A pedagogical Excel application of cumulative abnormal returns to Hewlett-Packard Company s takeover of 3Com Corporation

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1 Journal of Fnance and Accountancy A pedagogcal Excel applcaton of cumulatve abnormal returns to Hewlett-Packard Company s takeover of 3Com Corporaton Abstract Mchael R. Santos Sonoma State Unversy Antong Vctoro Vctora Unversy of Wellngton Ths paper uses Excel spreadsheets to ntroduce event study methods to both senor undergraduate and MBA students. The Hewlett-Packard Company s takeover of 3Com Corporaton s analyzed durng Frst, two common event study methods of the cumulatve abnormal returns (CARs) s explaned. Second, a lesson plan for faculty s ntroduced to make busness students to calculate the CARs for the event of HP s takeover of 3Com. Fnally, Excel graphs of the CARs llustrate the event study fndngs for busness students. Keywords: Cumulatve Abnormal Returns (CARs), Event Study, Excel spreadsheet. A Pedagogcal Excel Applcaton, Page

2 Journal of Fnance and Accountancy. Introducton The announcements of corporate earnngs and mergers have sgnfcant consequences for the fnancal health of frms and fnancal markets, and therefore fnancal researchers analyze these events usng the cumulatve abnormal returns (CARs). Even though the majory of manageral fnance and nvestment textbooks provde a graphcal llustraton of the CARs [see the examples at Ross et al. (2008), Bode et al. (200) and Jones (200)], the textbooks of manageral fnance wh Excel present lmed detals for busness faculty and students to apply ndependently. For example, the most common manageral fnance Excel textbooks such as Holden (2005), Mayes and Shank (200), and Adar (2005) do not ntroduce the CARs methodology at all. Even though Bennnga (2006) uses the technque n a chapter-end problem set, there are not enough applcaton detals for busness faculty and students to follow through ndependently. Ths paper flls ths gap by ntroducng an Excel spreadsheet applcaton of CARs to a takeover announcement. The event takes place on Nov., 2009 wh the announcement of Hewlett Packard Corporaton to purchase 3Com Corporaton for a prce of $7.90 per share n cash or for a total frm value of approxmately $2.7 bllon. The frst goal of ths paper s to provde an Excel spreadsheet treatment of the event studes. The second goal s to smplfy the CARs for faculty and ntermedate busness students usng a lesson plan. Fnally, the Excel graphs llustrate the return reactons of acqurng and target frms at and around the event date to mprove the students understandng. 2. Cumulatve Abnormal Returns (CARs) Methodology In the event study lerature, the abnormal returns (ARs) are commonly defned as: Abnormal Returns = Actual Returns Normal Returns For example, Brown (985) ntroduces normal returns as eher the requred return from the Capal Asset Prcng Model (CAPM), E( R ) = α + β R (Method ) or as an arhmetc average of hstorcal returns, n R (Method 2). N n N Method s called Market Adjusted Returns and defnes the cumulatve abnormal returns as CAR = R [ α + β RMt ], where R s the daly stock return and R Mt s the daly market ndex return and can be approxmated by the S&P500 ndex at tme t, and α s the ntercept and β s the slope of the characterstc lne from the CAPM. Method 2 s called Mean Adjusted Returns, and defnes CARs as = n CAR R R, where N s the number of average tradng days n a gven year, N n N and n s (event perod day)/2. The number of days n (- N to - n ) s called estmaton perod and provdes to the normal return estmatons. Also, the (- n to n ) s a relatvely short perod of days and called event perod, and the CARs are calculated for the event perod. The addon of estmaton and event perods should yeld the total tradng days n a gven year. Mt A Pedagogcal Excel Applcaton, Page 2

