Unit 3 Financial Management Assignment Level 3

Part A

Explain dividend relevance theory and dividend irrelevance theory?

Dividend means a part of a profit of the company which is given to the company shareholder. Company need is to provide funds for their long term investment and rather than investors wants to earn more profit on their investments. Dividend policy of the company will affect the wealth of the share holders and to long term investments.

Relevance concept of dividend: If a dividend policy affect the value of the firm is relevant. There are two dividend relevance theories of the firm: these are Walter's model and Gordon's model.

Walter's model :

In a business dividend policy will affect the value of the firm.  This model is given by James E Walter and they says that dividend policy always affect the value of firm or a business. And the company may use this to maximise the wealth of the shareholders. Walter  also give a mathematical model for proving his point of view (Titman, Keown and Martin, 2017).  This model is based on relationship between return on investment of the firm and firm cost of capital.

Assumption which is related to the Walter's model these are:

• The firm sourced their finances by retained earnings. The firm does not use the external sources of funds like debt or new equity capital.
• In the starting of a business earning per share and dividend per share should be constant. In the determining of the results that vale of earning per share (E),and value of dividend (D) it will be changed
• The firm has a very long life.
• The firms earnings are distributed as dividends or reinvested internally.
• The firm business risk not change after the additional investment is done. So it implies that firm internal rate(r) and cost of capital(k) remains constant.

For determining the market value of a share Walter's suggest the formula:

P=D/K=r(E-D)/K/K

In this P is a market price of an equity share, D is a dividend per share, r is the internal rate of return, E is earning per share And K is cost of equity capital rate. According to this theory , the dividend policy mainly depends on the relationship between the firms internal rate of return and cost of capital. If R is greater than K the firm should be retain their earnings and and If R is less than K then the firm distributed the earnings to their shareholders . In case of when R is greater than K so the firm is able to earn more return from retained earning.  It already clear that the market price per share is the present value of an infinite stream of constant dividends and the present value of the infinite stream of profits (Bekaert and Hodrick, 2017).  In the firm using the model firm can growth there are several investment opportunities where r is greater than K and the firm can reinvest earnings at a higher rate r thus they will maximize value per share if they reinvest all earnings. If the firm normally  increases there growth so there is not investment available for the firm that are earn higher rates of return thus the dividend policy has no effect on market price. Declining firm are not having profitable investment for the firm to reinvest its earnings . In this the firm pay out its earnings as a dividend to their share holders.

Gordon's model:

This model is related to the market value of the firm and this model is given by Myron Gordon. According to Gorden dividend per share is to grow when earnings are retained. In this model dividend per share is equal to the payout ratio and its multiplied by earnings (Priya and Mohanasundari, 2016). In this to determine the value of the firm therefore based on the dividend growth.

Assumption of Gordon's model are:

• In this no external financing is available
• the firm is an all equity firm
• The internal rate of return(r) of the firm is constant
• The discount rate (K) of the firm remain constant
• In this model corporate tax does not exist.
• The model assumes that company is an all equity company and there is no proportionof debt in the capital structure.
• Gordon's models believes that  perpetual earnings for the company

Formula for calculating the market per share which is suggested bye Gordon's :

P={EPS*(1-b)}/(k-g)

where P is a market per share , EPS denotes earnings per share , b denotes to retention ratio of the firm(1-b) payout ratio of the firm, k is the cost of capital of the firm  and g denotes to growth rate of the firm. This model indicates that the market value of the company's share is the sum total of the present value f dividends to be declared. This model is also used to calculate the cost of equity (M’rabet and Boujjat, 2016). According to Gordon when R is greater than k the price per share increase as the the firm dividend payout ratio decreases. When R is less than k the price per share increases similarly the dividend payout ratio increases, and when R is equal to k the price per share unchanged according to change in pay-out ratio. The optimum payout ratio for a growth firm is zero where R is greater than k. and no optimum ratio for a normal firm that is R equal to k and optimum payout ratio for a declining firm R is less than K is 100%  dividend pay out ratio earnings.

