What happens when two companies merge?

If you look at the great deal makers of our era – Donald Trump, Warren Buffet and Mark Cuban, to name just a few – the one thing they all have in common is their innate ability to identify opportunities and close lucrative deals. Mergers and Acquisitions are part of strategic management of any business. It involves consolidation of two businesses with an aim to increase market share, profits and influence in the industry. Indian M&A activities touched a six-year high in 2016 and deal values clocking $56.2 billion, the highest since 2010 and this escalation is expected to continue through 2017. Merger affects all the stakeholders of both the companies involved in many ways also merger is a cumbersome process which consume a lot time, then how mergers and acquisitions help companies?

Merger means when two companies come together to form a new company with a new name. Both companies’ stocks are surrendered and new companies stocks are issued in its place. Mergers help companies gain advantages over competitors. For example, if one company sells products similar to the other, the combined sales of a horizontal merger give the new company a greater share of the market.

New company formed will consist of a new name and a different capital structure in which both the companies involved have shares according to their contribution. All the assets as well as liabilities are valued and settlement is done accordingly. For example let the two companies involved in merger are company A and company B with 200 shares and 1000 shares respectively and new company formed be C. In this case the exchange ratio will be 0.2 which means for every 1 share of company B, 0.2 shares of company C will be given. Hence for 1000 shares of company B, 200 shares of company C will be given. Shareholders of company A will get 1 share of new company for every single share of company A. As a result new company formed will have total 400 shares with both companies having equal stakes in new company. However exchange ration can be altered as per the net gain or loss of the companies. Also if company A has liabilities of ₹ 3, 00,000 and assets worth ₹ 5,00,000 and company B has liabilities and assets amounting to ₹ 4,00,000 and ₹ 6,00,000 respectively, then the new company will have liabilities and assets worth ₹ 7,00,000 and ₹ 11,00,000 respectively.

The synergy may lead to improved market reach and industry visibility. M&A will combine the resources of companies involved and will help them to develop an edge over the others. Companies buy companies to reach new markets and grow revenues and earnings. A merge may expand two companies’ marketing and distribution, giving them new sales opportunities.  To stay competitive, companies need to stay on top of technological developments and their business applications. By buying or merging with a company with unique technologies, a company can maintain or develop a competitive edge over others.

Regardless of their category or structure, all mergers and acquisitions have one common goal: they are all meant to create synergy that makes the value of the combined companies greater than the sum of the two parts. It is well said that “never care about what something costs, care what it’s worth.”

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Monetary Policy

Monetary policy is the process by which the monetary authority of a country, like the central bank or currency board, controls the supply of money, often targeting an inflation rate to ensure price stability and general trust in the currency. Before knowing how does it helps in controlling inflation let’s understand what is inflation.

Inflation is defined as a sustained increase in the general level of prices for goods and services in a country, and is measured as an annual percentage change. Under conditions of inflation, the prices of things rise over time. Put differently, as inflation rises, every rupee you own buys a smaller percentage of a good or service. When prices rise, and alternatively when the value of money falls you have inflation.

The value of a rupee (or any unit of money) is expressed in terms of its purchasing power, which is the amount of real, tangible goods or actual services that money can buy at a moment in time. When inflation rises, there is a decline in the purchasing power of money. For example, if the inflation rate is 2% annually, then theoretically ₹10 pack of gum will cost ₹10.2 in a year. After inflation, your rupee does not go as far as it did in the past. In recent years, most developed countries have attempted to sustain an inflation rate of 2-3% by using monetary policy tools put to use by central banks. This general form of monetary policy is known as inflation targeting.

“RBI (Reserve Bank of India) has cut interest rates.”

“RBI has increased the interest rates.”

“RBI keeps the key rates unchanged. “

Have you heard or seen these kinds of headlines, we are sure you must have….

So, what are these interest rates? How are they going to help in controlling inflation? Let us try to find out.

One of the primary functions of RBI is to control the supply of money in the economy and also ‘the cost of credit.’ Meaning, how much money is available for the industry or the economy and what is the price that the economy has to pay to borrow that money.  ‘Availability of money’ is nothing but liquidity and ‘cost of borrowing’ is interest rates.

