Net Present Value
End of the Year
Cash Flow CF
Discount Rate DR*
Present Value
at 9%
CF/DR
0
-10,950,000
1.00
(10,950,000.00)
1
4,500,000
1.09
4,128,440.37
2
4,500,000
1.19
3,787,559.97
3
4,500,000
1.30
3,474,825.66
4
4,500,000
1.41
3,187,913.45
5
4,500,000
1.54
2,924,691.24
6
4,500,000
1.68
2,683,202.97
7
4,500,000
1.83
2,461,654.10
11,698,287.76
NPV=
11,698,287.76 – 10,950,000
=
748,287.76
*Equal to Required Rate of Return
Internal Rate of Return (Trial-and-Error)
End of the Year
Cash Flow
Discount Rate DR
Present Value
CF
at 12%
CF/DR
0
-10,950,000
1.00
-10950000.00
1
4,500,000
1.12
4017857.14
2
4,500,000
1.25
3587372.45
3
4,500,000
1.40
3203011.12
4
4,500,000
1.57
2859831.35
5
4,500,000
1.76
2553420.85
6
4,500,000
1.97
2279840.05
7
4,500,000
2.21
2035571.47
9,586,904.42
NPV=
9,586,904.42 – 10,950,000
=
(1,363,095.58)
Computation 1
Computation 2
Using Interpolation
0.35
Computation 1
1.06
Computation 1 multiplied by Computation 2
10.06
Add to r1
Approximately the IRR is 10%
1. Since the NPV has positive value (L 748,287.76), the expansion of product line of Fijisawa tends to increase investors wealth, thus, should be a worth while strategy. In the same manner, the IRR is greater than the required rate of return at approximately 10% versus 9% supporting the profitability of the expansion. However, as the NPV value is a mere 6.8% of the initial investment and there is only 1% difference between the rates of return of the expansion relative to the requirement of investors, the figure suggests minimal return for investors despite seven years waiting to recoup and profit from their investments. Aside from minimal compensation to adhere the time value of money, the investment also failed to sufficiently compensate investors from the risk of the new product line being eaten by competition or ignored by customers. Due to this, it is concluded that other investment alternatives should be sought and make this option the last resort.
2. Capital budgeting directly affects the long-term investment decisions of the firm (see appendix 1) to remain consistent to its goals (2002 ). It embodies the intention of the firm and sustains the relationship its culture affords to offer to its stakeholders. Thus, when capital budgeting has erred to protect its intentions and fails to derive its culture planted to (say) debtors, it may not receive the previous support from their financing. This can be in the case when the firm fails to accurately forecast its cash inflows that tell the profitability of an engagement. As it is strategic in nature, the capital budgets should be flawless when prepared and translated to a project. As an example, Airbus and Boeing had committed substantial resources to build A380 and Sonic Cruiser respectively (2003 ). If their capital budgeting has flaws, it is difficult to reverse the strategy due to the substantial costs of initial outlay or some outstanding contracts with suppliers as well as customer expectations for improved technology. And when Airbus or Boeing continued overturn their budget loopholes, they would suffer from stakeholder doubts that can result to reduce share attractiveness, broken supplier relationship, cancelled orders and lost opportunity in the airline industry.
3. Payback period method is advantageous when a firm tightly adheres to the time value of money concept, that is, the money to be received in the future has higher risks and lower value than the same amount of money on-hand today. This becomes crucial when a firm is bound to be acquired in which its objective is not to maximize profits rather minimize the time required to recoup investments (say) for a period of two years in which it is also bound to be formally acquired. Alternatively, its computation (see appendix 2) ignores time value of money due to the absence of discounting cash inflows to find their present values (1999) unlike NPV or IRR. Nonetheless, it is used frequently because it is the most popular and easily understood investment appraisal techniques (p. 357). Easy it is because it is internally-driven from the view and subjectivity of the firm preventing technical calculations and market research in favor of the “fastest way to recover investment” rule. .
4. From the period 1960 to 1992, Africa remained the region with the highest expropriation activity ( 1994). There are several options to consider such risk in view of my investment there. First, I can deploy foreign direct investments (FDI) provided that the government assures their investors protection through just compensation (Brownsville v. Pavazos) whenever a local bill is passed to exercise certain rights that only expropriation can obtain. Second, I can opt to rely on research findings to rationalize my decision to the risk of my business as an FDI. If my business is on agriculture, oil exploration or other natural resource utilizing or depleting, I would not dare to enter the region since they are the most active expropriation areas (1994). Considering that there are countries in Africa that uses selection rather mass expropriation, in the contrary, such could serve as a fair destination. Lastly, I can get out of my optimal dream of the region’s abundant resources and have practical and less risky portfolio investments in the South African stock exchange (). This can be a sub-optimal substitute but coupled with fixed, continuous and less anxious returns suitable for risk-averse, unrelated firms.
5. Mergers and acquisitions seldom results to added value expected can be suspected from over expectation of the acquirer. News Corporation expected to finally have its legacy after Direct TV acquisition ( 2004). However, with the post-merger outcome wherein the acquirer only have at most 30% stake in the latter (Direct TV website), the added value may not be suffice to call the acquisition successful. As a matter of fact, there was no acquisition but merely portfolio investment. In effect, there was a lack of accurate evaluation of the target response and necessary adjustments in the earlier pronouncement of acquisition goals to react to it. Thus, expected value is overvalued and is likely to be assessed as failure unless there emerge untoward developments like stock market bubble in the post-merger/ acquisition. Freezing this hypothesis, the primary factor would also be found within human specific characteristics since it is only the part of an organization that derives motivation for optimal performance.