Irrelevance concept of dividend : According to this concept dividend policy has no effect on the share prices of a company. In this concept the investor do not differentiate between dividends and capital gains . The basic need of the company is to earn maximum return on their investment

Modigliani and miller's model:

They have determined by its earning potentiality and investment policy and never do income distribution. According to them dividend policy of the firm is irrelevant and it has no affect the wealth of the shareholders. When an investment decision of the firm is given so dividend earning divided into retained earnings (Baker and Weigand, 2015).

The following assumption which is related to Modigliani and Miller's model:

• The firm operates in perfect capital market.
• Taxes does not exist in this model
• The firm has fixed investment policy
• In this model risk of uncertainty does not exist, And the investors are able to forecast future prices and dividend with certainty and in this one discount rate is applicable for all other securities and all time periods . Formula for calculating rate of return for share

r=D+(P₁+P₀)/P₀

Where D is dividends , P₁ is capital gain and P₀ is purchase price. This theory indicates that the leveraged firm value is same as the unleveraged firm value. If the company share of leveraged firm are purchased and it will be the same cost as the unleveraged firm share (Truong, Huong and Van Anh, 2017). Dividend and retained earnings division is no relevant from the context. In this capital markets are perfect transaction cost are nil and securities are divisible  and no investor can influence the market. 

            A firm which has to pay dividends will have raise the funds of a company external, by its investment plans. It is the advantage for external financing if a firm pay dividend. If the present value per share after dividends and external financing is equal to present value per share before it pays the dividends (Gostkowska-Drzewicka and Majerowska, 2016). Terminal value of the firm will be declines when dividends are to be paid . So the wealth of shareholder and dividend share price remain unchanged. There are some propositions which are without tax. In this the valuation of the firm is not been influenced by capital structure (Ojeme, Mamidu and Ojo, 2015). The share holders and debt holders are having same priority by the company,  earnings is equally distributed to the both.  If the debt component is increased their shareholders are facing risk for the firm. And therefore shareholder expect more return if the cost of the equity is increased. If the company retains their earnings by giving instead of retention , the shareholder  earn dividend and it is equal to the amount by which his capital would have been appreciated . It can be concluded that as actual debt cost is less than the nominal debt cost because of the tax advantage.

Part C

Merger and acquisition fundamental role External Growth:

            Merger is used to mean the combining of two business  and their entities which is result in common ownership . Merger is of three types horizontal, integration , vertical integration, and conglomerate integration. Acquisition means when a big company purchase a small company and then owned this company . All rights are goes to the big company all decision is taken by the acquiring company.

For the expansion into new market or expanding into new territories , gaining a competitive edge and acquiring skill full sets and advanced technology Merger and Acquisitions has become an important Business Strategic tool. They are constantly changing economy and marketplace. There are five situations in which M&A have proven as a growth strategy.

Filling of critical gaps in n the offerings of services or clients : Merger occurs when the     market place changes regarding external events or implementation of new laws and regulations.

Prominent way to acquire skilled and intellectual property : Many companies are suffering from deficit of experienced and qualified staff in the field of cybersecurity, accounting and engineering (Greve and Man Zhang, 2017). Actually intellectual and talented property is the new currency of modern and sophisticated business.

Chances to Leverage synergies : It results in synergies that presents the real value to both the parts i.e. Acquired and acquiring. There are two major types of synergies i.e. Cost and revenue. Cost synergy is getting advantage by trimming cost and overlapping of operations and resources and consolidating them in one entity. Revenue Synergies is just creating new opportunities by altering the balance of power so as to change market dynamics, selling more products and raise prices. Organisations can take more advantage of revenue synergies and create more money :through following ways:

• By Reducing Competition
• Opportunity to open new territories
• Gaining new markets
• Developing Expanding the customer area for cross selling opportunities
• Sales opportunities through complementary products of market

Introducing a new business model : Mergers present many types of services which includes brokerage, insurance or money management. Easiest way to consider a model is to acquire a firm who is already using the model successfully (Tanriverdi and Uysal, 2015). In this way the possible missteps are already avoided.

