Special Topics in Financial Management Example:

Reviewer: Final Examination A company has preferred stock that has an annual
dividend of $3. If the current share price is $25, what is
the cost of preferred stock?
CHAPTER 1: PREFERRED STOCK Rp = D / P
Preferred Stock
Rp = 3 / 25 = 0.12 or 12%
- Preferred Stock is also known as preference
shares. These are securities that represent
ownership in a corporation, and that have a Types of Preferred Stocks
priority claim over common shares on the
1. Prior Preferred Stock - refers to the order in
company's assets and earnings.
which preferred stock is ranked when considered
- The shares are more senior than common stock
for prioritization for creditors or dividend awards.
but are more junior relative to bonds in terms of
2. Preference Preferred Stock - considered the
claim on assets.
next tier of stock terms of prioritization. Though
- Holders of preferred stock are also prioritized
it falls behind prior preferred stock, preference
over holders of common stock in dividend
preferred stock often has greater priority
payments.
compared to other issuances of preferred stock.
Features of Preferred Share 3. Perpetual Preferred Stock - Some types of
preferred stock have a fixed end date in which,
1. Preference in assets upon liquidation. The
much like a bond, the original capital contributed
shares provide their holders with priority over
is returned to shareholders. In most cases,
common stockholders to claim the company's
preferred stock is considered perpetual. This
assets upon liquidation.
means that the initial capital invested will not be
2. Dividend payments. The shares provide
returned. An investor must sell their shares at
dividend payments to shareholders. The
their choosing to redeem the shares.
payments can be fixed or floating, based on an
4. Convertible Preferred Stock - allows a
interest rate benchmark such as LIBOR.
shareholder to trade their preferred stock for
3. Preference in dividends. Preferred shareholders
common stock shares. The exchange may happen
have a priority in dividend payments over the
when the investor wants, regardless of the prices
holders of the common stock.
of either share.
4. Non-voting. Generally, the shares do not assign
5. Cumulative Preferred Stock - an equity
voting rights to their holders. However, some
investment that guarantees dividend payments to
preferred shares allow its holders to vote on
shareholders. Unpaid dividends–also referred to
extraordinary events.
as dividends in arrears–accumulate and are then
5. Convertibility to common stock. Preferred
paid out at a future date. Those dividend
shares may be converted to a predetermined
payments are made before any dividends are paid
number of common shares. Some preferred
out to common stock shareholders.
shares specify the date at which the shares can be
6. Noncumulative Preferred Stock - allows the
converted, while others require approval from the
issuing company to skip dividends and cancel
board of directors for the conversion.
the company's obligation to eventually pay
6. Callability. The shares can be repurchased by the
those dividends. This means that shareholders
issuer at specified dates.
do not have a claim on any of the dividends
that were not paid out.
The Cost of Preferred Stock: Formula 7. Participating Preferred Stock - a type of
preferred stock that gives the holder the right to
Rp = D (dividend)/ P (price) receive dividends equal to the customarily
specified rate that preferred dividends are paid to
preferred shareholders, as well as an additional
dividend based on some predetermined condition.
 8. Adjustable Rate Preferred Stock - a type of CHAPTER 2: LEASING
preferred stock that pays out a dividend that is
Leasing
modified by changes in a benchmark rate.
- A common practice in business and personal
Preferred Stock Common Stock
finance, offering flexibility and financial
 Equity ownership  Equity ownership
of a company of a company advantages for both lessors and lessees. There are
 Tradable on public  Tradable on public various types of leases, each with its own
exchanges (for exchanges (for characteristics and implications.
public companies) public companies) Three Types of Leasing
 Have first right to  No guarantee of
dividends and dividends; must 1. Operating Lease - Operating leases, sometimes
must be paid wait until called service lease, provide for both financing
before common preferred and maintenance. Operating leases are short-term
stockholders stockholders are agreements where the lessor retains ownership of
 Typically do not made whole the asset.
have as much  Often has higher 2. Finance Lease - Finance lease sometimes called
capital capital
capital leases, are differentiated from operating
appreciation appreciation
leases in three respects: They do not provide for
 Typically has no  Typically has
maintenance services, they are not cancelable,
voting rights voting rights
and they are fully amortized.
