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7/27/2019 2013 M&A from Wiley
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Prepared byKen Hartviksen (MODIFED)
INTRODUCTION TO
CORPORATE FINANCE Laurence Booth W. Sean Cleary
Chapter 15 Mergers and Acquisitions
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CHAPTER 15
Mergers and Acquisitions
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CHAPTER 15 Mergers and Acquisitions 15 - 3
Lecture Agenda
Learning Objectives Important Terms Types of Takeovers
Securities Legislation Friendly versus hostile takeovers Motivations for Mergers and Acquisitions Valuation Issues Summary and Conclusions
Concept Review Questions
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CHAPTER 15 Mergers and Acquisitions 15 - 4
Learning Objectives
1. The different types of acquisitions2. How a typical acquisition proceeds3. What differentiates a friendly from a hostile acquisition4. Different forms of combinations of firms5. Where to look for acquisition gains6. How accounting may affect the acquisition decision
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CHAPTER 15 Mergers and Acquisitions 15 - 5
Important Chapter Terms
Acquisition Amalgamation Arbs Asset purchase Break fee Cash transaction Confidentiality agreement Conglomerate merger Creeping takeovers Cross-border (international)
M&A Data room Defensive tactic Due diligence
Extension M&A Fair market value Fairness opinion Friendly acquisition Geographic roll-up Going private
transaction/issuer bid Goodwill Horizontal merger Hostile takeover
Letter of intent Management buyouts(MBOs)/leveraged buyouts(LBOs)
Merger
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CHAPTER 15 Mergers and Acquisitions 15 - 6
Important Chapter Terms
No-shop clause Offering memorandum Over-capacity M&A Proactive models Purchase method Selling the crown jewels Share transaction Shareholders rights
plan/poison pill Synergy Takeover
Tender Tender offer Vertical merger White knight
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Types of Takeovers
Mergers and Acquisitions
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CHAPTER 15 Mergers and Acquisitions 15 - 8
Types of TakeoversGeneral Guidelines
Takeover The transfer of control from one ownership group to another.
Acquisition The purchase of one firm by another
Merger The combination of two firms into a new legal entity A new company may be created Both sets of shareholders have to approve the transaction.
Amalgamation A genuine merger in which both sets of shareholders mustapprove the transaction Requires a fairness opinion by an independent expert on the
true value of the firms shares when a public minority exists
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CHAPTER 15 Mergers and Acquisitions 15 - 9
Types of TakeoversHow the Deal is Financed
Cash Transaction The receipt of cash for shares by shareholders in the
target company.
Share Transaction The offer by an acquiring company of shares or a
combination of cash and shares to the targetcompanys shareholders.
Going Private Transaction (Issuer bid) A special form of acquisition where the purchaser already owns a majority stake in the target company.
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CHAPTER 15 Mergers and Acquisitions 15 - 10
Securities LegislationCritical Shareholder Percentages
1. 10%: Early Warning When a shareholder hits this point a report is sent to SC This requirement alerts other shareholders that a potential
acquirer is accumulating a position (toehold) in the firm.2. 20%: Takeover Bid (Malaysia : 30%)
Not allowed further open market purchases but must makea takeover bid
This allows all shareholders an equal opportunity to tender shares and forces equal treatment of all at the same price. This requirement also forces the acquirer into disclosing
intentions publicly before moving to full voting control of thefirm.
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CHAPTER 15 Mergers and Acquisitions 15 - 11
Securities LegislationCritical Shareholder Percentages Continued
3. 50.1%: (> 50%) Control Shareholder controls voting decisions under normal voting
(simple majority ORDINARY RESOLUTION) Can replace board and control management
4. 66.7%: Amalgamation (Malaysia: 75%) The single shareholder can approve amalgamation
proposals requiring a 2/3s majority vote (supermajority)SPECIAL RESOLUTION
5. 90%: Minority Squeeze-out Once the shareholder owns 90% or more of the outstanding
stock minority shareholders can be forced to tender their shares.
This provision prevents minority shareholders fromfrustrating the will of the majority.
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CHAPTER 15 Mergers and Acquisitions 15 - 12
The Takeover Bid ProcessMoving Beyond the 30% Threshold
Takeover circular sent to all shareholders. Target has 15 days to circulate letter to shareholders with the
recommendation of the board of directors to accept/reject. Bid must be open for 35 days following public announcement. Shareholders tender to the offer by signing authorizations. A Competing bid automatically increases the takeover window
by 10 days and shareholders during this time can with drawauthorization and accept the competing offer.
