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IAI Actuarial Core Principles · Business Finance · Corporate growth, restructuring and divestment

Which of the following is a recognised disadvantage to the acquirer of financing a takeover mainly with debt rather than with new equity shares?

Debt financing raises the acquirer's gearing and fixed interest burden, which increases financial risk and may bring covenant restrictions. It does not give target holders voting rights and does not necessarily dilute EPS, so the increased financial risk is the recognised disadvantage.

  1. ATarget shareholders must be given voting rights in the acquirer
  2. BThe acquirer's earnings per share is always diluted
  3. CThe acquirer's gearing and fixed interest obligations rise, increasing financial riskCorrect
  4. DTarget shareholders cannot defer any capital gains tax
  5. The acquirer's share price must be above the target's share price

Explanation

Debt finance adds fixed interest commitments and raises gearing, so the acquirer's financial risk rises, and covenants may restrict it. Debt does not give target holders votes and does not systematically dilute EPS. Tax deferral is a feature of share exchange offers, not a debt disadvantage.

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