 May have the  Do not have the
option to be option to be 3. Sale and Leaseback - Sale and leaseback, a firm
convertible to convertible to that owns land, buildings, or equipment sells the
common stock preferred stock property and simultaneously executes an
agreement to lease the property back for a
specified period under specific terms.
Right to Vote
- Preferred shares usually do not carry voting
rights, although under some agreements these Financial Statements Effects
rights may revert to shareholders that have not
1. Operating Lease
received their dividend.
- In income statement the lease payments are
Calling of Preferred Stock shown as operating expenses.
- It is often called "Off-balance-sheet financing"
- If shares are callable, the issuer can purchase - Cash payments for operating leases are recorded
them back at par value after set date. If interest as operating cash outflows.
rates fall, for example, and the dividend yield 2. Finance Lease
does not have to be as high to be attractive, the - The financial lease has an effect to income
company may call its shares and issue another statement through depreciation expense and
series with a lower yield. interest expense.
Convertibility - Financial Accounting Standards Board issued
FAS 13 (now referred to as Accounting Standards
- Some preferred stock is convertible, meaning it Codification Topic 840 or ASC 840), which
can be exchanged for a given number of common requires that for an unqualified audit report firms
shares under certain circumstances. The board of that enter into financial leases must restate their
directors might vote to convert the stock, the balance sheets to: report leased assets as fixed
investor might have the option to convert, or the assets, and show the present value of future lease
stock might have a specified date at which it payments as liabilities.
automatically converts.
Other Factors that Affect Leasing Decision
 Residual Value - It is the value of leased property
at the end of the lease term. This is also the
amount of money that a company can expect to
get if they sell the asset once it has been fully
depreciated.
 Increase Credit Availability - The available credit
is the amount of credit you have left to spend on
a credit account. You can calculate your available
credit by subtracting your card's current balance
from its credit limit.
 Warrants - Are derivatives that companies issue
that give investors the right — but not the
obligation to buy company stock at a particular
price on or before the expiration date.
CHAPTER 3: WARRANTS
Warrants
- Also called stock warrants. A long-term option to
buy a stated number of shares of common stock
at a specified price
Types of Warrants
1. Call Warrant - Call warrant provides the holder
with the option to purchase a particular quantity
of a company's shares at a predetermined price
during a specific time frame.
2. Put Warrant - A put warrant gives the holder the
right to sell a specific number of shares of a
company's stock at a predetermined price, within
a certain period.
3. Covered Warrant - Covered warrants are issued
by financial institutions, and they are backed by
the institution's own shares or by shares of
another company.
4. Naked Warrant - Naked warrants are similar to
covered warrants, except they are not backed by
any underlying assets.
Impact of Incorrect Pricing
Incorrectly pricing the warrants on the market price of the
bond can have significant consequences. If the bankers
underestimate the value of the warrants, they may attach
more warrants to each bond than necessary, leading to
more dilution of the original shareholders' equity than
necessary when those warrants are exercised. On the other
hand, if the bankers overestimate the value of the
warrants, the issue may not be sold at the offering price,
and the firm would not obtain the funds it needed.
Call Option Vs. Warrants
When call options are exercised, the stock provided to
the option holder comes from the secondary market; but
when warrants are exercised, the shares provided are
newly issued. As a result, the exercise of warrants
dilutes the value of the original equity, which could
cause the value of the original warrant to differ from the
value of a similar call option.