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CHAPTER 15 Mergers and Acquisitions 15 - 14
Friendly Acquisition
The acquisition of a target company that is willing to
be taken over.
Usually, the target will accommodate overtures andprovide access to confidential information to facilitate
the scoping and due diligence processes.
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CHAPTER 15 Mergers and Acquisitions 15 - 15
Friendly AcquisitionsThe Friendly Takeover Process
1. Normally starts when the target voluntarily puts itself into play. Target uses an investment bank to prepare an offering
memorandum May set up a data room and use confidentiality agreements to permit
access to interest parties practicing due diligence
A signed letter of intent signals the willingness of the parties to moveto the next step (usually includes a no-shop clause and atermination or break fee)
Legal team checks documents, accounting team may seek advancetax ruling
Final sale may require negotiations over the structure of the dealincluding:
Tax planning Legal structures
2. Can be initiated by a friendly overture by an acquirer seekinginformation that will assist in the valuation process.
(See Figure 15 -1 for a Friendly Acquisition timeline)
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CHAPTER 15 Mergers and Acquisitions 15 - 16
Friendly Acquisition
15-1 FIGURE
Friendly Acquisition
Informationmemorandum
Approachtarget
Sign letter of intent
Final saleagreement
Confidentialityagreement
Main duediligence
Ratified
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CHAPTER 15 Mergers and Acquisitions 15 - 17
Friendly TakeoversStructuring the Acquisition
In friendly takeovers, both parties have the opportunity tostructure the deal to their mutual satisfaction including:
1. Taxation Issues cash for share purchases trigger capital gainsso share exchanges may be a viable alternative
2. Asset purchases rather share purchases that may: Give the target firm cash to retire debt and restructure financing Acquiring firm will have a new asset base to maximize CCA
deductions Permit escape from some contingent liabilities (usually excluding
claims resulting from environmental lawsuits and control orders that
cannot severed from the assets involved)3. Earn outs where there is an agreement for an initial purchase pricewith conditional later payments depending on the performance of the target after acquisition.
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CHAPTER 15 Mergers and Acquisitions 15 - 18
Hostile Takeovers
A takeover in which the target has no desire to beacquired and actively rebuffs the acquirer andrefuses to provide any confidential information.
The acquirer usually has already accumulated aninterest in the target (30% of the outstanding shares)and this preemptive investment indicates thestrength of resolve of the acquirer.
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CHAPTER 15 Mergers and Acquisitions 15 - 19
Hostile TakeoversThe Typical Process
The typical hostile takeover process:1. Slowly acquire a toehold (beach head) by open market purchase of
shares at market prices without attracting attention.2. File statement with SC at the 10% early warning stage while not
trying to attract too much attention.
3. Accumulate 30% of the outstanding shares through open marketpurchase over a longer period of time4. Make a tender offer to bring ownership percentage to the desired level
(either the control (50.1%) or amalgamation level (67%)) - this offer contains a provision that it will be made only if a certain minimumpercentage is obtained.
During this process the acquirer will try to monitor management/boardreaction and fight attempts by them to put into effect shareholder rights plans or to launch other defensive tactics.
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CHAPTER 15 Mergers and Acquisitions 15 - 20
Hostile TakeoversCapital Market Reactions and Other Dynamics
Market clues to the potential outcome of a hostile takeover attempt:
1. Market price jumps above the offer price A competing offer is likely or The bid price is too low
2. Market price stays close to the offer price The offer price is fair and the deal will likely go through
3. Little trading in the shares A bad sign for the acquirer because shareholders are reluctant to sell.
4. Great deal of trading in the shares Large numbers of shares being sold from normal investors to arbitrageurs
(arbs) who are, themselves building a position to negotiate an even bigger premium for themselves by coordinating a response to the tender offer.
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CHAPTER 15 Mergers and Acquisitions 15 - 21
Hostile Takeovers Defensive Tactics
Shareholders Rights Plan Known as a poison pill or deal killer Can take different forms but often
Gives non-acquiring shareholders the right to buy 50 percent more sharesat a discount price in the event of a takeover.
Selling the Crown Jewels The selling of a target companys key assets that the acquiring
company is most interested in to make it less attractive for takeover. Can involve a large dividend to remove excess cash from the targets
balance sheet.
