Welcome to module three of the course Corporate Financial Decision-Making for Value Creation. A course designed specifically to address the key decisions made by firms whose key objective is to maximize returns to the contributors of capital. Now you'll recall that this course began with a module detailing how firms approach the investment decision using discounted cash flow techniques, such as net present value analysis and internal rate of return. And we supplemented those with other techniques such as payback period, that provided the firm with feedback on the liquidity of the firm. Now that module was primarily concerned with how firms decided upon between project proposals that were generated within the firm. The second module then dealt with how firms might raise the capital necessary to fund that investment decision detailed in that first module. We discuss the way in which firms go to market via an initial public offering. And then turned our focus to the use of debt within the firm and specifically, the impact of using debt on the returns of shareholders. We surveyed the key influences on a firm's decision to use debt rather than equity. And then turned our attention to how firms solve the problem of what proportion of earnings are distributed to shareholders in the form of dividends versus capital gains. In this third module, we're going to focus on the key issues associated with firms growing via external investment rather than investing in projects generated internally within the firm. External investment, as we'll see, occurs when firms acquire other businesses, or at least business units, via takeovers and mergers. We'll also consider the role of corporate restructuring in value creation. That is, when does it make sense for management to sell off one of its own business units to external parties? So why is this such an important topic? Well, firstly, the sheer value of the assets involved in merger and acquisition activity is enormous. With Thomson-Reuters estimating that over $3.1 trillion in assets was transferred in the M&A market in 2014. Secondly, by its very nature, the M&A market allows different firms to combine their operations. And where these firms may have operating in the same market, there are some very important questions that need to be considered with respect to impact of M&A on the competitiveness of markets and the possible formation of monopolies. Thirdly, as we'll see shortly, merger activity can result in the transfer of wealth from bidding to target shareholders, as well as from small time minority shareholders to large shareholders with a signifcant stake in the company. Finally, with the increasing integration of financial markets across borders, governments are very interested in the impact of merger activity on their own economy. So that's why this material is important on a global basis. What about from the perspective of an individual firm? Well let's head back to our mobile coffee business, which, you'll be pleased to know, has been a great success in New York City. So successful in fact, that you've decided to expand operations into Chicago. There are two choices available to you. Firstly, you can take the path of organic growth by setting up new operations in Chicago in much the same way as you began your business in New York. Alternatively, you could pursue growth via merger or an acquisition of a firm that's already operating in the Windy City. But to make that decision properly, there are a whole lot of problems that need solving, including the maximum amount to bid for the target firm. The optimal method of payment, that is cash or shares in the combined company. And if cash is used, how should that cash be raised? Ultimately, the most important question for us to consider is how does M&A activity create value for our shareholders? Now it's worth pausing here to make one very important point. Simply acquiring another business does not in and of itself create value for shareholders. For example, if you pay $1 million for an asset that's worth $1 million to you, you've done nothing but convert cash into a fixed asset. It's a zero NPV proposition that has no impact on the market value of equity. So what about corporate restructuring? That is the process of removing assets from the business to create value for shareholders. Let's turn back to our expansion to Chicago for our merger with an established company. Five years down the track, and we find that things haven't gone well at all. Indeed, our CFO has knocked on our door, and he's asking for additional funds to keep the Chicago business going. Now we're faced with at least three options. Firstly, we could exit the Chicago market completely and sell off the assets we have deployed there. That's what we would call a divestiture. Secondly, we could separate out the Chicago operations from the New York operations and establish the Chicago business as a separate listed entity. Now there are a whole lot of reasons why that might be a good idea, mostly relating to issues of focus, transparency, and incentive. This process is known as spinning off. Finally, we might establish Chicago as a separate business while asking an external investor to come on board as a partner in a transaction that we refer to as an equity carve-out. Each of these approaches are examples of corporate restructuring that we'll consider in this module. As with the M&A market, the key question we face with corporate restructuring is, how does this transaction create value for our shareholders? For example, let's say our Chicago operations have fallen in value such that they're worth only $800,000 to us. Simply selling the business for $800,000 in cash does nothing for our shareholders, in that once again, it's a zero NPV. All we've done is converted a fixed asset to a liquid asset, cash. We'll spend some time working through the rationale for these type of transactions later in the module. So, where to next? Firstly, we'll set the scene by describing the actual mechanics of an acquisition. Then using tools based upon discounted cash flow analysis, we're going to develop a framework for understanding the circumstances under which a merger will create value for our shareholders. We then switch our attention to identifying the factors that drive value creation in the M&A market before changing gears slightly to refocus on how firms might create value not by getting bigger, but instead by restructuring into a smaller entity. Finally, we review some of the empirical evidence with respect to identifying the winners and losers from M&A activity.