Use of Warrant in Financing
Small, rapidly growing firms generally use warrants as
"sweeteners" when they sell debt or preferred stock. Firms
often offer warrants along with the bonds. Receiving
warrants along with bonds enables investors to share in
the company's growth, assuming it does in fact grow and
prosper. A bond with warrants has some characteristics of
debt and some characteristics of equity. It is a hybrid
security that provides the financial manager with an
opportunity to expand the firm's mix of securities and thus
to appeal to a broader group of investors. Virtually all
warrants today are detachable. Thus, after a bond with
attached warrants is sold, the warrants can be detached
and traded separately from the bond. Further, even after
the warrants have been exercised, the bond (with its low
coupon rate) remains outstanding.
*’Yong computation sa ppt na lang nila kasi ‘di ko
mintindihan.
CHAPTER 4: CONVERTIBLES
Convertibles
- A "convertible security" is a security—usually a
bond or a preferred stock—that can be converted
into a different security—typically shares of the
company's common stock.
Convertible Bonds
- A convertible bond is a fixed-income corporate
debt security that yields interest payments, but
can be converted into a predetermined number of
common stock or equity shares.
Types of Convertible Bonds
1. Vanilla Convertible Bonds - These are the most
common types of convertible bonds. Investors are
granted the right to convert their bonds to a
certain number of shares at a predetermined
conversion price and rate at the maturity date.
 2. Mandatory Convertible Bonds - Mandatory
convertibles provide investors with an obligation
to convert their bonds to shares at maturity. The
bonds usually come with two conversion prices.
3. Reverse Convertible Bond - Reverse convertible
bonds give the issuer an option to either buy back
the bond in cash or convert the bond to the equity
at a predetermined conversion price and rate at
the maturity date.
Convertible Preferred Stock
- Convertible preferred stocks are preferred shares
that include an option for the holder to convert
them into a fixed number of common shares after
a predetermined date.
Advantages and Disadvantages of Convertible
Securities
Advantages:
1. Ease of Conversion
 The different types of bonds and debentures
which are convertible, allow their owners the
chance to convert them fast and without any
hassle. This allows them to better adapt to market
conditions and in turn effectively earn more in
interest payment.
2. Tax Benefits
 Compulsorily convertible debentures and some
specific types of securities which are convertible
are eligible for tax benefits. The interests earned
on these securities are eligible for deduction from
the total taxable income of an investor. However,
investors must also keep in mind that these
securities might not be eligible for tax benefits
after they are converted.
Disadvantages:
1. Risk of Dilution
 EPS or Earning Per Share rate of the stocks of a
company go down when it introduces convertible
securities. This can lead to further difficulties for
the company in availing any line of credit from a
financial institution for themselves in the future.
2. Risk of Losing Ownership
 When a company converts its securities to
common equity, the majority of shareholders
always run the risk of losing ownership.
Essentially, dilution of the share can lead to the
ownership being diluted across multiple
shareholders.
Conversion Price
- The conversion price is the price per share at
which a convertible security, such as corporate
bonds or preferred shares, can be converted into
common stock. The conversion price is set when
the conversion ratio is decided for a convertible
security.
𝑃𝑎𝑟 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐵𝑜𝑛𝑑 𝐺𝑖𝑣𝑒𝑛 𝑈𝑝
Conversion Price =
𝑆ℎ𝑎𝑟𝑒𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑
Conversion Ratio
- The conversion ratio is the number of common
shares received at the time of conversion for each
convertible security. The higher the ratio, the
higher the number of common shares exchanged
per convertible security.
𝑃𝑎𝑟 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐵𝑜𝑛𝑑 𝐺𝑖𝑣𝑒𝑛 𝑈𝑝
Conversion Ratio =
𝐶𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑃𝑟𝑖𝑐𝑒
Value Components of Convertibles
A convertible security can be as a combination of
a straight bond and a long call option on the shares of the
company. A straight bond is a bond that pays interest at
regular intervals, and at maturity pays back the principal
that was originally invested. A straight bond has no
special features compared to other bonds with embedded
options.