To control inflation and the growth, RBI uses certain instruments of monetary policy like REPO RATE, REVERSE REPO RATE etc.

When we need money, we take loans from banks. And banks charge certain interest rate on these loans. This is called as cost of credit (the rate at which we borrow the money).

Similarly, when banks need money they approach RBI. The rate at which banks borrow money from the RBI by selling their surplus government securities to the central bank (RBI) is known as “Repo Rate.” Repo rate is short form of Repurchase Rate. Generally, these loans are for short durations (up to 2 weeks).

It simply means the rate at which RBI lends money to commercial banks against the pledge of government securities whenever the banks are in need of funds to meet their day-to-day obligations.

Banks enter into an agreement with the RBI to repurchase the same pledged government securities at a future date at a pre-determined price.

Example – If repo rate is 5%, and bank takes loan of ₹ 1000 from RBI, they will pay interest of ₹ 50 to RBI.

So, higher the repo rate higher the cost of short-term money and vice versa. Higher repo rate may slowdown the growth of the economy. If the repo rate is low then banks can charge lower interest rates on the loans taken by us.

So whenever the repo rate is cut, can we expect that both the deposit rates and lending rates of banks to come down to some extent?

This may or may not happen every time. The lending rate of banks goes down to the existing bank borrowers only when the banks reduce their base rates, as all lending rates of banks are linked to the base rate of every bank. In the absence of a cut in the base rate, the repo rate cut does not get automatically transmitted to the individual bank customers. This is the reason why you might have observed that your loan EMIs remain same even after RBI lowers the repo rates.

Reverse repo rate is the rate of interest offered by RBI, when banks deposit their surplus funds with the RBI for short periods. When banks have surplus funds but have no lending (or) investment options, they deposit such funds with RBI. Banks earn interest on such funds.

REPO RATE REVERSE REPO RATE BASE RATE
6.25% 6.00% 9.3% – 9.7%

Other than these monetary policies there is a theory known as Quantity theory of Money which helps in determining price levels of different commodities at various stages.

The quantity theory of money states that there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold. According to QTM, if the amount of money in an economy doubles, price levels also double, causing inflation. The consumer therefore pays twice as much for the same amount of the good or service. So an increase in money supply causes inflation as they compensate for the decrease in money’s marginal value. The theory also assumes that the quantity of money, which is determined by outside forces, is the main influence of economic activity in a society. It is primarily these changes in money stock that cause a change in spending. And the velocity of circulation depends not on the amount of money available or on the current price level but on changes in price levels.

It is really important to understand these policies and theories because more better our monetary policies would be better the condition of our economy will be.

Market Dominance

 

Market share represents the percentage of an industry or market’s total sales that is earned by a particular company over a specified time period. Market share is calculated by taking the company’s sales over the period and dividing it by the total sales of the industry over the same period. This metric is used to give a general idea of the size of a company in relation to its market and its competitors.if a company has $1 million in annual sales and the total sales for the year in its industry is $100 million, the company’s market share is 1%. Under the percentage of units method, a company that sells 50,000 units annually in an industry where 5 million units are sold per year also has a market share of 1%.
Companies increase market share through innovation, strengthening customer relationships, smart hiring practices and acquiring competitors. Higher market share puts companies at a competitive advantage. Companies with high market share often receive better prices from suppliers, as their larger order volumes increase their buying power. Innovation is one method by which a company may increase market share. When a firm brings to market a new technology its competitors have yet to offer, consumers wishing to own the technology buy it from that company, even if they previously did business with a competitor. Many of those consumers become loyal customers, which adds to the company’s market share and decreases market share for the company from which they switched. By strengthening customer relationships, companies protect their existing market share by preventing current customers from jumping ship when a competitor rolls out a hot new offer. Gaining market share via word of mouth increases a company’s revenues without concomitant increases in marketing expenses. Companies with the highest market share in their industries almost invariably have the most skilled and dedicated employees. Bringing the best employees on board reduces expenses related to turnover and training, and enables companies to devote more resources to focusing on their core competencies. One of the surest methods to increase market share is acquiring a competitor. By doing so, a company accomplishes two things. It taps into the newly acquired firm’s existing customer base, and it reduces the number of firms fighting for a slice of the same pie by one. A shrewd executive, whether in charge of a small business or a large corporation, always has his eye out for a good acquisition deal when his company is in a growth mode.

