Computer Concepts/Computech Merger Analysis

5183 Words Nov 8th, 2015 21 Pages
Case 70

Computer Concepts/CompuTech

Merger Analysis

QUESTIONS
Question 1 Several factors have been proposed as providing a rationale for mergers. Among the more prominent ones are (1) tax considerations, (2) diversification, (3) control, (4) purchase of assets below replacement cost, and (5) synergy. From the standpoint of society, which of these reasons are justifiable? Which are not? Why is such a question relevant to a company like CompuTech, which is considering a specific acquisition? Explain your answers.
Answer: Synergy is by far the most socially justifiable reason for mergers. Synergy occurs when the value of the combined enterprise exceeds the sum of the values of the pre-merger firms. (If synergy exists, the whole is
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Merger motives that are questionable on economic grounds are diversification, purchase of assets below replacement cost, and control. Managers often state that diversification helps to stabilize a firm's earnings and reduces total risk, hence benefits shareholders. Stabilization of earnings is certainly beneficial to a firm's employees, suppliers, customers, and managers. However, if a stock investor is concerned about earnings variability, he or she can diversify more easily than the firm can. Why should Firm A and Firm B merge to stabilize earnings when stockholders can merely purchase both stocks and accomplish the same thing? Further, we know that well-diversified shareholders are more concerned with a stock's market risk than with its total risk, and higher earnings instability does not necessarily translate into higher market risk.
Sometimes a firm will be touted as a possible acquisition candidate because the replacement value of its assets is considerably higher than the firm's market value. For example, in the early 1980s, oil companies could acquire reserves more cheaply by buying out other oil companies than by exploratory drilling. However, the value of an asset stems from its expected cash flow, not from its cost. Thus, paying $1 million for a slide rule plant which would cost $2 million to build from scratch is not much of a deal if no one uses slide rules.
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