(a) Define and explain the concept of merger, takeover and amalgamation. What leads to the failure of a merger or an acquisition?…

(a) Merger, Takeover, and Amalgamation

Definitions and Concepts A Merger is a legal combination of two or more companies where at least one pre-existing entity survives. It typically takes the form of an "absorption," where the assets and liabilities of the disappearing entity vest in the surviving company. A Takeover refers to the acquisition of control over a target company, usually through the purchase of a majority of its shares or assets; the target may continue to exist as a subsidiary. Amalgamation, as defined in section 2(1B) of the Income-tax Act and AS 14, covers both forms: absorption of one company into an existing company, and consolidation of two or more companies into a new company formed for the purpose. In the narrower sense used to contrast it with merger, the transferor companies are dissolved without winding up under a scheme sanctioned under sections 230–232 of the Companies Act, 2013, and their assets and liabilities vest in the new company. Takeovers of listed companies are governed by the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.

Causes of Failure Mergers and acquisitions often fail due to:

• Overpayment: Hubris leads to paying a premium far exceeding the target's intrinsic value.
• Culture Clash: Incompatible organizational cultures and management styles cause internal friction.
• Inadequate Due Diligence: Failing to uncover hidden liabilities or legal issues.
• Lack of Integration: Absence of a pre-signed integration plan leads to operational chaos.
• Talent Flight: Key employees leave due to uncertainty or restructuring.

Ensuring Success To ensure success, a company must:

• Conduct comprehensive financial, legal, and HR due diligence.
• Perform conservative valuations to avoid overpaying.
• Develop a detailed integration roadmap before the deal closes.
• Retain key personnel through retention incentives.
• Establish a board-level Project Management Office (PMO) to track synergy realization.

(b)(i) Leverage Calculations

Given Data: Sales = ₹80 lakh; Variable Cost = ₹56 lakh; Fixed Operating Cost = ₹8 lakh; Fixed Finance Cost = ₹4 lakh.

Working Notes:

• Contribution = Sales - Variable Cost = 80 - 56 = ₹24 lakh
• EBIT = Contribution - Fixed Operating Cost = 24 - 8 = ₹16 lakh
• EBT = EBIT - Fixed Finance Cost = 16 - 4 = ₹12 lakh

Calculations:

• Degree of Operating Leverage (DOL) = Contribution / EBIT = 24 / 16 = 1.5
• Degree of Financial Leverage (DFL) = EBIT / EBT = 16 / 12 = 1.33
• Degree of Combined Leverage (DCL) = DOL × DFL = 1.5 × 1.33 = 2.0

Interpretation: The DOL of 1.5 indicates that a 1% change in sales results in a 1.5% change in EBIT. The DFL of 1.33 shows that a 1% change in EBIT leads to a 1.33% change in EBT. The DCL of 2.0 signifies that a 1% change in sales will cause a 2% change in EPS.

(b)(ii) Change in EPS

Given: Sales increase by 20%.

Calculation: Using the DCL calculated in part (i):

• Percentage Change in EPS = DCL × Percentage Change in Sales
• Percentage Change in EPS = 2.0 × 20% = 40%

Absolute Change:

• New EPS = Current EPS × (1 + 40%) = 9 × 1.4 = ₹12.60
• Change in EPS = 12.60 - 9 = ₹3.60

Result: A 20% increase in sales will result in a 40% increase in EPS, raising it from ₹9 to ₹12.60.

(c)(i) NI Model Calculation

Given: Leverage (L) = Debt / (Debt + Equity). At 20% leverage, Cost of Equity (Ke) = 18%.

Analysis: Under the Net Income (NI) model, the cost of equity (Ke) and cost of debt (Kd) are considered constant regardless of the level of leverage. The model assumes that as a company adds more debt, the risk to equity holders does not increase because the debt is serviced from earnings.

Calculation: Since Ke remains constant under the NI model:

• Ke at 40% leverage = Ke at 20% leverage = 18%

Result: The cost of equity at 40% leverage remains 18%.

(c)(ii) NOI Model Calculation

Given: Overall Cost of Capital (Ko) = 16%. Leverage at 20%: Ke = 18%. Leverage at 40%: Find Ke.

Step 1: Calculate Kd Using the NOI model formula: Ko = Kd × (D/V) + Ke × (E/V) At 20% leverage (D/V = 0.2, E/V = 0.8): 16 = Kd(0.2) + 18(0.8) 16 = 0.2Kd + 14.4 1.6 = 0.2Kd Kd = 8%

Step 2: Calculate Ke at 40% Leverage At 40% leverage (D/V = 0.4, E/V = 0.6): 16 = 8(0.4) + Ke(0.6) 16 = 3.2 + 0.6Ke 12.8 = 0.6Ke Ke = 21.33%

Result: Under the NOI model, the cost of equity at 40% leverage is 21.33%.