White Knight The target seeks out another acquirer considered friendly to make a
counter offer and thereby rescue the target from a hostile takeover
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Motives for Takeovers
Mergers and Acquisitions
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CHAPTER 15 Mergers and Acquisitions 15 - 23
Classifications Mergers and Acquisitions
1. Horizontal A merger in which two firms in the same industry combine. Often in an attempt to achieve economies of scale and/or
scope.2. Vertical
A merger in which one firm acquires a supplier or another firmthat is closer to its existing customers. Often in an attempt to control supply or distribution channels.
3. Conglomerate A merger in which two firms in unrelated businesses combine.
Purpose is often to diversify the company by combininguncorrelated assets and income streams4. Cross-border (International) M&As
A merger or acquisition involving a Canadian and a foreign firma either the acquiring or target company.
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CHAPTER 15 Mergers and Acquisitions 15 - 24
Mergers and Acquisition Activity
M&A activity seems to come in waves through theeconomic cycle domestically, or in response toglobalization issues such as:
Formation and development of trading zones or blocks (EU, North America Free Trade Agreement Deregulation Sector booms such as energy or metals
Table 15 -1 on the following slide depicts major M&A waves since the late 1800s.
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CHAPTER 15 Mergers and Acquisitions 15 - 25
M&A Activity in Canada Period Major Characteristics of M&A Activity1895 - 1904 Driven by economic expansion, U.S. transcontinental railroad, and the development of
national U.S. capital markets Characterized by horizontal M&As
1922 - 1929 60 percent occurred in fragmented markets (chemical, food processing, mining) Driven by growth in transportation and merchandising, as well as by communications
developments
1940 - 1947 Characterized by vertical integration Driven by evasion of price and quota controls
1960s Characterized by conglomerate M&As Driven by aerospace industry Some firms merged to play the earnings per share "growth game" (discussed in the section
The Effect of an Acquisition on Earnings per Share)1980s Characterized by leveraged buyouts and hostile takeovers1990s Many international M&As (e.g., Chrysler and Daimler-Benz, Seagram and Martell)
Strategic motives were advanced (although the jury is still out on whether this was trulyachieved)
1999 - 2001 High technology/Internet M&As Many stock-financed takeovers, fuelled by inflated stock prices Many were unsuccessful and/or fell through as the Internet "bubble" burst
2005 - ? Resource-based/international M&A activity Fuelled by strong industry fundamentals, low financing costs, strong economic conditions
Table 15 - 1 M&A Activity in Canada
Source: Adapted in part f rom Weston, J.F., Wang, F., Chung, S., and Hoag, S. Mergers, Restructuring, and Corporate Control. Toronto:Prentice-Hall Canada, Inc., 1990.
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CHAPTER 15 Mergers and Acquisitions 15 - 26
Motivations for Mergers and AcquisitionsCreation of Synergy Motive for M&As
The primary motive should be the creation of synergy.
Synergy value is created from economies of integrating a target and acquiring a company; theamount by which the value of the combined firm
exceeds the sum value of the two individual firms.
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CHAPTER 15 Mergers and Acquisitions 15 - 27
Creation of Synergy Motive for M&As
Synergy is the additional value created (V) :
Where:
VT = the pre-merger value of the target firmV A - T = value of the post merger firmV A = value of the pre-merger acquiring firm
)V -(V V V T AT A[ 15-1]
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CHAPTER 15 Mergers and Acquisitions 15 - 28
Value Creation Motivations for M&AsOperating Synergies
Operating Synergies1. Economies of Scale
Reducing capacity (consolidation in the number of firms in theindustry)
Spreading fixed costs (increase size of firm so fixed costs per unitare decreased) Geographic synergies (consolidation in regional disparate
operations to operate on a national or international basis)2. Economies of Scope
Combination of two activities reduces costs3. Complementary Strengths
Combining the different relative strengths of the two firms createsa firm with both strengths that are complementary to one another.
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CHAPTER 15 Mergers and Acquisitions 15 - 29
Value Creation Motivations for M&AEfficiency Increases and Financing Synergies
Efficiency Increases New management team will be more efficient and
add more value than what the target now has.