Saving Time and long Curves: If a firm is capable of delivering  and developing its own services but is taking more time , money and resources then one should be willing to devote it. It is simpler and cost effective for the firm to acquire the capability.

Externally mergers have played important role in most of the leading countries of the world. In USA between 1890 and Second World War Merger occurred for the first time. A series of mergers and acquisitions have occurred in Nigeria due to promulgation of banks and other Financial Institutions Degree (BOFID).

Almost 3899 firms were involved in activities related to mergers and acquisitions during 1997.And by the end of the year the data went to 2564 which tells that the firms involved in mergers and acquisitions have decreased (Zhang and et.al., 2015). Similarly, taking the entire population, industrial concentration is decreasing as an effect of mergers and acquisitions. There was a period horizontal mergers from 1897-1904, vertical mergers 1916-1929, diversified conglomerate mergers from 1965-1969, co-generic mergers from 1984-1989, mega mergers from 1992-2000, globalization , shareholder from 2003-2008. Starting of each  and every wave is not fixed but it ends definitely with a major war or crisis.

Is Merger and takeover activity  benefit to the shareholders of the acquiring company?

Two companies merged because decision makers and the company board member should agree to joint the businesses from this the firms results will be stronger and it is more profitable to the company. Merger is beneficial for the new firm and even their customer in the long run. Companies shareholder having some disadvantage and disadvantages from merger.

• Stock price: Company shareholders of both the companies have experience changes in their stock value during the merger officially announced . Targeted company shareholders can see that their share value should be rise and the shareholder of the acquiring company value should be down.
• Purchase Opportunities : Shareholders are presenting an opportunity to purchase their shares at discounted price and gain the maximum return later during the merger. In the market if merger of two companies news has come so the company share price of targeted company rises. The price of acquiring company will not be increases.
• Shares: The shareholder of the targeted company in the acquisition can keep their shares after a business merger should be done . Then the shareholder go for share to share purchases and it is essentially replace the stock of the target company.
• Growth: Shareholders have been retain their shares after both companies merger they have the chance to experience significant long term investment gains. Merger should create the larger business entity and having a great resources, and the growth of the company expands . And after this company continues to operate the long term and the shareholders equity grow faster before company acquired the target business.

If 90% of acquisition with price exceeding $100 million are related to shareholders. If the acquisition deal values increases , the percentage of contested deals may face multiple shareholder lawsuit.

Corporate conflict:  in acquisition company executives can have agendas that conflict with the maximising shareholder wealth it creates conflict with the investors .

• Size matters : Post acquisition benefits were largely a function of target company size . And in research also found that the only transactions of long tern benefit to shareholders were acquisitions of subsidiaries
• Staff reduction: all employees knows that merger and acquisition tend to job losses. All the money will save from reducing the number of staff (Holburn and Vanden Bergh, 2014).
• Ownership over intangible assets: if buying a smaller company with unique technologies and intellectual properties these properties are patents , copyrights etc. And a big company gain control over these intangible assets.
• Taxation: If the transaction of a company is made with share then it is not taxable. There is simply an exchange of share certificates.
• Increased financial disclosure : When a company's traditional line of business differ from the separated business unit and the company has to issue separate financial statements . Separate financial disclosure there is investors are better equipped value of the main corporation.

Recent merger and acquisition activity:

Blackstone bought Hilton hotels corporation for $26bn it gives the private equity company the biggest hotel group in the world by many properties. The deal between both corporation was at $47.50 a share , it represents a 31.7 % premium on last before it has been merged and its closing price was $36.05 and a 40 % premium on Hilton's price at the day after merging they start trading . This the biggest deal in the hotel sector. In this acquisition it gives Blackstone , 2800 hotels includes brands like Hilton, double tree, Embassy suites, Hampton Inn , Home wood suites and the Waldorfastoria collection under this500000  hotel rooms .

Blackstone now a budget business hotel chain, it is real estate investment group for $8bn, and already had a global assets under which total 100000 rooms. This deals comes two year after Hilton hotels corporation merged with Hilton international. Hotels deals have have quickend even faster comparatively with last year $70bn plus estimated. The Blackstone Hilton deal means , deals in the hotel sector so far which is already outstripped .