Competitive advantages are not permanent. You need to continually adjust, adapt and evolve your competitive advantages and positioning to respond to changes in customer preference, challenges from competitors, and changes within the company itself.

Too many companies don’t do a good enough job of connecting with or listening to their customers. Your customers might be drifting away from you, and you might not realize it until it’s too late. After all, most customers don’t announce their plans – even if you’re in a relationship business like hairstyling, consulting or sales; your customers might decide to switch to a competitor even though everything seemed fine to you. 10 years ago, Blockbuster Video was one of America’s favorite sources of weekend entertainment – “make it a Blockbuster night!” That was back before Netflix upended the video rental market with their mail order service – no more late fees, which wrecked Blockbuster’s business model. Today, Blockbuster is on the brink of bankruptcy, and Red Box rental kiosks, video on demand and online streaming video are putting the final nails in the coffin. No competitive advantage is safe for long; often, just when a company figures out its competitive advantage, a competitor swoops in to change the game. Technological improvements, new marketing strategies, new ways of identifying underserved niches within the existing market – all of these are ways that competitors are constantly dueling to undermine each other’s competitive advantages. Companies change in ways that are often imperceptible, and this influences their competitive advantages as well.

The conventional argument against market dominance is that monopolists can earn abnormal (supernormal) profits at the expense of efficiency and the welfare of consumers and society.

The monopoly price is assumed to be higher than both marginal and average costs leading to a loss of allocative efficiency and a failure of the market. The monopolist is extracting a price from consumers that is above the cost of resources used in making the product and, consumers’ needs and wants are not being satisfied, as the product is being under-consumed.

The higher average cost if there are inefficiencies in production means that the firm is not making optimum use of scarce resources. Under these conditions, there may be a case for government intervention for example through competition policy or market deregulation. The lack of competition may give a monopolist less incentive to invest in new ideas. Even if the monopolist benefits from economies of scale, they have little incentive to control their costs. If the industry is taken over by a monopolist then the monopolist is able to charge a higher price restrict total output and thereby reduce welfare because the rise in price reduces consumer surplus.A high market concentration does not always signal the absence of competition; sometimes it can reflect the success of firms in providing better-quality products, more efficiently, than their rivals.Despite the fact that the market leadership of firms like Microsoft, Toyota, and Sony is often criticised, investment in research and development can be beneficial to society because they expand the technological frontier and open new ways to prosperity.

 

 

 

 

 

 

 

Understanding Section 80C

The hardest thing to understand in the world is the income tax.

-Albert Einstein

This statement is justified for a country like India where citizens pay such a large part of their income as taxes. Taxes are an integral component in our country, with them accounting for a major portion of the income earned by the government, income which is utilized to provide certain basic provisions to citizens. High tax rates force people to disclose only a limited part of their income. This gives rise to black money and affects the government’s income. Higher tax collection is beneficial for a country however it adds burden to the citizens.

When it comes to income tax, most people start sweating and running around looking for ways in which they can save on it. Reducing the tax burden is necessary to produce economic growth. While government keeps on adding to this burden which could be harsh on the bank balance of a taxpayer, the government also provides certain provisions wherein one can save taxes. Tax deductions can help one reduce the taxable income, lowering their overall tax liability and thereby helping them save on taxes. Section 80C of the Income Tax Act provides provisions for tax deductions on a number of payments, where a person can reduce up to Rs.1.5 Lakhs from his/her total taxable income per year.

