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l will be given with their pros and cos. Moreover, the nature of gearing and potential effected of high gearing on perceived risk and cost of capital. II)Main ideas: 1)Reason for take over: A takeover is the purchase of one company by another. There are many reasons behind takeover such as: Market share: the companies want to look toward a higher market share. When takeover a competitive company, Jebb will have bigger economic of scales, thus, the price per unit will reduce. The company takes advantage of price competitive. The acquisition of a large competitor is a reasonable way to attain significant market share. Tax: Take over brings more profits for the shareholder because the tax liability of the combination will be lower than two individual company. Geographic reach: Strong company always wants to expand their market in a new geographic. But it is big challenge of understanding and operating in new local culture. Thus, it is easier and faster for Jebb to acquire local company than building one. Market share: When, Jebb acquires a rival company, the resultant organization can increase the market share because the new company will take advantage of cost efficiency and competitive as compared to its financially weak parent organization . Synergy: Reduce production cost and administrative costs is one part of synergy. Furthermore, it is also arise from enhanced managerial capabilities, human resources, R&D investment, etc. Other business will also bring new skills and specialist departments to the Jebb. Reduce risk: Inherent risk will be reduced resulting from diversification of product s and services. If one product fails due to market conditions, the other products in another market won’t be affected. The combination of management, strengthen the capacity of combined firm, diversification of product and services, will help the new firm to withstand bad unforeseen economic factor. Reduce competition because a rival is taken over. 2)Methods to takeover a company: There are 3 methods to takeover a company Cash offer: Cash offer is an offer to buy a publicity- traded company in exchange for cash. A cash offer may be either friendly or hostile. Before making offer to a company, bidder company usually inform to board of directors first. In private company, board directors and shareholders have closely connected, thus if the boards accept the offer, the shareholder also agreed. Private acquisition is friendly. However, if the boards and shareholders reject the offer, but the bidder still continues to peruse it without inform to them. It is called hostile takeover. There are some advantage for bidding company is they can see exactly how much is offered and it has no effect to issued shares. However, by cash offer method, the seller may be liable to pay capital gains tax on shares sold to bidder. Share for Share offer: The acquiring firm offers its share for an equal number of shares in the target firm. If accept both shareholders of two companies become owners of resulting company. By this method, the target company shareholders could retain equity interest in their company. There is no brokerage costs from re-investing cash and no capital gains tax liability. However, acquiring company might take some disadvantages such as the company should keep the offer price not fall in market price. Mixed bid: Mixed bid method is used when a share for share offer is supported by a cash alternative. It is popular financing choice because it is more accepted by target company’s shareholder.( Corporate finance book) 3)There will be some impacts that affect to the company: Economies of scale: Combination of two business will support economies of scale e.g.: increase in productivity and output, increase cost efficiency, long term cost might reduce. The larger economic of scale, the bigger of amount of products will be produced whereas unit cost will decrease. People: From a survey in 1985 of Training Magazine, 85 % top executive believed that people problem were more likely affect a acquisition’s long term success. Two different company, they have different value, performance, behavior and attitude. Thus it might be lead to big conflicts in new company after acquiring. Thus, managerial communication contributes an important role in organizational acquisition. Managers should aware of acquisition’s potential affect to employees’ attitude and performance, what are their expectation. Financial: According Ansof ( 1971), it stated that after an acquisition, low sales growth companies showed significant higer rates of growth, whereas, high sales growth companies showed lower rates of growth. Low sales growth companies showed higher rates of growth after acquisition, they still suffered decreasing in P/E ratios. 4)Methods of investment appraisal to evaluate and rank potential opportunities There are four methods the company can use to evaluate opportunities: Payback period: “Payback period is the time required to cover the initial investment in a project “( C.Paramasivan, 2003, p122) Payback period = Pros: It is an easy way to compute and simple for managers, shareholders to understand. It also reduces the possibility of loss on account of obsolescence and handles investment risk effectively Cons: The method doesn’t recognize the Time value of Money and it ignores profitability of an investment. Accounting Rate of Return: “ARR means the average rate of return or profit taken for considering the project evaluation.” ( C.Paramasivan, 2003, p127) ARR % x 100 Pros: This method is based on the accounting information rather than cash flow. Moreover, it considers the total benefits associated with the project. It is easy to calculate and simple to understand Cons: It ignores the time value of money and the reinvestment potential of a project. It doesn’t adjust for the greater risk to longer term forecasts. Net present value According Financial management book, NPV is one of modern methods for evaluating the project proposals. It describes as the