Value of Convertible Security = Value of Straight Bond
+ Value of the Call Option or the Conversion Option
Use of Convertibles In Finance
A “convertible security” is a security—usually a
bond or a preferred stock—that can be converted into a
different security—typically shares of the company’s
common stock. In most cases, the holder of the
convertible determines whether and when to convert. In
other cases, the company has the right to determine when
the conversion occurs.
How Will Companies Know if the Price of Stock is
Temporarily Depressed?
Management may know, for example, that
earnings are depressed because of start-up costs
associated with a new project, but they expect earnings to
rise sharply during the next year or so, pulling up the stock
price. Thus, if the company sold stocks now, it would be
giving up more shares than necessary to raise a given
amount of capital.
How can the Company Make Sure that Conversion
Will Occur if the Stock Price Rises Above the
Conversation Price?
Most convertibles contain a call provision that
allows the issuer to force conversion to the common
stock. Such a provision limits the value associated with
potential growth in the stock price.
A Final Comparison of Warrants And Convertibles
Warrants
It grants investors the right to purchase the underlying
bond, share, or other security at a given price and on a
specified future date. Investors are not obligated to
purchase the underlying security at that particular time or
price, though. Furthermore, an investor must pay the
predetermined amount in order to purchase the stock,
investment, or instrument if they want to exercise their
warrant. A warrant and an option have many
characteristics.
Convertible
Convertible securities offer investors the chance to
repurchase bonds or preferred stocks at a predetermined
price and date in the future. This kind of security is
typically used by businesses who need to borrow funds
quickly or do not have access to conventional finance
sources.
CHAPTER 5: RATIONALE OF MERGERS
Mergers and Acquisition
- Mergers and acquisitions (M&A) refer to
transactions between two companies combining
in some form. Although mergers and acquisitions
(M&A) are used interchangeably, they come with
different legal meanings. In a merger, two
companies of similar size combine to form a new
single entity.
Rationale for Mergers
- Some companies pursue a merger as a one-time
opportunity that arises, whereas others make it an
ongoing strategy they utilize to grow their
business.
Synergistic Effects Can Arise from These Sources
1. Operating Economies
2. Financial economies
3. Differential Efficiencies
4. Increased Market Power
Tax Considerations
- Tax considerations are the potential impact of
taxes on a financial decision. Businesses and
individuals alike factor in tax implications before
making choices to minimize their tax burden and
keep more of their money.
Importance of Tax Considerations
- Financially responsible decisions
- Compliance
- Reduced tax burden
- Decision-making
- Business planning
Purchase of Assets Below Their Replacement Cost
A replacement cost may fluctuate, depending on factors
such as the market value of components used to
reconstruct or repurchase the asset and the expenses
involved in preparing assets for use.
Sometimes a firm will be touted as an acquisition
candidate because the cost of replacing its assets is
considerably higher than its market value.
Purchase of Assets Below Their Replacement Cost
- Cost Savings
- Strategic Advantage
- Increased Profitability
- Market Impact
- Tax Benefits
Things to Consider Before Buying Below Replacement
Cost
- Warranty
- Reason for Discounted Price
- Forced Sale
- Condition of the Asset
- Remaining Useful Life pact
Diversification
Managers often cite diversification as a reason for
mergers. They content that diversification helps stabilize
a firm's earnings and thus benefits.
Manager’s Personal Incentives
Financial economists like to think that business decisions
are based only on economic considerations, especially
maximization of firms' values. However, many business
decisions are based more of managers' personal
motivations than on economic analyses.
Breakup Value
- Breakup value refers to the value of a company if
its individual components (such as business
segments or subsidiaries) were to be sold off or
spun off and operated independently. It is an
important consideration in valuation, especially
when analyzing potential takeover opportunities.
CHAPTER 6: TYPES OF MERGERS
Merger
- A merger is a corporate strategy involving the
combination of two or more companies into a
single entity. This is usually done to achieve
synergies, increase market share, expand into
new markets, or gain competitive advantages.