Section 80C allows both individuals and Hindu Undivided Families to avail the benefits. Section 80c lists some government owned investment schemes where one can invest and reduce their taxable income. If you have paid excess taxes but have invested in any of such schemes, you can file your Income Tax Return and get a refund. Every scheme yields returns at different rates and has different lock in periods and risk profiles. Following are the investment schemes covered under this section:

Equity Linked Savings Scheme (ELSS) – ELSS are tax-saving mutual funds that invest at least 65% of their assets in the stock markets. Even though these tax-saving mutual funds don’t offer guaranteed returns, the best performing ones have generated 12-15% returns over the long term through the power of compounding. The advantage of ELSS funds is that they come with the lowest lock-in among all tax-saving investments i.e. just 3 years. Since ELSS funds are equity-oriented funds, all gains on investments held for over one year are tax-free for the investor.

Investment in tax-saving Fixed Deposits – Tax saving FDs are like regular fixed deposits but offers the lowest return out of all the investment options available under Section 80C, which range from 7-9%, with 5 years of lock in period. FDs offer 100% capital protection but upon maturity, the interest is added to the investor’s taxable income.

Investment in Sukanya Samriddhi Yojana – Deposits of up to Rs 1.5 Lakhs can be added to a Sukanya Samriddhi Yojana account for tax saving under Section 80C. The current interest rate on Sukanya Samriddhi Yojana deposits has been set at 8.6%. Accounts under this scheme mature 21 years after the opening of the account. The deposits have to be made for a girl child by the parent or guardian. A partial withdrawal of up to 50% of the previous year’s balance is allowed after the account holder turns 18.

Investment in Senior Citizens Savings Scheme (SCSS) – Investments under SCSS yield annual interest at 8.6% with lock in period of 5 years. The SCSS is a scheme exclusively for anyone who is over 60 years old or someone over 55 who has opted for retirement. Investments of up to Rs 1.5 Lakhs in SCSS can be made to save taxes under Section 80C.

Investment in Public Provident Fund (PPF) – Deposits made in PPF account offer a current rate of interest of 8.1%, compounded annually. The PPF has tenure of 15 years, after which the withdrawals are tax-free. While the PPF doesn’t allow premature withdrawals, the account holder can take loans against the corpus in their PPF account.

Investment in Employee Provident Fund (EPF) – An employee’s contribution to the Employee Provident Fund (EPF) account also earns a tax break under Section 80C of up to Rs 1.5 Lakhs. This amounts to 12% of salary that is deducted by an employer and deposited in the EPF or other recognized provident fund. The current interest rate on the EPF is 8.8%.

Purchase of National Savings Certificate (NSC) – NSCs are eligible for tax breaks for the financial year in which they are purchased. NSCs can be bought from designated post offices and come with a lock-in period of 5 years. The interest is compounded annually but is taxable. The current interest rate on NSC is 8.1%.

Investment in Unit Linked Insurance Plans (ULIP) – ULIPs are a mix of insurance and investment. A part of the invested amount in ULIPs is used to provide insurance and the rest of the amount is invested in the stock markets. ULIPs don’t offer guaranteed returns because they are an equity market-linked product.

Investment in National Pension Scheme (NPS) – The NPS is a pension scheme to allow the unorganized sector and working professionals to have a pension after retirement. The NPS offers different plans that the subscriber can choose as per their risk profile. But the highest exposure to equity is capped at 50%. A major disadvantage of the NPS is that the proceeds upon maturity are taxable. Furthermore, there is no guarantee of the returns that can be earned from the NPS.

Section 80C lists some other investments on which one can earn a tax break:

  • 5 year deposit scheme in post office
  • Subscriptions of notified securities like NSS
  • Sum paid to National Housing Bank’s Home Loan Account Scheme
  • Contribution to notified LIC annuity plan
  • Subscription to notified bonds of National Bank for Agriculture and Rural Development

Further certain payments are also eligible for tax saving deductions under this section:

Life Insurance Premium –The annual premium paid for life insurance in the name of the taxpayer or the taxpayer’s wife and children is an eligible tax-saving payment. The deduction is valid only if the premium is less than 10% of the sum assured.

Children’s Tuition Fee –The tuition fee paid for the education of two children to any school, college, university or educational institute situated in India is tax deductible under this section up to Rs 1.5 Lakhs.

