Strategic Financial Management

Units as per Syllabus

1.Introduction and Ethical Aspects in SFM

2.Risk Analysis & Classification

3.Investment Decision and Project Cash Flows

4.Capital Budgeting Decisions

5.Expansion and Financial Re-structuring

6.Corporate Governance and Valuation

 Expansion and Financial Re-structuring
• Need for financial restructuring –
• Restructuring through privatization
• Restructuring of sick companies –
• Mergers and amalgamations –
• Evaluation of M&A decisions (problems)
• legal procedure for merger –
• Benefits and cost of merger;
• Corporate and distress restructuring –
• Demergers- Leverage buyout-share repurchases-Spin off-
Divestiture.
 The privatization initiative has as its objectives the
following:
• To reduce the fiscal burden and to permit industries to raise funds
from the capital market.
• To increase competition and efficiency and induce technological
modernisation as well as provide better consumer services.
• To encourage broad-based share ownership in the society.
• To create an enterprise culture.

Air India: The government of India considered the privatization of Air India to be
a significant milestone in its privatization drive.

Maruti Suzuki: Maruti Udyog was sold to Japan's Suzuki Motor Corporation and
renamed Maruti Suzuki India. Maruti Suzuki India is now India's largest
carmaker.
 Introduction
• Corporate restructuring includes mergers
and acquisitions (M&As), amalgamation,
takeovers, spin-offs, leveraged buy-outs,
buyback of shares, capital reorganisation
etc.
• M&As are the most popular means of
corporate restructuring or business
combinations.
• Why corporate restructuring?
 Corporate Restructuring

Corporate Restructuring

Competition

Globalisation Technology
 Corporate Restructuring helps in

• Reorganisation
• Realignment of Assets & liabilities of
• Reorientation organisation

That Results in
Effective, Efficient & competitive manner so that
Increase in Market share
Increase in Brand Image
Synergies
 Mergers and Acquisitions
• Mergers and Acquisitions M&A, have become very popular
strategy all over the world in last 3 decades.
• The value of global mergers and acquisitions (M&A) deals in
2023 was $2.5 trillion
• PVR and INOX merged in February 2023 to form PVR
Inox, India's largest multiplex chain
• Tata Steel-Corus(UK) Acquisition by Tata Steel for $12
Billion is very significant and a landmark for the Indian
Corporate World.
• Prosus and BillDesk: Prosus acquired BillDesk, an
Indian payment service provider, for $4.7 billion
• Adani-NDTV: An acquisition that took place in India
• Air India-Vistara: A merger that took place in India
 Difference Between Merger And Acquisition
Merger Acquisition
1. Merging of two organization 1. Buying one organization by
into one. another.
2. It is the mutual decision. 2. It can be friendly takeover or
3. Merger is expensive than hostile takeover.
acquisition(higher legal cost). 3. Acquisition is less expensive
4. It is time consuming and the than merger.
company has to maintain so 4. It is faster and easier
much legal issues. transaction.
5. Dilution of ownership occurs 5. The acquirer does not
in merger. experience the dilution of
ownership.
 Acquisition: why & Why Not
Why Is Important Problem With Acquisition
1.Increased market 1.Inadequate valuation
share. of target.
2.Increased speed to 2.Inability to achieve
market synergy.
3.Lower risk comparing 3.Finance by taking huge
to develop new debt.
products.
4.Increased
diversification
5.Avoid excessive
 Merger: why & Why Not
Why Is Important Problem With Merger
1.Increase Market Share. 1.Clash of corporate
2.Economies of scale cultures
3.Profit for Research and 2.Increased business
development. complexity
4.Benefits on account of 3.Employees may be
tax shields like carried resistant to change
forward losses or
unclaimed depreciation.
5.Reduction of
competition.
 Types Of M&A