Types of Mergers
There are five basic categories or types of mergers:
1. Horizontal merger: A merger between companies that
are in direct competition with each other in terms of
product lines and markets
A horizontal merger is a merger between companies that
directly compete with each other. Horizontal mergers are
done to increase market power (market share), further
utilize economies of scale, and exploit merger synergies.
2. Vertical merger: A merger between companies that
are along the same supply chain (e.g., a retail company in
the auto parts industry merges with a company that
supplies raw materials for auto parts.)
Vertical mergers can have mixed effects on small
businesses. On one hand, small businesses may benefit
from increased access to distribution channels or
improved relationships with larger vertically integrated
companies. However, vertical mergers can also create
challenges if small businesses face increased competition
or encounter barriers to accessing certain markets
controlled by the merged entity.
3. Congeneric merger: Congeneric mergers involve the
combining of companies that serve the same customer
base but offer different products or services. This results
in the merged entity becoming able to cross-sell or bundle
products, creating synergies in marketing and
distribution.
A congeneric merger, also known as concentric merger
or product-extension merger is a merger between
companies that are part of the same industry and operate
in the same market but feature a different line of
products.
A congeneric merger, also known as concentric merger
or product-extension merger is a merger between
companies that are part of the same industry and operate
in the same market but feature a different line of
products.
4. Conglomerate merger: A merger between companies
in unrelated business activities (e.g., a clothing company
buys a software company)
These mergers provide the merging companies with the
advantage of diversification of business operations and
target markets. As the merging companies operate in
distinct industries and/or markets, the merged company is
less vulnerable to declines in sales in one industry or
market.
CHAPTER 7: LEVEL OF MERGER ACTIVITY
The level of merger activity in the industry has been
steadily increasing over the past few years. Companies are
seeking to consolidate their resources, expand their
market reach, and gain a competitive edge by joining
forces with other businesses. This trend is driven by
various factors such as the desire for economies of scale,
access to new technologies, and the need to diversify
product offerings.
First Wave (1897 - 1907)
During this period, majority of merger activities – about
two thirds of them – were concentrated in a few industries
which were mainly the dealers in petroleum products,
metals, mining, transportation, and food products. These
industries also became highly concentrated because most
of the mergers were horizontal mergers.
Second Wave (1916 -1929)
It began during the period of the World War I and
persisted until the stock market crash of October 29, 1929.
Due to the heightened Government vigilance that
emerged towards the end of the first Merger Wave, the
Second Merger Wave endured an even greater and
increased Government scrutiny. In addition to the
Sherman Antitrust Act, federal authorities used the
Clayton Act (1914) against uncompetitive mergers.
Third Wave (1965-1969)
This wave was characterized by a period of economic
prosperity in the United States, during which firms had
accumulated significant wealth, allowing them to afford
acquisitions of other companies. The focus was on
diversification and creating conglomerates.
Fourth Wave (1981 - 1990)
Occurring during the economic boom of the 1980s, this
wave saw a mix of friendly mergers and a greater number
of hostile takeovers than in any previous wave. It was a
time of strategic realignments and industry
consolidations.
Fifth Wave (1993 - 2000)
The Fifth Merger Wave lasted from 1993 to 2000, a
period after the economic slump of 1990 to 1991. The rate
at which large mergers were formed was about the same
level as that of the Fourth Merger Wave. However, there
was a major decline in the rate of hostile takeovers. As
compared to the Fourth Merger Wave, creation of debt-
financed mergers had reduced too.
 Friendly takeovers are typically negotiated and
agreed upon by both companies' management
teams.
 The acquiring company may offer a premium to
the target company's shareholders to gain their
approval.
 Friendly takeovers are often driven by strategic
goals such as expanding market presence,
diversifying product offerings, or achieving cost
synergies.
