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Unit 3 Financial Management Assignment Level 3

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Introduction

Financial management is how to manage the funds and all related money activities that are prepared, directed, and managed to control them. Financial management creates wealth for the business and it also provides a return on investments. This is used to maximize the company's wealth and to increase the business productivity. In this report, I am discussing whether the dividend payment is relevant or not in the share price of the company and also evaluate both dividend relevant and irrelevance theories viewpoints. And also discusses the merger and takeover fundamental role in corporate finance, which affects external and internal growth opportunities, is possible or not. In this report, I am also evaluating that evaluate that merger and acquisition are core financial objectives for maximizing the shareholder's wealth.

Part A

Explain Dividend Relevance Theory and Dividend Irrelevance Theory.

Dividend means a part of the profit of the company which is given to the company shareholder. Companies need to provide funds for their long-term investment and rather investors want to earn more profit on their investments. The dividend policy of the company will affect the wealth of the shareholders and long-term investments.

Relevance concept of dividend: If a dividend policy affects 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.

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Walter's Model :

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

Assumptions which is related to the Walter's model are:

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

For determining the market value of a share Walter suggests the formula:

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

In this P is the market price of an equity share, D is a dividend per share, r is the internal rate of return, E is earnings per share And K is the cost of equity capital rate. According to this theory, the dividend policy mainly depends on the relationship between the firm's internal rate of return and cost of capital. If R is greater than K the firm should retain its earnings and If R is less than K then the firm distributes the earnings to their shareholders. In the case of when R is greater than K the firm is able to earn more return from retained earnings.  It is 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 grow 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 there is no investment available for the firm that earns higher rates of return thus the dividend policy has no effect on market price. Declining firms are not having a profitable investment for the firm to reinvest its earnings. In this, the firm pays out its earnings as a dividend to its shareholders.

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 is multiplied by earnings (Priya and Mohanasundari, 2016). This is to determine the value of the firm therefore based on dividend growth.

Assumptions 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 remains constant
  • In this model, corporate tax does not exist.
  • The model assumes that the company is an all-equity company and there is no proportion of debt in the capital structure.
  • Gordon's model believes that  perpetual earnings for the company

The formula for calculating the market per share which is suggested by 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) the 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 of 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 increases 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 is unchanged according to the 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 the optimum payout ratio for a declining firm R is less than K is 100%  dividend payout 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 does not differentiate between dividends and capital gains. The basic need of the company is to earn maximum return on their investment.

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Modigliani and Miller's Model:

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

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

  • The firm operates in a perfect capital market.
  • Taxes do not exist in this model
  • The firm has a fixed investment policy
  • In this model risk of uncertainty does not exist, And the investors are able to forecast future prices and dividends with certainty, and in this one discount rate is applicable for all other securities and all time periods. The formula for calculating the 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 the same as the unleveraged firm value. If the company share of the leveraged firm is purchased it will be the same cost as the unleveraged firm share (Truong, Huong, and Van Anh, 2017). The dividend and retained earnings division is not relevant from the context. In these capital markets, perfect transaction costs are nil securities are divisible and no investor can influence the market. 

A firm that has to pay dividends will have to raise the funds of a company external, by its investment plans. It is an advantage for external financing if a firm pays dividends. If the present value per share after dividends and external financing is equal to the present value per share before it pays the dividends (Gostkowska-Drzewicka and Majerowska, 2016). The terminal value of the firm will be declined when dividends are to be paid. So the wealth of shareholders and dividend share price remain unchanged. There are some propositions that 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 have having same priority in the company,  earnings are equally distributed to 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 its earnings by giving instead of retention, the shareholder earns a 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 B

Merger and Acquisition Fundamental Role External Growth:

The merger is used to mean the combining of two businesses and their entities which results in common ownership. Merger is of three types horizontal, integration, vertical integration, and conglomerate integration. Acquisition means when a big company purchases a small company and then owns this company. All rights go to the big company all decision is taken by the acquiring company.

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

Filling of Critical Gaps in the Offerings of Services or Clients: A merger occurs when the marketplace changes regarding external events or the implementation of new laws and regulations.

A Prominent Way to Acquire Skilled and Intellectual Property: Many companies are suffering from a deficit of experienced and qualified staff in the fields 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 present the real value to both the parts i.e. Acquired and acquired. There are two major types of synergies i.e. Cost and revenue. Cost synergy is getting an advantage by trimming costs overlapping 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, sell more products, and raise prices. Organisations can take more advantage of revenue synergies and create more money: through the following ways:

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

Introducing a new business model: Mergers present many types of services which include brokerage, insurance, or money management. The easiest way to consider a model is to acquire a firm that 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 an important role in most of the leading countries of the world. In the USA between 1890 and Second World War Mergers occurred for the first time. A series of mergers and acquisitions have occurred in Nigeria due to the promulgation of banks and other Financial Institutions Degree (BOFID).

