A Merger and Acquisition Simulation

Abstract

"The objective of this paper is to examine the design and use of a merger and acquisition simulation. The simulation selected for study was developed at the University of Texas at Austin and is currently being used in a graduate managerial strategy and planning course. Basically the simulation generates alternatives which may be used for comparison and evaluations, and for decision making. The computer model was designed so that users of the model could modify the important decision variables that enter into the acquisition process. Dean George Kozmetsky and J. Barry Gertz were primarily responsible for the development of this model. In order to achieve a desired growth rate, many companies have found it necessary to enter into a merger, acquisition program. During this program they have found that an enormous amount of data must be analyzed within a fixed time period so that a decision can be made as to the impact that a particular acquisition candidate will have on the parent company. During the period of the negotiations, many variables affecting both the acquisition candidate and the parent company will change. The computer simulation examined provides a working tool for formulating and evaluating alternative growth and diversification strategies. If this process is oversimplified the actual impact that the merger will have on the parent company will become more obscure thus making financial planning, either long or short range, extremely difficult. In order to overcome many of these disadvantages, a model has been developed that takes advantage of the ability of a computer to process great quantities of data within a short time span. The model that has been developed is a long-range merger, acquisition computer model that will optimize the effect that an acquisition will have on the parent company’s earnings per share while considering the dividends received and the market value per share of the acquisition candidate’s stockholders. The model will produce income statements, balance sheets, and the funds flow statements for the parent company while allowing it to acquire tome one to one hundred acquisitions over a ten year period. The model produces four types of outputs; one looking at each company before the acquisition and three that will evaluate the impact that the acquisition(s) will have on the parent company. The merger, acquisition computer model has been designed to aid the company in a program of planned growth from the time the acquisition candidates are selected to the time the companies are actually acquired. The computer model has been designed so that its users can modify the decision variables that enter into an acquisition without changing the model itself. This flexibility has been provided by allowing the user to specify as part of the inputs to the program all variables which will enter into the decision concerning each particular acquisition. The model has been designed so that the user determines which of the various financial statements are to be produced and the type of output desired. In this manner the user directs all of the operations that the model is to perform. The user of the simulation is required to develop ten year projections by years of sales growth, gross margins on sales, tax rates on income, payout ratios, and price/earnings ratios. The average interest on debt for the acquiring company is also projected. Preference as to the financial arrangements desired by acquiring company are a part of this input data. Projections of the future financial and marketing performance of prospects for acquisition are based on historical performance and on estimates of future trends and performance. The simulation output provides the data necessary to analyze performance and establish trends which can be used as indicators of the future performance of prospects for acquisition. The model will generate financial statements by years for ten years for the parent company (the acquiring company) , statement by years for each of the acquisition candidates, and a consolidated financial statement by years for the combined companies. The financial statements generated can be used to identify the various alternatives and in selecting the alternatives that best satisfies the goals, objectives, and strategies of the acquiring company. The Base Case statements are financial projections based on the input data for each company. The projections are used to calculate an income statement, balance sheet, and funds flow statement for each company before any acquisitions take place. This output allows the user to check the validity of the input data that he has prepared to ensure that the projections he has made are reasonable and consistent. The primary reason for developing a Base Case for each company is 50 that the ten (10) year financial projections can be stored and used whenever the company is acquired. This alleviates the problem of requiring the user to specify the year and the sequence that the candidates will be acquired while he is developing the input data. The entries goodwill, written-up assets, surplus, depreciation of written-up assets, and amortization of goodwill are all zero. These entries are associated with the accounting performed during an acquisition run only. "