Homework #2

1. There are potential agency conflicts in the exchange between HP director Sam Ginn and McKinsey experts. McKinsey consultants wanted the merger between HP and
Compaq to occur because they might have been able to collect higher fees. Therefore, they immediately squashed any doubts and gave advice for the merger to happen, even if carrying out such an acquisition would have destroyed value for HP shareholders. 2. For Patricia Dunn, the past successful consolidation mergers are vulnerable but overcome key challenges in the first two years. She believes that the merger between
HP and Compaq will ultimately help her company. The cost savings mentioned by
McKinsey consultants provides confirming evidence in support of Patricia Dunn’s views and HP’s acquisition of Compaq. She responds positively because McKinsey consultants reaffirm her decision.

3. The technique that HP executives used is not the same or comparable to traditional discounted cash flow analyses. Two years from now, HP expects to save $1.5 billion after tax every year into perpetuity. If HP discounted those savings at 5%, then the present value of those savings would be $30 billion in Year 1, and $28.57 in current dollars (still discounted at 5%). HP executives valued the $1.5 billion in after tax cost savings as incremental earnings that extend into perpetuity. Since HP’s P/E ratio at the time was about 20, they valued the incremental earnings stream by multiplying the $1.5 billion by 20. Because the incremental earnings would occur in two years,
HP discounted the associated $29.4 billion by about 15% per year. There is no attempt to figure out what P/E value makes sense. The original $2.1 billion premium that HP perceives that it paid for Compaq stems from the nature of the sharing rule. Effectively, the sharing rule provided HP shareholders with 64.4% of