Horizontal merger Vertical merger

 Types Of M&A
• Horizontal mergers:
– A horizontal merger involves two firms operating and
competing in the same kind of business activity.
– Example: Tata Motors & Jaguar Land Rover
• Vertical mergers:
– Vertical mergers occur between firms in different
stages of production operation.
– Example: Zee Entertainment & Dish TV
• Conglomerate Merger:
- Reliance Industries & Viacom 18
 Motives & Benefits of M&A
• Accelerated Growth (Expansion)
• Enhanced Profitability (Synergy)
• Diversification of Risk
• Reduction in Tax Liability (Loss Set-offs)
• Financial Benefits
 The Cost of M & A
• External growth could be expensive if the
company pays an excessive price for
merger. Price may be carefully determined
and negotiated so that merger enhances the
value of shareholders
The Cost to Stockholders from Reduction in Risk
• In a firm with debt, the gains are likely to be
shared by both bondholders, and stock holders.
The benefit gained by bond holders are on the
expense of stock holders.
• The gains to the creditors are at the expense of
the shareholders if the total value of the firm
does not change.
• An acquisition can create an appearance of
earnings growth, which may fool investors into
thinking that the firm is worth than it really is.
The Cost to Stockholders from Reduction in Risk
• The Base Case
• If two all-equity firms merge, there is no transfer
of synergies to bondholders, but if…
• One Firm has Debt- The value of the levered
shareholder’s call option falls.
• How Can Shareholders Reduce their Losses
from the Coinsurance Effect?
• Retire debt pre-merger.
 Value Creation
• Economic Advantage (EA)
PV of merged firms is greater than the sum of
individual present values as separate entity.

PV(AB) > PV(A) + PV(B)

EA = PV(AB) – (PV(A) + PV(B)))
 Value under M & A
• Discounted Cash Flow (DCF) Approach
• Adjusted PV and Capital Cash Flow (CCF) Approach
• P/E Ratio & EPS Analysis
 Financing the M&As
• Cash Offer
• Shares Exchange
• Mezzanine Financing
 DCF Approach
• Estimation of Free Cash Flows over the
Horizon Period
• Estimation of the value of CF beyond
Horizon Period (Horizon Value)
• Discount Rate
 Adjusted PV and Capital Cash Flow (CCF)
Approach
Adjusted Present Value separates a firm's value into two
components: its value if financed entirely by equity, and
the present value of tax shields and other financing
effects.

Adjusted Present Value = Unlevered Firm Value + NE

where:NE = Net effect of debt​
Capital Cash Flow: Finally the CCF approach
incorporates the effect of Debt on PV of Cash flows.
i.e Tax shield for use of Debt.
 Exchange Ratio
Earning Approach
• The acquiring firm must consider the effect the
merger will have on the EPS of the merged or
amalgamated corporation.
• EPS is the base for swap ratio.
= EPS of the acquired company
EPS of the acquiring company
• For example: Times Bank & HDFC Bank Ltd
= EPS of the Times Bank
EPS of the HDFC Bank
 Market Value Approach
• The exchange ratio is determined keeping in view the
market values of the companies shares involved in in the
merger.
= Market price per share of the acquired company
Market price per share of the acquiring company
• For example: Times Bank & HDFC Bank Ltd
= Market price per share of the Times Bank
Market price per share of the HDFC Bank
 Book Value Approach
• The exchange ratio is determined according to the
book values of the concerned companies shares.
= Shareholders Funds or Networth
No of equity shares No of equity shares
= Book value per share of the acquired company
Book value per share of the acquiring company
• For example: Times Bank & HDFC Bank Ltd
= Book value of the Times Bank
Book value of the HDFC Bank
 Negotiated Value Approach
• A negotiation process conducted for
the merger or joining of two companies into a
single business entity, or the outright purchase of
a company by another company.
• More numbers M & A deal with Negotiated
value.
Corporate Restructuring Activities
Acquisitions
 Mergers
 Purchase of a unit or plant
 Takeovers
 Business alliances

Divestitures
 Sell offs
 Demergers
 Equity carve outs
Corporate
Restructuring
Ownership Restructuring
 Going private
 Leveraged buyouts