summation of the present value of cash inflow and present value of cash outflow. It is the difference between total present value of future cash inflows and the total present value of future cash outlows. Pros: It recognize the time value of money. The value of dollar today is more than the value of a dollar received a year from now. NPV also recognize the risk associated with future cash flow. It helps to maximize shareholders’ profit. Cons: It doesn’t tell us when a positive NPV is achieved, it only tell us to accept all investment with NPV > 0. Furthermore, the method assumes that capital is abundant. There is no capital rationing. Interest Rate of Return: Interest rate of return is time adjusted technique and it is a rate at which discount cash flows to zero. It is calculated by the ratio: Cash inflow/ Investment initial. Pros: It accounts the time value of money, gives the nearest rate of return. It also provide guidance on a project’s value and associated risk . Cons: It is complicated to calculate. It produces multiple IRR if evaluating a project that has more than one change in sign for the cash flow stream. In addition, IRR assumes that all intermediate cash flows are reinvested at the internal rate. 5)The nature of gearing and the potential effects of high gearing on perceived risk and cost of capital Source of finance: Depend on the amount of capital needed, the firm will choose the suitable source of financial. There are 4 kinds of sources of finance: Based on the period: Long term Sources: Equity shares, Preference shares, debenture, long term loans, fixed deposites. Short term sources: Bank credit, customer advances, trade credit, factoring, public deposits. Based on ownership capital: Ownership capital is the capital owned by the shareholders. The company can rise substantial funds through an IPO. There are two types of share can be issued : Ordinary share and preference share. Furthermore, retained earning is also an ownership source. Based on sources of generation: It is classified into 2 categories: Internal and external. Internal source includes: Retained earnings, depreciation funds and surplus. External source includes share capital, debenture, public deposits, loans from banks and financial institutions. Based in Mode of Finance: It includes : security finance ( share capital, debenture), retained earnings( retained earnings, depreciation funds), loan finance ( long term and short term loans) Capital structure Capital structure refers to corporate finance by combining different long term sources such as equity shares, preference shares, debentures, long term loans, and retained earnings. If a firm sells $30 millions in equity and $70 millions in debt, it is said that 30% equity financed and 80% debt financed. When a company decide capital structure, it should base on 2 objectives: maximize the value of the firm and minimize overall cost of capital. The computation of cost of capital is very important for the company. It is used to capital budgeting decision. It is also used to determine which affects the capital budgeting, value of the firm. Thus, it helps to evaluate the financial performance of the firm. Formulation of overall cost of capital: Ko= Kd Wd + Kp Wp + Ke We + Kr Wr Ko= overall cost of capital Kd= cost of debt Kp= cost of preference share Ke= cost of equity Kr= cost of retained earnings Wd= Percentage of debt of total capital Wp= Percentage of preference share to total capital We= percentage of equity to total capital Wr= percentage of retained earnings Weighted average cost of capital is calculated in the following formula: Kw= Weighted average cost of capital X= Cost of specific sources of finance W= Weight, proportion of specific sources of finance. Gearing ratio: Gearing ratio measures the proportion of the company’s total capital that is borrowed: Gearing ratio = Loan capital/ Capital Employed If the gearing ratio is high, it means that the proportion of the company money that is borrowed is big. It leads to bigger risk. It is very dangerous for the company if interest rate are going up. Interest payable amount will be rise fast and company might suffer loss. III)Inconclusion: As analyse above, acquisition is not good for the company. Mc Kinsey that 74 % of acquisition fail to create shareholder value. Thus, if Jebb want to takeover the competitor, they should have to prepare carefully and think about pros and cos of all decisions. Appendix Year Company A Company B Company C 0 ($350,000,000) ($350,000,000) ($350,000,000) 1 $20,000,000 $95,000,000 $30,000,000 2 $40,000,000 $50,000,000 $25,000,000 3 $45,000,000 $90,000,000 $90,000,000 4 $150,000,000 $160,000,000 $100,000,000 5 $100,000,000 $150,000,000 $190,000,000 a/Payback period: Payback period of A = 4 years + = 4.95 years Payback period of B = 3 years + = 3.72 years Payback period of C = 4 years + = 4.55 years b/ARR: ARR of A = x 100% = 1.42% ARR of B = x 100% = 1.1% ARR of C = x 100% = 4.8% c/NPV: cost of capital = 10% NPV (A) = ($20,000*0.91 + $40,000*0.83+ $45,000*0.75 + $150,000*0.68 +$100,000*0.62) – $350,000 = -$100,850. NPV (B) = ($95,000*0.91 + $50,000*0.83 + $90,000*0.75 + $100,000*0.68 + $190,000*0.62) - $350,000 = $31,250. NPV (C) = ($30,000*0.91 + $25,000*0.83 + $90,000*0.75 + $100,000*0.68 + $190,000*0.62) – $350,000 = -$48,650. d/IRR: Company A Company B Company C Year Cash flow PV rate @ 20% PV per year Cash flow PV rate @ 20% PV per year Cash flow PV rate @ 20% PV per year USD’000 USD’000 USD’000 USD’000 USD’000 USD’000 0 (350,000) 1.00 (350,000) (350,000) 1.000 (350,000) (350,000) 1.000 (350,000) 1 20,000 0.83 16,600 95,000 0.83 78,850 30,000 0.83 24,900 2 40,000 0.69 27,600 50,000 0.69 34,500 25,000 0.69 17,250 3 45,000 0.58 26,100 90,000 0.58 52,200 90,000 0.58 52,200 4 150,000 0.48 72,000 160,000 0.48 76,800 100,000 0.48 48,000 5 100,000 0.40 40,000 150,000 0.40 60,000 190,000 0.40 76,000 NPV (167,700) (47,650) 131,650 IRR (A) =10%+ IRR (B) = 10% + IRR (C) = 10% + Reference: C.paramasivan, 2003,Financial management, New age international publisher, Newdehil. ._.