Long-Term Financial Management Decisions

Long-Term Financial Management Decisions

Part 1

The motives for one firm purchasing another are multiple . The most plausible explanation is that managers acquire a firm is their desire to maximise shareholders ' wealth as they expect that the combined value of the firms will be greater than the sum of the values of the individual firms (Seth , 1999 . The increase in value can be driven by the realization of the natural synergy between the two entities , which in turn can be the product of operational changes , increase in market power that enables

the combined firm to dictate prices in a consolidated market , or increase in product differentiation . International acquisitions make sense because the acquiring firm may be seeking expertise in the new market that will help it `set the foot in the door or seek to circumvent restrictive regulations that limit the activities for foreign entrants but open more possibilities for joint ventures

However , quite often the target firm will cost more to the acquirer than it can generate benefits , resulting in loss to shareholders . One explanation of this loss can be that since managers are frequently compensated based on the size of the assets under their control , they may seek higher rates of growth in assets than in profits (Seth 1999

An acquisition can fail , or result in losses to shareholders , even when the management is well-meaning and actually believes it is trying to maximise shareholders ' value . Harbir Singh of Wharton Business School in his analysis of why mergers fail in the financial industry states that that success ifs negatively impacted by the degree to which the new management will replace the old one . From this replacement stem disruptions in processes , routines and personal motivation stemming from a change in leadership (Wharton Financial Institutions Center n .d . Other problems can include incompatibility of cultures , lack of adequate due diligence inspection , lack of managerial expertise in mergers and acquisitions , and other things . All of this results in the failure of the merger to maximise value and leads to losses

Part 2

1 . Prepare a statement showing the incremental cash flows for this project over an 8-year period

The cash flow for each period is obtained by subtracting the costs from the sales revenue , multiplying by after tax return rate , and adding depreciation shield

Annual Cash Flow (Sales Revenue- Direct Costs - Indirect Costs (1-Tax rate Annual Depreciation Expense Tax rate

In this way , we obtain the statement of incremental cash flows

2 . Calculate the Payback Period (P /B ) and the NPV for the project

The payback period is calculated by subtracting the amount of cash flow the company can hope for in each year from the initial investment that combines 1 ,000 ,000 invested in the plant and 200 ,000 , net investment in inventory and receivables . The company will be able to repay the investment in 2 .97 years

Calculating NPV , we first of all find the present value of the annual cash flow for each year , given that the company 's...