Organisational Restructuring
 Organisational redesign
 Major performance
enhancement programmes
 Reasons For Corporate Restructuring
Reasonable Reasons
• Strategic benefit
• Economies of scale
• Economies of scope
• Economies of vertical integration
• Complementary resources
• Tax shields
• Utilization of surplus funds
• Managerial effectiveness
Unsure Reasons
• Diversification
• Lower financing costs
• Earnings growth
 Takeovers or takeover
• A takeover generally involves the acquisition of
a certain block of equity capital of a company
which enables the acquirer to exercise control
over the affairs of the company.
• A takeover may be done through the following
ways
• Open market purchase
• Negotiated acquisition
• Preferential allotment
 Regulation Of Takeovers

• Takeovers may be regarded as a legitimate

device in the market for corporate control
provided they are regulated by the following
principles:
– Transparency of the process
– Protection of the interest of small shareholders
– Realisation of economic gains
– No undue concentration of market power
 Business Alliances
• Business alliances such as Joint ventures,
Strategic Alliances, Equity Partnerships,
licensing, franchising alliances, and network
alliances have grown significantly.
• In many situations, well-designed business
alliances are viable alternatives to mergers and
acquisitions.
• No wonder they have become common place in
diverse fields like high-technology, media and
entertainment, automobiles, pharmaceuticals, oil
exploration, and financial services.
 Business Alliances….

Here are some examples:

• General Motors and Toyota entered into an
unprecedented (extraordinary) joint Venture
agreement in the 1980s.
• In 1999, IBM announced business alliances
worth $ 30 billion with companies like Cisco
and Dell computers.
• Oracle has over 15,000 alliances with its
business partners.
 Common Forms Of Business Alliances
• Joint Ventures
• Strategic Alliances
• Equity Partnership
• Licensing
• Franchising Alliance
• Network Alliance
 Collaboration
• Process where an organisation join hands with
another organisation which technically or
financially superior and resourceful.
• Collaboration brings both
– Technology
– Funds
 Spinning off / Demerger
• Process where a business division or a product
line of a company is separately reorganized into
a different entity.
• The entity so formed may either be in the form
of a subsidiary company or altogether a separate
company.
• For Example: Ultra Tech Demerger from L &
T
 Hive off
• Sell off loss making division or a product line by
a multi product company.
 Amalgamation
• Amalgamation or consolidation refers to a
situation where two or more existing companies
are combined into a new company formed for
news purpose.
• The old companies cease to exist and their
shareholders are paid by the new company in
cash or in its shares or debenture.
• For Example:
 Amalgamation

R limited Li
q
ui
da
ti
U limited Y limited o
RUBY
n
Pr
oc
es
B limited s

EPS, Profit
& Networth
 Absorption
• In absorption a financially strong company takes
over the business of weak company which loses
its identity.
 Absorption

Face value + Premium

X limited
Assets, P & M, XYZ limited
L & B, BR & Business Only Assets &
Debtors valuation liabilities
Liabilities Assets &
liabilities
Share Capital,
Creditors and
etc Equity shares