The combined firm can make use of unusedproduction/sales/marketing channel capacityFinancing Synergy
Reduced cash flow variability
Increase in debt capacity Reduction in average issuing costs Fewer information problems
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CHAPTER 15 Mergers and Acquisitions 15 - 30
Value Creation Motivations for M&ATax Benefits and Strategic Realignments
Tax Benefits Make better use of tax deductions and credits
Use them before they lapse or expire (loss carry-back, carry-forward provisions)
Use of deduction in a higher tax bracket to obtain a large taxshield
Use of deductions to offset taxable income (non-operating capitallosses offsetting taxable capital gains that the target firm wasunable to use)
Strategic Realignments Permits new strategies that were not feasible for prior to the
acquisition because of the acquisition of new managementskills, connections to markets or people, and newproducts/services.
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CHAPTER 15 Mergers and Acquisitions 15 - 31
Managerial Motivations for M&As
Managers may have their own motivations to pursue M&As.The two most common, are not necessarily in the bestinterest of the firm or shareholders, but do address commonneeds of managers
1. Increased firm size Managers are often more highly rewarded financially for building a
bigger business (compensation tied to assets under administration for example)
Many associate power and prestige with the size of the firm.2. Reduced firm risk through diversification
Managers have an undiversified stake in the business (unlike
shareholders who hold a diversified portfolio of investments and dontneed the firm to be diversified) and so they tend to dislike risk(volatility of sales and profits)
M&As can be used to diversify the company and reduce volatility (risk)that might concern managers.
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CHAPTER 15
Mergers and Acquisitions 15 - 32
Empirical Evidence of Gains throughM&As
Target shareholders gain the most Through premiums paid to them to acquire their shares
15 20% for stock-finance acquisitions 25 30% for cash-financed acquisitions (triggering capital gains
taxes for these shareholders) Gains may be greater for shareholders will to wait for arbs tonegotiate higher offers or bidding wars develop betweenmultiple acquirers.
Between 1995 and 2001, 302 deals worth US$500.
61% lost value over the following year The biggest losers were deals financed through shares which
lost an average 8%.
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Valuation Issues in Corporate
TakeoversMergers and Acquisitions
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CHAPTER 15
Mergers and Acquisitions 15 - 35
Valuation IssuesWhat is Fair Market Value?
Fair market value (FMV) is the highest price obtainable in anopen and unrestricted market between knowledgeable,informed and prudent parties acting at arms length, withneither party being under any compulsion to transact.
Key phrases in this definition:1. Open and unrestricted market (where supply and demand can
freely operate see Figure 15 -2 on the following slide)2. Knowledgeable, informed and prudent parties3. Arms length 4. Neither party under any compulsion to transact.
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CHAPTER 15
Mergers and Acquisitions 15 - 36
Valuation IssuesValuation Framework
15-2 FIGURE
Demand Supply
B1
S1
P
P*Q
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CHAPTER 15
Mergers and Acquisitions 15 - 37
Valuation IssuesTypes of Acquirers
Determining fair market value depends on the perspective of theacquirer. Some acquirers are more likely to be able to realizesynergies than others and those with the greatest ability to generatesynergies are the ones who can justify higher prices.
Types of acquirers and the impact of their perspective on value include:1. Passive investors use estimated cash flows currently present2. Strategic investors use estimated synergies and changes that are
forecast to arise through integration of operations with their own3. Financials valued on the basis of reorganized and refinanced
operations4. Managers value the firm based on their own job potential and ability
to motivate staff and reorganize the firms operations. MBOs andLBOs
Market pricing will reflect these different buyers and their importance atdifferent stages of the business cycle.
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CHAPTER 15
Mergers and Acquisitions 15 - 38
Market Pricing Approaches
Reactive Pricing ApproachesModels reacting to general rules of thumb and therelative pricing compared to other securities
1. Multiples or relative valuation2. Liquidation or breakup values
Proactive Models A valuation method to determine what a target firmsvalue should be based on future values of cash flowand earnings
1. Discounted cash flow (DCF) models
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CHAPTER 15
Mergers and Acquisitions 15 - 39
Reactive ApproachesValuation Using Multiples
1. Find appropriate comparators Individual firm that is highly comparable to the target Industry average if appropriate
2. Adjust/normalize the data (income statement and balance sheet) for differences between target and comparator including: Accounting differences
LIFO versus FIFO Accelerated versus straight-line depreciation Age of depreciable assets Pension liabilities, etc.