 They generally face fewer regulatory hurdles
and legal challenges compared to hostile
takeovers.
CHAPTER 9: MERGER ANALYSIS
Merger - A legal consolidation of two companies into a
single entity.

Types of Mergers
CHAPTER 8: HOSTILE VERSUS FRIENDLY
TAKEOVER 1. Horizontal Merger - Combines competitors
within the same industry.
2. Vertical Merger - Integrates different stages of
Hostile Takeover the production process.
3. Conglomerate Merger - Merges companies in
- A hostile takeover occurs when one company (the
acquiring company) attempts to take over another unrelated industries.
company (the target company) against the wishes Objectives of Mergers
of the target company's management and board of
directors. 1. Economies of scale - Achieve cost savings
through increased production volume.
2. Economies of scope - Leverage shared resources
Characteristics and Strategies and expertise across different business units.
 Hostile takeovers usually involve a direct offer to
3. Market power - Gain a larger market share and
the target company's shareholders.
influence over pricing.
 The acquiring company may use tactics such as a
tender offer or a proxy fight to gain control. 4. Product diversification - Offer a broader product
 Hostile takeovers can be motivated by a desire to range to customers.
gain access to valuable assets, eliminate 5. Tax benefits - Utilize tax advantages of the target
competition, or achieve other strategic objectives. company.
 They often face legal and regulatory challenges,
as well as opposition from the target company's Steps in Merger and Acquisition
management. 1. Pre-Acquisition Review
2. Search & Screen Targets
3. Investigate & Value The Targets
Friendly Takeover
- A friendly takeover, also known as a friendly 4. Acquire Through Negotiation
acquisition or merger, occurs when the target 5. Post-Merger Integration
company's management and board of directors Valuation in Mergers
are in agreement with the acquisition proposal put
forth by the acquiring company.  Discounted cash flow (DCF) - Estimate the
present value of the merged company’s future
Characteristics and Strategies cash flows.
  Market multiples - Compare the target company’s
valuation to similar companies in the industry.
 Precedent transactions - Analyze past M&A deals
in the same industry for reference.
CHAPTER 10: ROLES OF INVESTMENT
BANKERS
Investment Banker - an individual who often works as
part of a financial institution and is primarily concerned
with raising capital for corporations, governments, or
other entities.
The Role Investment Bankers
1. Arranging Mergers
- The term mergers and acquisitions(M&A) refers
to the consolidation of companies or their major
business assets through financial transactions
between companies. A company may purchase
and absorb another company outright, merge with
it to create a new company, acquire some or all of
its major assets, make a tender offer for its stock,
or stage a hostile takeover.
2. Developing Defective Tactics
- Target firms that do not want to be acquired
generally enlist the help of an investment banking
firm, along with a law firm that specializes in
mergers.
Vocabulary for Defective Tactics
White Knight - A company that is acceptable to the
management of a firm under threat of a hostile take-over
and that will compete with the potential acquirer.
White Squire - An individual or company who is friendly
to current management and will buy enough of the target
firm's shares to block a hostile takeover.
Poison Pill - An action that will seriously hurt a company
if it is acquired by another.
Golden Parachutes - Large payments made to the
managers of a target firm if it is acquired.
3. Establishing a Fair Value
If a friendly merger is being worked out between two
firms' managements, it is important to document that
the agreed-upon price is a fair one; otherwise, the
stockholders of either company may sue to block the
merger. Therefore, in most large mergers, each side
hires an investment banking firm to evaluate the
target company and to help establish the fair price.
4. Financing Mergers
- Financing mergers refers to the process of
obtaining funds to facilitate the acquisition of
merger of companies. This typically involves
securing capital to cover the costs associated with
buying another company or combining
operations.
5. Arbitrage Operations
- Arbitrage generally means simultaneously
buying and selling the same commodity or
security in two different markets at different
prices and pocketing a risk-free return. However,
the major brokerage houses, as well as some
wealthy private investors, are engaged in a
different type of arbitrage called risk arbitrage.