Settlement of debt, Liquidation

Creditors & O/ S Expenses
 Motives behind mergers
• The motivations for buyers are as follows.
– To increase the value of the firms stock that is
mergers often lead to increase in stock price and or
price earning ratio.
– To increase the growth rate of the firm.
– To make a good investment a firm may make better
use of funds by purchasing instead of ploughing the
same funds into internal expansion.
– To improve the stability of the firms earnings and
sales.
– To balance or fill out the product line.
 Motives behind mergers
– To diversify the product line when the current
products have reached their peak in the life cycle.
– To reduce competition by purchasing a competitor.
– To acquire a needful resource quickly.
• For example: High quality technology or highly
innovative management.
– Tax reasons: prior tax losses which will offset current
or future earnings
– To increase efficiency and profitability, especially if
there is synergy between the two companies.
 Motives behind mergers
• The sellers motives
– To increase the value of the owners stock and investment in
the firm.
– To increase the firms growth rate by receiving more
resources from the acquiring company.
– To acquire resources to stabilize operations and make them
more efficient.
– Tax reason: if the firm is owned by a family or an
individual a merger makes it easier to deal with estate tax
problems.
– To help diversify the owning family holdings beyond the
present firm.
– Management succession for an entrepreneur or dissension
among top mangers.
Advantages of Mergers and Acquisitions
• Maintaining or accelerating profitable growth of a
company.
• Enhancing profitability through cost reduction.
– Economic of scale.
– Operating efficiency
– Synergy
• Diversifying the risk of the company by way of
acquiring the business of different income streams.
• Reducing tax liability
• Enhancing the market power of the company.
 Value creation
• Value creation
– Marketing synergy
– Operational synergy
– Investment synergy
– Management synergy
 Accounting for Mergers & Acquisition
The entity that has If the business If one of the combining
significantly greater fair combination is effected entities dominates the
value than that of other through an exchange of selection of the
combining entity is equity interests, the management team of
likely to be the acquirer entity that issues the the combined entity, the
equity interests is entity which so
normally the acquirer. dominates is likely to
If one of the combining be the acquirer.
entities dominates the
selection of the
management team of
the combined entity, the
entity which so
dominates is likely to
be the acquirer.
Accounting for Amalgamation – Indian GAAP
– AS14
• This is meant for amalgamation/ merger not acquisition. i.e. where
one company acquires or purchases shares of another company, the
acquired entity is not dissolved and its separate entity continues to
exist.
• AS 14 uses the terms ‘transferor’ (for acquiree i.e. target) and
‘transferee’ (for the acquirer).
• Two types of amalgamation
– Amalgamation in the nature of merger (Amalgamation/
consolidation)
• Pooling of Interests Method
– Amalgamation in the nature of purchase (absorption)
• Purchase Method of Accounting
 Amalgamation in the nature of merger
• All of the following conditions must be satisfied:
– All the assets and liabilities of transferor
companies become the assets and liabilities of
the transferee company.
– Shareholders holding not less than 90% of the
face value of the equity shares of the transferor
companies become the shareholders of the
combined company.
– The purchase consideration is discharged
wholly by the issue of equity shares, except that
cash maybe paid in respect of fractional shares.
Amalgamation in the nature of merger
– The businesses of combining companies is intended to
be carried on by the combined company at least for
five years.
– No adjustment is intended to be made to the book
value of net assets of combining companies while
incorporating the same in the financial statements of
the combined company, except to ensure uniformity of
accounting policies.
 Example: Balance Sheet of Merging and
Merged Firm(s) ( Rs in Crore)
Particulars Firm A Firm B Firm C
(Merging Firm) (Merging Firm) (Merged Firm)
Assets
Net Block 64 77 64+77= 141
Current Assets 24 36 24+36=60
Total 88 113 88+113=201
Liabilities
Share Capital 40 50 40+50=90
Reserve and 10 20 10+20=30
Surplus
Long Term Loans 15 15 15+15=30
Current Liabilities 23 28 23+28=51
Total 88 113 88+113=201
 Amalgamation in the nature of Purchase
• Amalgamation in the nature of purchase is an
amalgamation which does not satisfy any
one or more of the conditions specified in
earlier.
• The pre merger assets and liabilities of the
merging firms become the assets and
liabilities of the firm that absorbs other firms
and all merging companies, except one.
 Methods of Accounting
Pooling of Interest Method Purchase Method
(Amalgamation in nature of (Amalgamation in nature of
merger) purchase)
• Balance sheet of both companies, would be • If Consideration Paid =NAV=Effect
combined at book value without revaluing same as Pooling of Interest Method
assets or creation of goodwill and liabilities.
• If Consideration Paid >NAV =Assets
• Balances of P/L a/c of both companies would
recorded at increased price in
be added or else would be transferred to
General Reserve A/C consolidated B/S, Excess Amount=
• Any difference between consideration paid to
Goodwill
the transferor company and amount recorded • Goodwill written off over a period of
as nominal value of share capital of to the five years.
transferor company is adjusted in general • If Consideration Paid <NAV =Assets
reserves
recorded at written down value in
• The assets & liabilities are valued at their
consolidated B/S, Less amount=
book value or on basis of fair value.
Adjusted as Capital Reserve
• Total Assets-Liabilities=Net Asset Value
• (NAV)
 Pooling of Interest Method
Particulars Firm ABC Ltd Firm XYZ Post Merger Firm
(Rs In Lakh) Ltd (Rs In PQX (Rs In Lakh)
Lakh)
Fixed Assets 100 50 100+50=150
Current 30 15 30+15=45
Assets
Total Assets 130 65 130+65=195