Morrison takeover Safeway Plc, these are the grocery retailers giants in UK. This the fourth largest supermarkets Safeway takeover by Morrison in 2004.  earlier in retail markets throughout the world began to be transformed by acquisition and merger. Many of the largest retailers particularly in the food and grocery sectors involve and this is to reduce the struggling competition between the leading competitor (Koenig, Kramer and Vogel, 2014). Merger and acquisitions still one of the areas of finance which will be attracted interest from publically and as the finance analyst and the managers. It has a horizontal integration of merger the company express same interest.

The commission has recommended that if Morrison is successful in their bid that they have to sell some of their stores to ensure that competition is not compromised. Unfortunately Morrison regional market strength mirror those of ASDA and acquisition of Morrison operations . Morrison has slashed price on over 800 safeway products to bring them in line with its prices strategies. After this takeover of Safeway in 2004 it leads supermarket chain which owned 479 stores. Merger and acquisition have a profound impact on an organisational member .The grow size of retailers not only replaced the manufactures dominance in the supply chain but it is also eliminated many wholesaler and started the trends (Boschma and Hartog, 2014). This industry structure is characterised by a number of common include greater store size increase in retailer and they adopt the changes. Merger and acquisition may help in increasing the growth of the business and to earn more profit.

Conclusion

This report is based on financial management, it is very crucial part of any business. It is used for right allocation of resources to earn more profit. In this report I am concluded that dividend policy is relevant and it considered that it affects the value of the firm. Dividend is a profit which is distribute  to the shareholder by the company , and it is a type of reward. In this report I am also explaining that the different types of dividend policies theories. And in the other part I am explaining  the  merger and acquisition Fundamental role in corporate finance and it is a source for external and internal growth of any business. Merger and acquisition is help to any business and company to expand their entire business in terms of revenue and goodwill. Corporate finance main aspect are merger and acquisition because it is based on corporate strategy.  In this report I am concluded that merger and acquisition both are helps in business to maximise the shareholder wealth.

References

• Baker, H.K. and Weigand, R., 2015. Corporate dividend policy revisited. Managerial Finance, 41(2), pp.126-144.
• Bekaert, G. and Hodrick, R., 2017. International financial management. Cambridge University Press.
• Boschma, R. and Hartog, M., 2014. Merger and acquisition activity as driver of spatial clustering: The spatial evolution of the Dutch banking industry, 1850–1993. Economic Geography. 90(3). pp.247-266.
• Gostkowska-Drzewicka, M. and Majerowska, E., 2016. THE RELEVANCE OF DIVIDEND SMOOTHING IN THE CONSTRUCTION COMPANIES LISTED ON THE WARSAW STOCK EXCHANGE. Financial Sciences/Nauki o Finansach. 2(27).
• Greve, H. R. and Man Zhang, C., 2017. Institutional logics and power sources: Merger and acquisition decisions. Academy of Management Journal. 60(2). pp.671-694.
• Holburn, G. L. and Vanden Bergh, R. G., 2014. Integrated market and nonmarket strategies: Political campaign contributions around merger and acquisition events in the energy sector. Strategic Management Journal. 35(3). pp.450-460.
• Koenig, W. P., Kramer, G. A. and Vogel, M. B., Shareholder Representative Services LLC, 2014. System and method of generating investment criteria for an investment vehicle that includes a pool of escrow deposits from a plurality of merger and acquisition transactions. 8. pp.706,599.
• M’rabet, R. and Boujjat, W., 2016. The relationship between dividend payments and firm performance: A study of listed companies in Morocco. European Scientific Journal, ESJ. 12(4).
• Ojeme, S., Mamidu, A. I. and Ojo, J. A., 2015. Dividend Policy and Shareholders’ Wealth in Nigerian Quoted Banks. Canadian Social Science. 11(1). pp.24-29.
• Priya, P. V. and Mohanasundari, M., 2016. Dividend Policy and Its Impact on Firm Value: A Review of Theories and Empirical Evidence. Journal of Management Sciences and Technology. 3 (3).

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