Repayment of Home-Loan –The repayment of the principal of a loan taken to buy or construct a residential property is eligible for tax deductions. This deduction is also applicable on stamp duty, registration fees and transfer expenses.

These are the few ways in which one can reduce their taxable income. There are a number of more ways covered under section 80CCC and 80CCD to save taxes beyond the Section 80C deductions. It is important for one to be aware of these provisions to avail the benefit of the tax deductions being offered.

Budget 2017!

2016! The year that started with a Union budget of 19.78 lakh crores, went through passing of GST bill in parliament in August, watched a quarrel between Tata and Mistry in October, surfed through waters of demonetization in the history of India and the world in November and ended in the most controversial presidential elections in The United states of America.

Demonetization took a toll by hitting Indian economy that stood 7.6% in the period 2015-2016 to 7.1% in the fiscal period 2016-2017. Joining the office US President Donald Trump made certain laws and regulations that affected India’s IT industry.

The budget drafted by the Finance Minister looked promising at some factors but when it came to taxes and rebates on individual’s income and corporate it kept fading away.

Minimum Alternate Tax (MAT) on special economic zones was expected to be reduced to 10 per cent in the Budget to boost investments. MAT rates have more than doubled from 7.5 per cent in 2007 to 18.5 per cent today. MAT allowed to be carried forward for 15 years from 10 years now. In a similar move, while the government refrained from cutting the tax rate for large corporates, it announced a 5 percentage point reduction in tax rate for companies with annual turnover of up to Rs.50 crore, which would benefit medium and small enterprises.Capital infusion of Rs.10000 crores in public sector banks in the next fiscal yearfell way short of Rs.15000 crores of the previous year. There was no change in indirect tax norms due to GST implementation. Going against expectations, budgetalso didn’t touch the securities transaction tax.

UNION Budget 2017-2018 got some cookies in form of taxation policies, exemptions. This 5% exemption on income of 2.5-5 lakh will help in increasing disposable income of a person. But won’t the high income group matter? Exempting one class and levying it on other won’t make a difference to the tax collected but surely will discourage the high income group to contribute their best to the economy and society. It may also lead to tax evading by the people. As a result of the additional surcharge of 10 per cent on the rich category, an individual having a net taxable income of Rs.51 lakh per annum, will have to pay an additional tax of Rs.1.25 lakh. Similarly, an individual with a net taxable income of Rs.99 lakh will have to bear an additional tax burden of Rs.2.73 lakh.After demonetization, every class of citizens had big expectations realistic or not from the government to offer some sort of relief. However, Budget 2017 has failed to meet most of the raised expectations.

It is all for none situation where the exemptions or benefits appear to be favorable but do not dent out the major difficulties for the businesses. Business sector hopes for benefits, allowances, tax cuts and exemptions but gets the least from every budget. Never the less, this budget was not analyzed on the basis of what good can happen but rather on what bad could havehappened. With the negative wave prevailing, no bad news seemed to be good news and market gave thumbs up to a rather neutral budget.

Undisclosed Income? New disclosure scheme!

Pradhan Mantri Garib Kalyan Yojana, new  income disclosure scheme,  after demonetization.

Fiscal year 1973-74: An year that set an extraordinary record in direct taxation. The maximum Income tax rate reached to as high as 97.5%. This humongous tax rate created a subconscious anti feeling towards Income tax. The feeling created then, has grown with time and has completely infested our economy like termites.  For most of the people, running away from taxation is a psychological reaction of this past action.

Anyways on public demand to curb ‘Black money’, government took everyone by surprise. The step of demonetization is debatable and should be debated on. But the deed is done and hope it is for the well being of our country.

Looking forward, government has given one ‘last opportunity’ to the people who have untaxed income with them. They can come clean with the help of “Taxation and Investment Regime for Pradhan Mantri Gareeb Kalyan Yojna” bill made by the Government.

Here is the mathematics of the aforementioned bill:

The Declarant under this regime shall be required to pay tax of about 50% of the undisclosed income.

