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Examine whether the use of cash reserves for the acquisition of other companies would increase a Company’s share price. Is this a good alternative to share buy-back?

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Introduction

Examine whether the use of cash reserves for the acquisition of other companies would increase a Company's share price. Is this a good alternative to share buy-back? The assessment of an expansion as such from a firm attaining another enterprise relies upon the circumstances of the acquisition made and the environment in which the firm operates. The 1980's situation where there was a boom in takeovers and mergers boom provides a good source of analysis in this subject matter. There is no uncertainty about the effect of leveraged acquisitions on the shareholders of companies that were takeover targets, from historical data on this subject matter. By the end of the 1980s, shareholders in leveraged acquisitions gained significant wealth. Analysts disagree only over the amounts gained. It seems that on average, stock prices increased 20 percent over pre-announcement prices for mergers, 30 percent for tender offers, and 20 percent to 37 percent for leveraged buyouts7. With bidding firm shareholders breaking even and target shareholders enjoying significant gains, leveraged acquisitions in the past two decades have produced a total shareholder wealth increase. It was found that average value improvement (the total gains by bidder and target shareholders) was 45 percent of the value of the target. ...read more.

Middle

Cost of raising external capital for the firm if dividends are paid out; (c) Opportunity cost of using payout for productive investments******. Even if competing bidders do not appear, a seller's shareholders could use the bidder's disclosures to price their stock before consummation of the acquisition, capitalising the expected gain in the pre-acquisition stock price. The run-up in target stock price affects the acquisition price. At minimum, a seller's managers would bargain for an advantageous price based on the bidder's disclosures. What seller in any line of business would not want credible evidence of a buyer's bottom line price? The early disclosure requirements exacerbate two of the market phenomena mentioned above. Both the winner's curse and competition among bidders weakens winning bidders when all bidders are required to reveal their material information on the potential benefits of the target's assets. This begs the question ultimately as to whether share repurchases are preferable to dividend payment in view as a means for distributing cash to shareholders. Repurchases permit the shareholder to collect cash payment than dividend returns. A shareholder who pays a higher tax rate on this income than capital gains would prefer repurchases to dividend payout. To see a brief example of share repurchasing benefiting in the same way as shares we assume9: * Company A earns �4.4 million in 1981 and wishes to pay out half of this as dividends or repurchase. ...read more.

Conclusion

As mentioned before, debt interest is tax deductible, while the cost of dividends is not. The abolition of advance corporation tax, and 1997's ditching of the associated dividend tax credit, has decreased attractiveness of dividends to non-taxpayers such like pension funds - that can no longer reclaim the credit. It has also made it easier for companies to return cash to shareholders via share buy- backs. Companies are therefore developing an improved understanding of the "cost" associated with equity (which is equivalent to the rising dividend payments businesses are expected to make.)******** I know buybacks can also be beneficial in the alternative for paying high unsustainable dividends, whilst 'preserving choice for investors' (long-term pay out ratio sufficient to satisfy shareholder needs shareholder needs).10 I do think ultimately the optimal and effective way to raise a share price of companies is to acquire a firm with cash reserves (that may deplete in the short term) and the long run benefits are more profound providing the managers have scrutinised the project in every scenario and aspect, otherwise the cash reserve that would be '...burning a hole in companies pockets..'(Wagener, Director-general of the Association of Corporate Treasurers). For consideration though, is the danger managers with excess capital obtain a sense of comfort, and power to take on riskier projects (in the form of perhaps furthering firm acquisition), will take on other business ventures mindlessly, dipping into activities they have no real knowledge of. ...read more.

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