre-merger value of target
S = synergies created by the merger
C = cash paid to target shareholders
The pre-merger value of the target, V should be the price of the target stock before
any market speculation causes the target’s stock price to jump.
Gains Accrued to the Target
Gain =TTP = P – T T
Gains Accrued to the Acquirer
Gain =AS - TP = S- (P T V )T
Gain T gains accrued to target shareholders
Gain A gains accrued to acquirer shareholders
TP = takeover premium
P T price paid for target
V T pre-merger value of target
S = synergies created from by the merger
Synergy = Gain +TGain A All Cash Offer
Cash offer of $27 per share for PNP Grocery’s stock.
C = $27 × 24m = $648 m
The value of combined firm
V AT= V A V +TS – C
= 1,800 m + 576 m + 120 m – 648 m = $1,848 m
Gain to Target (PNP Grocery ) = GainT= TP = P T V T
= $648 m - $576 m = $72 m
Gain to Acquirer (Giant Food) = GainA= S- TP
= $120 m - $72 m = $48 m
The Value of PNP (target) to Giant ( Acquirer) is:
V T = S + V T $120 m + $576 m = $696 m
NPV = V *T– Cost to Giant of the acquisition = T * – PT
= $696 m – $648 m = $ 48 m ( NPV equals to gain to acquirer )
Need to find the number of new shares first.
Let n= number of new shares
$36 n = $27 × 24m yields n = 18 m new shares
The total shares outstanding for Giant is 50m + 18m = 68m
V AT= V A V +TS – C = 1,800 m + 576 m + 120 m – 0 = $2,496 m
The price The Value of PNP (target) to Giant ( Acquirer) is:
V * T S + V = T120 m + $576 m = $696 m
NPV = V * –TCost to Giant of the acquisition = V T – P T
Per share for the combined company
PAT = V AT/ 68m = 2,496 m / 68m = $36.70
The actual price paid to PNP (target) is (After Merge, same stock price)
PT= 18m × P AT= 18m × $36.70 = $660.60 m
Gain to Target (PNP) = Gain T TP = P –TV = T660.60 m - $576 m= $84.60m Gain to Acquirer (Giant) = GainA= S -TP = $120 m - $84.60 m= $35.40 m
The value of PNP (target) to Giant ( Acquirer) is:
V T = S + V =T$120 m + $576 m = $696 m