Kappa Pro-Plc the Managerial Team Essay

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593)

Pike and Neale (2006, p.454) peg the impact to the return shareholders require on their investments (ke) -- if ke is lower than the expected return on the new investment, the dividend cut has a positive impact on organizational value; if ke is higher than the ROI on the new investment project, the impact is that of decreasing the firm's value; finally, if the two ratios are similar, the impact is neutral.

g) Pros and Cons of Mitilin Bros Takeover

Arguments in favor:

Diversification of activities and incomes, which translates into lower levels of risk

Access to a wider customer market

Benefits derived from the extensive expertise of the managerial team at Mitilin Bros

Increases in income and the gaining of a stronger competitive position

From a theoretical standpoint, the acquisition of Mitilin would be beneficial due to its ability to "ensure management accountability, offer easy growth opportunities, create mobility of resources, avoid gestation periods and hurdles involved in new projects, offer a chance to sick units to survive and open up alternatives for selective divestment" (Kazmi, p.191)

Arguments against:

Mitilin sells its products to a further global region, meaning that it would be difficult to centralize the operations and decisions

The company operates in a different currency (the euro, as opposed to the Great British pound), meaning that difficulties in accounting and necessity for hedging against currency risks would arise

From a theoretical standpoint, the takeover would be undesirable as it could lead to personnel downsizing, the need to cope with the hidden liabilities of the target organization (Mitilin Bros), cultural / managerial conflicts or the possibility of price increases (Spiritus Temporis, 2005)

h) Relative P/E

Compared to the more commonly used price-earnings ratio which assesses the price of a share in terms of earnings per share, the relative P/E ratio compares this price against the prices of other organizational stocks within the market (Damodaran, 2002, p.487). The implementation of a relative P/E ratio would also be useful as it would allow an analysis of the company's evolution in time. Generally, a relative P/E assessed as time evolution indicates a strong relationship with the company in the meaning that relative P/E develops in the same direction as the relative growth and the relative risk. Furthermore, the ultimate advantage of relative P/E is that it is not influenced by other organizational ratios, but remains rather objective (New York University, Leonard N. Stern School of Business). The financial advantage of such an endeavor would rely in the registration of a combined net income of £195 million. Furthermore, due to the 1:4 conversion rate, KP would only have to assign 12.5 million shares in order to purchase the totality of Militin stocks.

i) Maximum offer price

Based on the principles of the free cash flow method of organizational valuation, the Kappa Pro-Plc would offer a maximum price of Militin Bros' net income, discounted by the cost of capital (Koller, Goedhart, Wessells and Copeland, 2005, p.166). Considering a 10% cost of capital (debt), the maximum offer would be of £60 x 0.9 = £54 million.

j) Cash vs. stock

The final decision on the payment mechanism depends on the internal features of each organization, but both alternatives present advantages and disadvantages. For once, issuing stock reduces the control of the owners, who will be forced to include the new investors in the decision making process. Then, payment in cash generally implies either debt, either a reduction in the firms' future development opportunities. On the other hand, cash payments reveal the advantage of maintained control and lower costs, with the specification that debt is tax deductible. The main benefit of stock is that the payment of dividends does not represent a priority in the face of creditors and other organizational obligations (Fabozzi and Peterson, 2003).

k) Bid's impact on share price

A final question that has to be asked refers to the impact on the share's price upon a bid made for the acquisition of Militin Bros. The question is a fairly complex one and the literary sources answering it are extremely scarce. Yet, it can be assumed that the price will increase. The explanation is a fairly simple one -- investors realize the growth and development opportunities created by Kappa Pro-Plc's prospective purchase of Militin and buy more shares in order to be included in the distribution of the larger profit; this increased demand leads to increases in the prices of the KP share.

Based on the previously assessed elements, it is now safe to recommend the selection of the second alternative -- that of external expansion through the acquisition of Militin Bros. This recommendation is based on the multitude of comparative advantages offered by the alternative, such as the increased access to a wider market, the diversification of the portfolio with the adjacent reduction of risks or the increased expertise of the managerial team at Militin. In terms of financial impacts, these vary based on the payment mechanism selected. If we chose cash, we will need to increase the levels of debt; on the other hand, if we select equity, we will save money, but lose control. Given this status quo, combined with the numerous advantages and disadvantages of both alternative payment mechanisms, the structure of the capital (from the analysis of the optimal weighted average cost of capital) and Modigliani and Miller's second proposition, it is recommended that we select debt as the main payment method.

References:

Calamos, N., 2003, Convertible Arbitrage: Insights and Techniques for Successful Hedging, John Wiley and Sons, ISBN 0471423610

Damodaran, a., 2002, Investment Valuation: Tools and Techniques for Determining the Value of Any Asset, 2nd Edition, John Wiley and Sons, ISBN 0471414905

Evatt, B., Adopt an Optimal Capital Structure to Improve Shareholder Value, Burleigh Evatt, Retrieved from http://www.burleighevatt.co.nz/Document.aspx?Doc...pdf on September 9, 2009

Fabozzi, F.J., Peterson, P.P., 2003, Financial Management and Analysis, 2nd Edition, John Wiley and Sons, ISBN 0471234842

Kazmi, Strategic Management and Business Policy, Tata McGraw-Hill, ISBN 0070263620

Koller, T., Goedhart, M., Wessells,…[continue]

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