There are different reasons for merger and acquisitions and examples can illustrate these. HP acquired Compaq to not overly rely on its well-known businesses of printers and computer accessories but to intensely compete on the PC industry; consequently, the merged firm overtook IBM in terms of market and revenues (). On the other hand, Merck & Company was trailed by its competitors replacing the former in the number 1 spot in pharmaceutical industry as it resisted acquiring a successful firm and minimizing the cost and time spent on internal drug research and development (). Lastly, the Australian-based News Corporation, the owner of Twentieth Century Fox and other international media firms, acknowledged its offered acquisition to satellite pay television leader in the US market, Direct TV, would make its ultimate objective of being the world’s largest media company (2004).
Such citations have different causes and implications. HP wanted to increase market power and reshape its competitive scope, Merck & Company is bounded to significantly spend and wait for new-product development, and News Corporation aspired to overcome entry barriers, reduce risk of developing new products and increase diversification (). On the other extreme, not all acquisitions are successful particularly in delivering the expected added value for the merged firm (). The acquirer may have conducted inadequate evaluation of target leading to too much diversification or large extraordinary debt. The merged firm also may have integration difficulties that result to inability to achieve synergy, being large without substance and managers overly focused in acquisition disregarding managerial functions for sustainable growth.
In 1989, HP acquired Apollo workstation business. HP had succeeded to integrate the compensation, engineering and marketing aspects of the merged firm (1998). However, the last aspect they have intricacy to deal with is the different work philosophies of each firm employee. HP environment foster cooperation while Apollo allows competition between teams. Another, the former is customer-focused while the latter is technology-focused. This example is basically a submission that intangible resources are unique to a firm and is difficult to imitate unlike tangible assets. As a result, the pre-merger goals of HP and Apollo of increased market power and generate cash flow respectively is not easily attained. In this case, the human-side dictated the major post-acquisition problem. And since organizational culture is the social energy that drives or fails to drive a (merged) firm towards its goal (), resolving the behavioral conflict was also the major focus of the new firm.
The expectation not only on added value per se but also considering the period in which they can be obtained and integrated by people is a function of three merger effects: namely, looking over one’s shoulder, win-loss game and feeling of isolation ( 2000). They are demoralizing effect of post-merger downsizing, inconvenience and adaptation of/to the new firm. Ultimately, as what happened in HP-Apollo case, the integration of physical, financial and technological resources were completed faster than organizational resources and culture. This is because culture grows over time. And since humans are the foundation of capabilities (), core competencies cannot be simply obtained from resources. They are also subjected to behavioral adjustments of integration.
In a different case, there are acquisitions that did not submerge the culture of the acquired into the acquirer. AT&T let McCraw Communications preserve its entrepreneurial, philanthropic and casual culture (). Similarly, IBM did the same when it acquired Lotus. The former let the latter to price their unit products and even mimic some of Lotus work style like attending meeting in non-formal clothes. The preservation of cultural identities is crucial particularly when the acquired firm has business that is new or unfamiliar with the acquirer. This idea gives the acquirer bigger bargaining power to retain its philosophies and business strategies. Otherwise, the advantages of the acquired firm skills and knowledge cannot be exploited by the acquirer.
In cross-border acquisitions, a research was conducted to study the reasons of underperformance of two firms since the acquisition: one is a UK company and German subsidiary and the other is A German company and UK subsidiary (2003). For the former case, the study showed that cultural differences of firms blemish acquisition strategy because of homogeneity of control system particularly in accounting methods. The UK company underestimated the finance function of Germany and showed uncompromising approach to German’s precise accounting models. In effect, the added value of vertical integration it aspires with the acquisition has yet to be obtained at the time of the study. On the other hand, the German company do not see this as success barrier instead the lack of control system that focus on strategic objectives.
Price leadership strategy is undermined in both cases in favor of product differentiation and innovation. In both cases, the firms obtained their own accounting method that undermines the value of currency exchange fluctuations to overall profit but continued their entrepreneurial skills. Also, there are merely special visits to assess proper controls on subsidiaries deepening the problem of financial integration. Seemingly, there were substantial looses on efficiency and economies of scale hindered by language barriers and local knowledge. And so, not only the firm-specific culture was hampering the value added expectation by mother companies but also country specific. This communication, coordination, integration and adaptation difficulties all sum-up to make sense with the underperforming post-acquisition scenario.
Appendix 1: Corporate Goal, Financial Management and Capital Budgeting
Appendix 2: Payback Period Method Example
Turbo charge is considering one of the following two investments.
Machine X
Machine Y
Net cash flow (after tax):
£
£
Year 1
4,000
15,000
Year 2
5,000
6,000
Year 3
16,000
4,000
Total cash flow
25,000
25,000
Initial investment (cash outlay)
25,000
25,000
Payback Period (PBP)
3 Years
3 Years
Credit:ivythesis.typepad.com
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