It has been divided into 3 categories:

  1.   30% of the undisclosed income
  2.   A penalty of 10% of the undisclosed Income
  3.  A surcharge of 33% on the 30% tax on undisclosed income.

After paying this amount, the declarant shall have to deposit 25% of the undisclosed income under a deposit scheme “ Pradhan Mantri Gareeb Kalyan Yojna“. They will get this amount back after 4 years without any additional interest.

To understand it in a more lucid manner, let’s consider the following scenario:

Suppose you have Rs.10,00,000 worth of undisclosed income. You want to come clean by paying all the taxes as under the Tax regime by government. Here’s how it will be done-

First you will pay 30% of undisclosed income. Then a penalty of 10% of the undisclosed income will be charged against you. After that you will pay a surcharge of 33% which would be charged on 30% of the undisclosed income.

To summarize it let’s compute it in a formula

Tax to be paid= 30% of the undisclosed income +   A penalty of 10% of the undisclosed Income +  A surcharge of 33% on the 30% tax  on undisclosed income.

i.e

Total tax to be payable = 30%(10,00,000) + 10%(10,00,000) + 33%(30% of 10,00,000)

This will amount to nearly about Rs. 5,00,000

You would be left with the Rs. 5,00,000. You will have to deposit 50% of this amount (which comes out to 2,50,000 in our case) as under PMGKY. You can withdraw that amount after 4 years without getting any additional interest.

The aforementioned scheme is only valid till this fiscal year ie till March 31, 2017.

With this, government is aiming to get the stagnant money back into the system. It is also giving chance to everyone to be part of the mainstream economy, with a fair treatment to honest citizens. The time seems to have come to overcome the psychological myth, that was imbibed in us decades back.

 

A historic blunder or a sound decision?

(Both the faces of a coin called ‘Demonetization’)

Stronger the ills, stronger the pills! It was in context of this line PM Modi demonetized all the high value currency notes. Indian economy remained stunned as a war against black money begun on November 8, 2016. This news was a surprise for even  PM’s cabinet. It took a while for the country to understand that what the government has done. However the bigger question that arises is that how will this move affect the economy? Will this effectively curb the black money or it will only lower down the growth and add to people’s misery?

Only a negligible part of the India’s population use banking system for their daily transactions which means our economy is highly dependent on cash.  India’s 86% of currency was in denomination of 1000 and 500 Rupees notes, so it’s demonetization created a huge shortage of cash available in the country. Cash crunch adversely affected the liquidity present in the system. At the same time, shortage of supply of new currency notes of 2000 worsened the conditions. As a result people started conserving the every 100 Rupees note available with them in form of cash in hand. This led to a sharp decline in spending which took a big toll on demand and pulled down the growth in Q3. Reserve Bank of India  lowered its GDP’s growth estimate to 7.3% from 7.6%.

Through this step government aims at giving a boost to cashless economy.  Increased cashless payments will not only enable government to exercise more control and collect tax efficiently but also will act as a strong measure against black money. People can evade tax only if payments are made through cash. Increased tax revenue will give a push to growth rate of our economy.

But at what cost?

Government gave only limited days to people for exchanging and depositing their cash. As a result, banks started receiving large amount of deposits of cash and at the same time people started to withdraw the new currency from bank and ATMs.  Cash crunch forced people to stand in the long queues to withdraw cash as soon as possible. Farmers were not able to buy seed, many business enterprises came to a halt, hospitals refused to treat patients without the new notes and the workers employed on the basis of daily wages lost their jobs. Economists are busy in understanding the rapid changes caused by the ground-shattering news. Government believes that this move will benefit the economy in longer term  and for this citizens will have to face some amount of problem in shorter term.

But as Dr. Manmohan Singh quoted John Keynes saying that “We all are dead in long term”, there seems to be a large section of Economists not endorsing this idea of curbing black money.

As far as black money is concerned, only a small amount of black money is stored in form of cash. The major portion is held in form of physical assets and most of which is used to transact outside our country. Government need to take more steps to control illegal property, fake bank accounts etc. This is just a small but radical step in this very long journey towards making India free from black money.