Share Capital 60 30 60+30=90

Debentures 40 20 40+20=60
Current 30 15 30+15=45
Liability
Total 130 65 130+65=195
 Purchase Method
1. Fixed Assets of firm XYZ Ltd are valued at Rs 30 lakh
2. Current assets of firm XYZ Ltd are also valued at Rs 30 lakh.
3. Consideration Paid is Rs 50 Lakh worth equity shares
4. Goodwill= Rs 10 lakh (Balancing figure)
Particulars Firm ABC Ltd Firm XYZ Post Merger Firm
(Rs In Lakh) Ltd ABC(Rs In Lakh)
(Rs In Lakh)
Fixed Assets 50 25 50+30=80
Current Assets 50 25 50+30=80
Goodwill - 0 10
Total Assets 100 50 170

Share Capital 60 30 60+50=110

Debentures 40 20 40+20=60
Total Liability 100 50 170
 Balance Sheet as on 31st March
Liabilities ABC XYZ Assets ABC XYZ
Share Capital Fixed Assets:
Equity Shares of Rs.10 each 550 325 Land and Building 215 135
13% Preference Shares of Rs.10 each 60 Plant and Machinery 400 250
Reserves and Surplus: Furniture 75 50
General Reserve 200 125 Investment 125 80
Development Allowance Reserve 40 Current Assets, Loans &
Advances
Profit and Loss A/c 70 50 Inventories 250 225
Secured Loan: Sundry Debtors 85 50
14% Debentures 200 100 Cash and Bank balance 30 15
Unsecured Loan: Advance Tax 35 30
Fixed Deposit 75 50
Current Liabilities and Provisions:
Sundry Creditors 50 55
Bills Payable 30
Provision for Tax 40 30
1215 835 1215 835
 Legal framework for M&A
The primary statutes governing M&A activity
include:
The Companies Act, 2013;
The Indian Contract Act, 1872;
The Securities and Exchange Board of India Act,
1992;
The Foreign Exchange Management Act, 1999;
The Income Tax Act, 1961;
The Competition Act, 2002; and
The Insolvency and Bankruptcy Code, 2016.
 Legal Procedure for M&A

1. Memorandum of Association (MOA)

2. Intimation to Stock Exchanges
3. Board of Directors- Draft Proposal
4. High Court
5. National Company Law Tribunal (NCLT)
6. Regulatory Authorities – SEBI, CCI
7. Registrar of Companies
• New Market price of both the firms
Particulars Sunny Ltd Rainy Ltd

PAT 3,00,000 75,000

Number of equity shares 50,000 10,000
EPS 3,00,000/50,000 75,000/10,000
Rs.6 Rs.7.5
P/E ratio 3 2
Market price of share Rs.6 *3 = 18 Rs.7.5 * 2 = 15

Swipe ratio = Market price of Sunny Ltd

Market price of Rainy Ltd
= 18/15
=1.2
Every 12 shares in Rainy Ltd, will get 10 shares in Sunny
Ltd.
• New EPS of Combined firm
= Earnings of both the company
No of outstanding equity shares
= 10000*10/12
= 8333.33 shares
New EPS = 300000+75000
50000+8333
New EPS Rs.6.43
• EPS of both the companies
ABC Ltd XYZ Ltd
EAT 50,00,000 6,00,000
No of O/S eqty shares 10,00,000 18,00,000
EPS =50,00,000/10,00,000 = 18,00,000/6,00,000
Rs. 5 EPS is Rs.3
Market price Rs.42 Rs. 28

• Exchange ratio based on market price

= Market price of ABC Ltd
Market price of XYZ ltd
= 42/28
= 1.5
Every 15 shares in XYZ ltd will get 10 shares of ABC Ltd.
Problematic Co. has decided to acquire Diplomatic Company. The following are the relevant
financial data for the two companies.

