Billion Merger Between Freeport Mcmoran Research Proposal

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Thus, a broad market index is the best available comparison for the time period studies.

CAPM

The capital asset pricing model is appropriate for this particular event study. The event is an acquisition by Freeport McMoran of an asset, Phelps Dodge. Many mergers are made for operating synergies, but in this case the move was made for different strategic reasons. Phelps Dodge knew Atticus was going to sell their stake and wanted to make a pre-emptive strike against that. For Freeport, the move was made to more than double their size. They went from being a medium-sized mining firm to being a major world player. In the process, they removed themselves from the position of being a takeover target (the BHP rumors never amounted to anything). The merger was therefore done for long-term reasons more than anything else. Thus, its effectiveness cannot truly be measured until long-term returns have been realized, preferably through an entire business cycle (mining being a cyclical industry).

The best proxy for the risk free rate in the market is treasury securities. We will examine the rate of return on 1-year treasuries at the time of the purchase. In November 2006, the yield curve was inverted, and 2-year treasury notes were yielding 4.718%. This is the risk free rate used in the CAPM calculation. The beta was calculated to be 1.068. The market return in the period was calculated to 7.29%.

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Thus, the expected rate of return on this investment is 4.718 + 1.068 (7.29 -- 4.178) = 8.04%.

Abnormal Returns

The returns were generally abnormal. The actual returns on Freeport McMoran stock were considerably higher than the returns on the market over the study period. There was significant week-over-week variance, showing that on a week-to-week basis there is little if any correlation to the market.

Analysis of Results

Over the study period, Freeport McMoran's stock increased 44.28%, versus an expected increase of 8.04%. The stock should have finished the period at slightly above $62 per share. However, the acquisition appears to have boosted the fortunes of Freeport stock significantly in the first several months after the purchase announcement. The cyclical nature of the industry can explain some of the movements as commodity prices increased substantially over the study period. Copper prices rose 25% between November 2006 and June 2007. This increase was less than the increase on Freeport's stock, however.

The purchase was made for strategic reasons. One of the main outcomes is that Freeport emerged as one of the world's largest mining companies. This stronger position helped to propel the stock higher in the months following the purchase. It was unusual that Freeport stock did not fall immediately following the bid, a consequence of buyout rumors. This was followed by the rise in copper prices. Combined with favorable investor reaction to the purchase, Freeport.....

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