CHAPTER 11: CORPORATE ALLIANCE
Strategic/Corporate Alliance
- A close and collaborative relationship between
two or more entities that share assets, strengths,
risks, rewards, and control. Typically, strategic
alliances have a broad and long-term impact on
corporate performance and valuation. Often,
strategic alliances are formed to create
competitive advantage and greater value for the
partners than they would be able to achieve
independently.
Difference Between Merger and Corporate Alliances
An alliance is a relationship that is formed for some
mutual benefit or to achieve a common goal. Merger, on
the other hand, occur when two separate entities combine
to form one single entity.
Types of Corporate Alliance
1. Joint Venture - In a joint venture partnership, two
parent companies establish a child company. These
alliance partners maintain the relationship by sharing
resources and equity with a binding legal agreement.
Whether formed for a specific purpose or ongoing
strategy, a joint venture has a clear objective, and profits
are split between two companies.
2. Equity Strategic Alliance - An equity strategic
alliance is created when one company purchases a certain
percentage of equity from another company. This is also
referred to as a partial acquisition. If each business
purchases equity in the other, this is called a cross-equity
transaction.
3. Non-Equity Strategic Alliance - Another common
type of strategic alliance is called non-equity. In a non-
equity strategic alliance, two companies sign a contract
agreeing to pool resources, decision-making, and core
capabilities.
Key Benefits of Forming a Joint Venture
o Sharing Assets – Joint ventures allow sharing of
resources like intellectual property, funding, equipment,
and expertise to achieve common goals.
o Sharing Critical Expertise and Experience – Partners in
joint ventures can combine their knowledge, management
skills, and industry experience to enhance the success of
the venture.
o Sharing Costs - Joint ventures enable participants to
divide financial responsibilities, reducing individual
financial burdens and allowing ventures that may not be
feasible independently.
o Sharing Business Risk – Participants in joint ventures
distribute the risks associated with business endeavors,
making it more manageable and less intimidating for each
party involved.
o Access to New Markets – Joint ventures provide
opportunities to enter new markets or access existing ones
more effectively through shared resources and networks.
o Diversification – It allow businesses to diversify their
operations, reducing risk and potentially increasing
profitability by entering new markets or industries.
o Flexibility – Joint ventures offer various structures and
arrangements to suit the needs of participating businesses
while maintaining their individual identities and
operations.
CHAPTER 12: PRIVATE EQUITY INVESTMENTS
Private Equity
- a type of investment that involves investing in
companies that are not publicly traded.
- Private equity firms raise money from investors
and use that money to buy companies.
Steps Involved in A Private Equity Investment
1. Private equity firms raise money from investors.
These investors can be institutions, such as
pension funds and insurance companies, or high-
net-worth individuals.
2. The private equity will source and evaluate
potential investments. The private equity firm
will look for companies that they believe have the
potential for improvement but are also
undervalued.
3. The private equity firm will conduct due
diligence. This is a process of investigating the
company’s financial statements, business
operations, and management team.
4. If the private equity firm is satisfied with its due
diligence, it will then negotiate a deal to buy the
company.
5. Once the deal has closed, the private equity firm
will work with the company to improve its
operations and value. This may involve making
changes to the company’s management team,
investing in new growth initiatives, or cutting
costs.
6. Once the company has been improved, the private
equity firm will then look to exit its investment.
This can be done by selling the company to
another company or taking it public.
Types of Private Equity Investments
1. Leveraged Buyouts (LBOs) - A company is
acquired using a significant amount of debt
financing. The debt is repaid with the acquired
company’s cash flow. LBOs can be risky but also
very profitable.
2. Venture Capital (VC) - VC focuses on investing
in early-stage, high-growth companies with
significant potential. These companies are often
unproven and involve a higher risk, but the
potential returns can be much larger.
