Mergers And Acquisitions: Please Respond To The Following

Mergers And Acquisitionsplease Respond To The Following

Discuss the concept of goodwill and the reason why balance sheets show it as an asset. Determine whether or not you believe that some companies deliberately inflate this number. Provide a rationale for your response. Examine the Free Cash Flow to Equity approach (FCFE). Determine the essential aspects in which this approach differs from other models, as well as the most subjective part of using this approach. Provide a rationale for your response. Derivatives" Please respond to the following: * From the e-Activity, examine the derivatives that were involved in the financial collapse of 2008. Speculate on the most likely cause of the collapse. Support your position with one (1) example. Imagine that you are the CFO of an MNC with a million dollar obligation payable in euros in 90 days. Determine the type of derivative that you would use to protect yourself against either a drop in the dollar or an increase in the euro. Provide a rationale for your decision.

Paper For Above instruction

Analysis of Goodwill, FCFE, Derivatives, and Risk Management Strategies

The concepts of goodwill and its representation on the balance sheet are fundamental topics within financial accounting and valuation. Goodwill is an intangible asset that arises when a company acquires another business for a price exceeding the fair value of its identifiable net assets. It reflects factors such as brand reputation, customer relationships, intellectual property, and other non-physical assets that contribute to future earnings potential. Companies record goodwill on their balance sheets to recognize this premium paid during acquisitions, acknowledging the expected economic benefits derived from these intangible assets.

Balance sheets show goodwill as an asset because accounting standards (such as IFRS and GAAP) require the recognition of intangible assets acquired in a business combination if they meet specific criteria. These standards aim to provide a comprehensive view of a company's assets and liabilities, including assets that are not physical but still hold economic value. Goodwill is considered an asset because it can potentially generate future economic benefits through synergies, increased customer retention, or enhanced market position.

There is ongoing debate about whether some companies deliberately inflate the goodwill figure. Critics argue that certain firms may overstate goodwill during acquisitions or when impairment charges are unnecessarily delayed to inflate assets and earnings. Such manipulation can distort financial statements, misleading stakeholders about a company's true financial health. The rationale behind this concern is that overestimating goodwill can inflate asset values and net income, potentially leading to inflated stock prices or misleading performance indicators. Empirical evidence from corporate scandals suggests that goodwill impairment abuses have occurred, emphasizing the importance of rigorous audit procedures.

The Free Cash Flow to Equity (FCFE) approach is a valuation method used to estimate the amount of cash available to equity shareholders after all expenses, reinvestments, and debt repayments. Its essential aspects include adjusting net income for non-cash charges, changes in working capital, and capital expenditures, and then subtracting net debt repayments to arrive at the cash flow attributable to equity holders. This approach differs from other valuation models, such as Discounted Cash Flow (DCF) models that focus on enterprise value, by directly estimating cash flows available to equity shareholders rather than the entire firm.

One of the most subjective parts of using the FCFE method is the estimation of future cash flows, particularly projecting revenues, profits, capital expenditures, and changes in working capital. These projections are inherently uncertain and susceptible to managerial bias or optimistic assumptions. Additionally, determining the appropriate discount rate for FCFE, reflecting the cost of equity capital, requires judgment, especially amid fluctuating market conditions and risk premiums. Therefore, sensitivity analysis is crucial to assess how variations in these assumptions influence valuation results.

Role of Derivatives in the 2008 Financial Collapse and Risk Management Strategies

The 2008 financial crisis was significantly impacted by derivatives, particularly mortgage-backed securities (MBS) and collateralized debt obligations (CDOs). These derivatives were based on complex pooling and tranching of subprime mortgages, which were often poorly understood by investors. The widespread use of these derivatives concealed the actual risk exposure and created a situation where the collapse of the housing market triggered massive losses across financial institutions. A likely cause of the collapse was the over-leverage and mispricing of risk associated with these structured products, which led to a chain reaction of defaults and insolvencies.

For example, Lehman Brothers heavily invested in MBS and CDOs, and when the housing market declined, the value of these securities plummeted, exposing the bank's excessive leverage and lack of liquidity. The failure to accurately price the risk and the excessive reliance on mathematical models that underestimated tail risks contributed to the systemic breakdown.

As a CFO of a multinational corporation (MNC) facing a euro-denominated obligation of one million dollars payable in 90 days, risk management would require using derivatives such as a currency forward contract. A forward contract to buy euros at a fixed rate would protect against a potential appreciation of the euro, which would increase the cost of settlement in dollars if the euro appreciates. Conversely, if there is a risk of the dollar weakening (and euro strengthening), engaging in a forward to buy euros secures a known cost in dollars, shielding the company from unfavorable currency movements.

The rationale for choosing a forward contract is its simplicity and cost-effectiveness. It enables locking in the exchange rate, eliminating uncertainty about future costs. Since the obligation is fixed at a specific date, a forward contract aligns precisely with the timing of the liability, reducing exposure and financial risk associated with currency fluctuations. Using such derivatives is a prudent risk management strategy, especially when dealing with sizable obligations and volatile currency markets.

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