Problematic Diplomatic
Net Sales (Rs.lakhs) 350 45
Profit after tax (Rs.lakhs) 28.13 3.75
Number of shares (lakhs) 7.5 1.5
Earnings per share (Rs) 3.75 2.5
Dividend per share (Rs) 1.3 0.6
Total market capitalization (Rs in 420 45
Lakhs
Calculate
(a) Pre-merger market value per share for both the companies.
(b) Post-merger EPS, MPS and PE if Diplomatic Company’s shareholders are offered a share of
(i) Rs.30 or (ii) Rs.56, or (iii) Rs.20 in exchange for a merger.
(c) Problamatic's EPS if Diplomatic's shareholders are offered Rs.100, 15% convertible
debentures for each 3 shares held in Diplomatic company.
(d) Post merger dividend or interest available to Diplomatic Company shareholders with
exchanges referred in (b) and (c) Assume 50% tax rate.
Post-merger EPS, MPS and PE if Diplomatic Company’s shareholders are offered a
share of (i) Rs.30 or (ii) Rs.56, or (iii) Rs.20 in exchange for a merger.

Share exchange ratio: Offer Price/ MPS

(i) 30/56 = 0.536
(ii) 56/56 = 1
(iii) 20/56 = 0.357
Number of shares of the Problematic company:
(i) 0.536 × 1.5 = 0.804; Total = 7.5+0.804 = 8.30
(ii) 1×1.5 = 1.5; Total = 7.5+1.5 =9
(iii) 0.357 × 1.5 = 0.535; Total = 7.5 + 0.54= 8.04
Combined EPS: Combined PAT/Combined number
of shares
(i) (28.13 + 3.75)/8.30 = ₹ 3.84
(ii) (28.13 + 3.75)/9.00 = ₹ 3.54
(iii) (28.13 + 3.75)/8.04 = ₹ 3.97

Combined firm’s P/E ratio = Weighted average of

the individual firm’s pre-merger P/E ratio =

{(MPS/EPS) × {(PAT/PAT of Both)}

• {(MPS/EPS) × {(PAT/PAT of Both)}

P = {(56/3.75) × {(28.13/(28.13 + 3.75)}

D= {(30/2.5) × {3.75/(28.13 + 3.75)}

Combined P/E =
14.93× 0.882 + 12 × 0.118 = 14.58
• Market value per share of the surviving firm:

MPS = EPS x P/E

(i)(3.84×14.58) = ₹ 56
(ii)(3.54 ×14.58) = ₹ 51.61
(iii) (3.97 × 14.58) = ₹ 57.88
 Problamatic's EPS if Diplomatic's shareholders are offered Rs.100, 15%
convertible debentures for each 3 shares held in Diplomatic company.

Number of convertible debentures:

1.50/3 = 0.50 lakh
Interest on debenture:
0.50 × ₹ 100 × 15% = ₹ 7.5 lakh
Combined profit after-tax
= (28.13 + 3.75) – 7.5 + (0.5 × 7.5)
P’s EPS after merger = 28.13/7.50 = ₹ 3.75
Post merger dividend or interest available to Diplomatic Company shareholders
with exchanges referred in (b) and (c) Assume 50% tax rate.

Dividend/Interest to D’s shareholders after

merger:
Number of Shares x Div per Share :
(i) 0.804 × 1.30 = ₹ 1.05 lakh
(ii) 1.50 × 1.30 = ₹ 1.95 lakh
(iii) 0.536 × 1.30 = ₹ 0.70 lakh
Interest 0.50 × 100 × 15% = ₹ 7.50 lakh

Pre-merger dividend: 1.50 × 0.6 = ₹ 0.90 lakh

 Distress Restructuring
• Financial Restructuring
• Organisational Restructuring

Select Companies which restructured due to

Distress
Reliance Communications
Reliance Infrastructure
CG Power and Industrial Solutions
Reliance Capital