Page 22 - CIMA SCS Workbook February 2019 - Day 2 Suggested Solutions

SUGGESTED SOLUTIONS

Boot-strapping - Companies with high P/E ratios are in a good position to acquire other
companies as the market will often apply the higher P/E ratio to both companies’ earnings after
the acquisition, thus increasing the value. Unfortunately we don’t know how many shares Vita has
in issue, or what its P/E ratio is, so it is not clear whether this would be possible for Vita.
Other synergistic effects

Market power – A horizontal combination could give Vita increased market power (e.g. greater
bargaining power with customers and suppliers). However, if this power created a monopoly
situation in the industry, which was not in the best interests of customers, it could attract the
attentions of the competition authorities, e.g. like when Funfitt tried to acquire Gopher-IT last
year. The authorities could block the acquisition or only allow it to proceed under certain
conditions.

Surplus cash – Vita has N$ 51.604 million of cash in its most recent statement of financial
position. Admittedly that is less than in the previous year, so Vita may not have any surplus cash
at the moment. However, in theory any spare cash should always be either invested in new
projects to increase shareholder wealth or alternatively paid out to shareholders so they can
make better use of the cash.

Speed – As mentioned above, acquisition may be far faster than organic growth, although there
could be extra costs involved such as paying for the goodwill and intangible assets of the target
company.

Conclusion
The main objective of a company is to maximise the wealth of its shareholders. An acquisition
strategy is a good way of generating an increase in wealth if some of these synergies can be
achieved.

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