3. Growth Equity - Targets established companies
with a history of growth but looking to expand
 further. The private equity firm helps these
companies reach the next level by providing
capital and expertise.
4. Distressed Investing - Targets companies facing
financial difficulties. The private equity firm
attempts to turn around the company through
restructuring, cost-cutting, or new management.
Benefits of Private Equity Investments
- High potential returns
- Access to exclusive investment opportunities
- Diversification
Risk of Private Equity Investments
- Illiquidity
- High fees
- Potential loss
CHAPTER 13: DIVESTITURES
Divestitures
- also known as divestment, involves the partial or
complete disposal of a company’s assets or
business units. This could be done through
various methods such as sales, closures,
exchanges, or even bankruptcy proceedings. The
assets involved in divestitures can be tangible,
like real estate or business divisions, or
intangible, such as intellectual property or
exploration rights. Essentially, divestiture is
about reshaping the company’s portfolio to
optimize its resources and focus on its core
businesses or strategic priorities.
Six reasons why divestitures occur
1. Disposal of underperforming business units
- Divesting underperforming business units is
often a strategic move to cut losses and
refocus resources on more profitable
ventures.
2. Disposal of underperforming business units
- Divesting underperforming business units is
often a strategic move to cut losses and
refocus resources on more profitable
ventures.
3. Resale value increase
- Divesting certain assets or business units at
the right time can maximize their resale
value, leading to higher returns for the
company.
4. Compliance with regulatory requirements
- Regulatory changes or legal obligations may
compel companies to divest certain assets or
business units to comply with antitrust laws,
merger control regulations, or other
regulatory mandates.
5. Disposal of the non-core assets
- Divestitures are often undertaken to shed
non-core assets or business units that do not
align with the company’s strategic objectives
or core competencies.
6. Ethical or political reasons
- Divestiture may occur for ethical or political
reasons, such as to align with stakeholders’
values, respond to public pressure, or
mitigate reputational risks associated with
controversial industries or practices.
Types of Divestiture
1. Sell-off – This is the process of selling a
portion or all of a company’s assets.
2. Spin-off – This is where a company
establishes a new company from a part of its
business, creating a separate entity.
3. Equity Carve-out – This is the public offering
of a portion of a company where the company
continues to maintain control over the
remaining entity.
4. Liquidation – This is the closing down of a
company and selling off all of its assets to pay
off its debts and other liabilities before it
ceases to exist.
Regulator-Mandate Divestiture
1. You sell parts of your own business and parts
of the business you will acquire
- You need to give up some parts of your
existing business to make the deal more
balanced.
2. You are likely to be selling a highly related
and entangled business
- You also need to sell parts of the business
you’re about to acquire to make sure the deal
is fair.
 3. You will often need to accept a discounted
divestiture valuation.
- You might not get the best price for the
businesses you’re selling because you need to
sell them quickly and fairly.
4. You must evaluate the impact that walking
away would have on the entire acquisition.
- You need to think about the big picture before
deciding to sell, you need to think about how
walking away from the deal would affect
your entire business, including the
acquisition.
5. The process is complex, iterative, and
synchronized with the timeline of the
acquisition.
- The process involves many steps, and you
need to go back and forth between selling and
negotiating until you reach an agreement.

Standard Divestiture
1. You sell part of your own business.
 You’re giving up some parts of your
existing business, but you’re still in
control.
2. You are selling a well-defined and likely
more separate business.
 The business you’re selling is likely
to be more separate and well-defined,
making it easier to sell.
3. You can expect to receive at least fair value
for the assets divested.
 You can expect to get a good price for
the assets you’re selling, because
they’re separate and easy to value.
4. You can choose to walk away from the
transaction while negotiating.
 If you’re not happy with the offer,
you can choose to walk away from the
deal without affecting the rest of the
business.
5. You can define the transaction timeline and
streamline the process.
 You can define the timeline and pace
of the divestiture process, making it
more streamlined and manageable.