Different capital structures3. Calculate a variety of ratios for both the target and the comparator including:
Price-earnings ratio (trailing) Value/EBITDA Price/Book Value Return on Equity
4. Obtain a range of justifiable values based on the ratios
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CHAPTER 15
Mergers and Acquisitions 15 - 40
Reactive ApproachesLiquidation Valuation
1. Estimate the liquidation value of current assets2. Estimate the present value of tangible assets
3. Subtract the value of the firms liability fromestimated liquidation value of all the firms assets =liquidation value of the firm.
This approach values the firm based on existing assets and is notforward looking.
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CHAPTER 15
Mergers and Acquisitions 15 - 41
The Proactive ApproachDiscounted Cash Flow Valuation
The key to using the DCF approach to price a target firm isto obtain good forecasts of free cash flow
Free cash flows to equity holders represents cash flows leftover after all obligations, including interest payments havebeen paid.
DCF valuation takes the following steps:1. Forecast free cash flows2. Obtain a relevant discount rate3. Discount the forecast cash flows and sum to estimate the value
of the target
(See Equation 15 2 on the following slide)
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CHAPTER 15
Mergers and Acquisitions 15 - 42
Discounted Cash Flow AnalysisFree Cash Flow to Equity
esexpenditur )securities
(/.),
,(/
capital net marketableand
cashincluding not capital working net inchangesetctaxesdeferred
onamortizatiitemscashnonincomenet equityto flowcash Free[ 15-2]
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CHAPTER 15
Mergers and Acquisitions 15 - 43
Discounted Cash Flow AnalysisThe General DCF Model
Equation 15 3 is the generalized version of theDCF model showing how forecast free cash flowsare discounted to the present and then summed.
)1()1(.. .
)1(
)1( 12
21
10
t t
t
k CF
k CF
k CF
k CF
V [ 15-3]
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CHAPTER 15
Mergers and Acquisitions 15 - 44
Discounted Cash Flow AnalysisThe Constant Growth DCF Model
Equation 15 4 is the DCF model for a target firm where thefree cash flows are expected to grow at a constant rate for theforeseeable future.
Many target firms are high growth firms and so a multi-stagemodel may be more appropriate.
(See Figure 15 -3 on the following slide for the DCF Valuation Framework.)
10 g k
CF V [ 15-4]
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CHAPTER 15
Mergers and Acquisitions 15 - 45
Valuation IssuesValuation Framework
15-3 FIGURE
Time Period Free Cash Flows
TerminalValue
Discount Rate
)1()1(10
T
t T
T t
t
k V
k C
V
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CHAPTER 15
Mergers and Acquisitions 15 - 46
Discounted Cash Flow AnalysisThe Multiple Stage DCF Model
The multi-stage DCF model can be amended toinclude numerous stages of growth in the forecastperiod.
This is exhibited in equation 15 5:
)1(
)1(10 T
T T
t t
t
k
V
k
CF V [ 15-5]
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CHAPTER 15 Mergers and Acquisitions 15 - 47
Valuation IssuesThe Acquisition Decision and Risks that Must be Managed
Once the value to the acquirer has been determined, theacquisition will only make sense if the target firm can beacquired at a price that is less.
As the acquirer enters the buying/tender process, the
outcome is not certain: Competing bidders may appear Arbs may buy up outstanding stock and force price concessions
and lengthen the acquisition process (increasing the costs of acquisitions)
In the end, the forecast synergies might not be realized
The acquirer can attempt to mitigate some of these risk throughadvance tax rulings from CRA, entering a friendly takeover andthrough due diligence.
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CHAPTER 15 Mergers and Acquisitions 15 - 48
Valuation IssuesThe Effect of an Acquisition on Earnings per Share
An acquiring firm can increase its EPS if it acquiresa firm that has a P/E ratio lower than its own.
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Concept Review Questions
Mergers and Acquisitions
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CHAPTER 15 Mergers and Acquisitions 15 50
Copyright
Copyright 2007 John Wiley & SonsCanada, Ltd. All rights reserved.Reproduction or translation of this workbeyond that permitted by AccessCopyright (the Canadian copyrightlicensing agency) is unlawful. Requestsfor further information should beaddressed to the PermissionsDepartment, John Wiley & Sons Canada,Ltd. The purchaser may make back-upcopies for his or her own use only andnot for distribution or resale. The author and the publisher assume noresponsibility for errors, omissions, or damages caused by the use of these filesor programs or from the use of theinformation contained herein.