Almost 3899 firms were involved in activities related to mergers and acquisitions during 1997. By the end of the year, the data went to 2564 which shows that the number of firms involved in mergers and acquisitions has 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 of horizontal mergers from 1897-1904, vertical mergers from 1916-1929, diversified conglomerate mergers from 1965-1969, co-generic mergers from 1984-1989, mega mergers from 1992-2000, globalization, shareholder from 2003-2008. The starting of each  and every wave is not fixed but it ends definitely with a major war or crisis.

Is Merger and Takeover Activity Beneficial to the Shareholders of the Acquiring Company?

Two companies merged because decision makers and the company board members should agree to join the businesses from this the firm's results will be stronger and it will be more profitable to the company. The merger is beneficial for the new firm and even its customers in the long run. Companies shareholder have some disadvantage and disadvantages from mergers.

  • Stock Price: Company shareholders of both companies have experienced changes in their stock value during the merger was officially announced. Targeted company shareholders can see that their share value should rise and the shareholder of the acquiring company value should be down.
  • Purchase Opportunities: Shareholders are presenting an opportunity to purchase their shares at a discounted price and gain the maximum return later during the merger. In the market, if the merger of two companies comes the company share price of the targeted company rises. The price of acquiring a company will not be increased.
  • Shares: The shareholder of the targeted company in the acquisition can keep their shares after a business merger is done. Then the shareholder goes for share-to-share purchases and it essentially replaces the stock of the target company.
  • Growth: Shareholders have retained their shares after both companies' mergers they have the chance to experience significant long term investment gains. Mergers should create a larger business entity and having great resources, and the growth of the company expands. After this company continues to operate in the long term and the shareholder's equity grows faster before the company acquires the target business.

If 90% of acquisitions with prices exceeding $100 million are related to shareholders. If the acquisition deal values increase, the percentage of contested deals may face multiple shareholder lawsuits.

Corporate conflict:  in acquisition company executives can have agendas that conflict with maximizing shareholder wealth creating conflict with the investors.

  • Size matters: Post-acquisition benefits were largely a function of target company size. Research also found that the only transactions of long-term benefit to shareholders were acquisitions of subsidiaries
  • Staff reduction: all employees know that mergers and acquisitions tend to job losses. All the money will be saved by 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 gains control over these intangible assets.
  • Taxation: If the transaction of a company is made with a 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 differs from the separate business unit the company has to issue separate financial statements. Separate financial disclosure there is investors are better equipped to value the main corporation.

Recent Merger and Acquisition Activity:

Blackstone bought Hilton Hotels Corporation for $26bn it giving the private equity company the biggest hotel group in the world by many properties. The deal between both corporations was at $47.50 a share, which represents a 31.7 % premium on the last before it was merged and its closing price was $36.05 and a 40 % premium on Hilton's price on the day after merging they started trading. This is the biggest deal in the hotel sector. In this acquisition, it gives Blackstone, 2800 hotels including brands like Hilton, Double Tree, Embassy Suites, Hampton Inn, Home wood suites, and the Waldorf Astoria collection under this500000  hotel rooms.

Blackstone now a budget business hotel chain, it is a real estate investment group for $8bn, and already has global assets under which total of 100000 rooms. This deal comes two years after Hilton Hotels Corporation merged with Hilton International. Hotel deals have quickened even faster compared with last year's $70bn plus estimated. The Blackstone Hilton deal means, deals in the hotel sector so far which is already outstripped.

Morrison takes Safeway Plc, which is the grocery retailer giant in the UK. This is the fourth largest supermarket 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 involved and this is to reduce the struggling competition between the leading competitors (Koenig, Kramer and Vogel, 2014). Mergers and acquisitions are still one of the areas of finance that will attract interest from publically and finance analysts and managers. It has a horizontal integration of merger the company expresses the same interest.

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

Conclusion

This report is based on financial management, it is a very crucial part of any business. It is used for the right allocation of resources to earn more profit. In this report, I concluded that dividend policy is relevant and it considered that it affects the value of the firm. The dividend is a profit that is distributed to the shareholder by the company, and it is a type of reward. In this report, I am also explaining the different types of dividend policy theories. In the other part, I explain 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 help any business and company to expand their entire business in terms of revenue and goodwill. Corporate finance's main aspects are merger and acquisition because it is based on corporate strategy.  In this report, I concluded that merger and acquisition both help in business to maximize shareholder wealth.

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References

  • Baker, H.K. and Weigand, R., 2015. Corporate dividend policy revisited. Managerial Finance41(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 a 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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