3 Journal of Fnance and Accountancy 3. An Excel Applcaton to the CARs There are 250 stock tradng days n the sample for the calculaton of the abnormal returns: CAR = R α + β R, and Method : Market Adjusted Cumulatve Abnormal Returns: [ ] 0 CAR s calculated for an event perod of 2 tradng days, 0 Mt R where n takes a value of 0, (event perod day)/2. The event perod s also called event wndow, (-0, 0, +0 days), and ncludes the event day at tme 0. Method 2: Mean Adjusted Cumulatve Abnormal Returns: = n CAR R R, and N n N the n R s the arhmetc average of hstorcal returns from the estmaton perod of N n N 229 tradng days, R It s also possble to use a shorter event wndow of days, (-5, 0, +5 days), and a shorter sample perod of 25 tradng days representng a 6-month daly tradng actves. The selecton crera for the length of the estmaton and event perods should concern wh the optmaly of measurement for the frm and market fundamentals. 4. Fndngs from the HP s Takeover of 3Com On November, 2009 at 5 p.m. ET / 2 p.m. PT, Hewlett-Packard Company (HP) announced to s stockholders that HP wll purchase 3Com Corporaton at a prce of $7.90 per share n cash or an enterprse value of approxmately $2.7 bllon. After the announcement, the followng day on November 2, 2009, the target frm s (3COM) stock prce closed at $7.46 up from $5.69 a day earler, and stayed n that range for the followng 0 days perod. Also, the acqurng frm s (HPQ) stock prce on November 2 was $49.62 slghtly down from the prevous day $49.92, and stayed n that range for the followng 0 days. Table provdes a lesson plan for faculty and students to calculate the CARs. Addonally, the mn-table n Table summarzes the data for the sample and event perods (notce that there are hdden rows). The event perod data s located at Rows 2-22 and estmaton perod data s located at Rows The event perod has 2 days total wh 0 days before and 0 days after the event. Tables 2 present how the data from Table can be appled to Method (wh CAPM). The Column A (DAYS RT=Days Respect to the event) counts days before and after the event. To generate ths column, type 0 nto A2, the event date (//2009), and =A2+ at cell address of A, and =A2- at A3. After the second column, Column B, named as DATE, the stock prces and ndex numbers for COMS, HPQ, and S&P500 respectvely occupes Column C through E. The followng three columns from Column F to H are returns of the stocks and the market ndex, and obtaned by typng =C2/C3- at F2 cell and coped and pasted to the remanng cells. Furthermore, to generate the Market Adjusted Abnormal Returns: AR = R α + β R use the followng shortcut n Excel at I0 cell for the AR of COMS: [ ] Mt A Pedagogcal Excel Applcaton, Page 3

4 Journal of Fnance and Accountancy =F2(INTERCEPT($F$23:$F$25,$H$23:$H$25)+(SLOPE($F$23:$F$25,$H$23:$H$25)*H 2)), and copy and paste for the event perod of 2 days. In the expresson, The regresson component, α + βrmt, refers to: INTERCEPT($F$23:$F$25,$H$23:$H$25)+(SLOPE($F$23:$F$25,$H$23:$H$25)*H2 and can be generated alternatvely by usng a regresson analyss correspondng to a characterstc lne (see the steps to run a regresson wh Excel 2007 n the Appendx). Next, the generaton of cumulatve abnormal returns requre summng up the abnormal returns over the event perod, and therefore choose K22 cell to start strategcally and type the followng: =SUM(I22:$I$22), and copy and paste from K22 through K2 backwards. On Table 3, to generate the Mean Adjusted Abnormal Returns: = n AR R R, use the followng shortcut n excel at I0 cell for the AR N n N of COMS: =F2-AVERAGE($F$23:$F$25), and copy and paste for the event perod of 2 days. Next, agan fndng of cumulatve abnormal returns requres summng up the abnormal returns over the event perod, and follows the process appled n Table2. And, the last column counts the total number of days on the worksheet. A entry at M2, and =M2+ at M3 wll suffce to generate ths column. Fnally, Table 4 uses the CARs nformaton for 3Com from Tables 2 and 3, and plot return reactons around the event date for a wndow of 2 tradng days. To acheve the graphng on both Tables 2 and 3, hghlght cells of DATE, CARs (COMS), and CARs (HPQ) smultaneously by holdng down the CTRL key, and fnd 2-D lne graph from the Insert menu. Frst graph s based on Method, and clearly show that there was about 30% of return reacton for 3Com stock just one day after the announcement date whle the returns of HP stay flat. Ths one day of delayed reacton s consstent wh the exact tmng of takeover announcement: the Hewlett-Packard announced the merger news after the markets were closed on November, Addonally, the last graph on Table 4 shows the same return reactons usng Method 2. Overall, the graphs clearly ndcate that whle there were sgnfcant CARs for 3Com Corporaton, there are no sgnfcant abnormal return reactons for the acqurng frm, Hewlett Packard Company. 5. Summary and Conclusons The Excel applcaton of HP s takeover of 3Comm event yelds the typcal results of an event study n merger lerature: The target frm s CARs take posve values at and after the event date and the acqurng frm s CARs stays relatvely nsgnfcant or mght take negatve values at and after the event date. A spreadsheet applcaton of an event study from s start to fnsh takes relatvely short tme for busness faculty and students to accomplsh whn the confnes of one lecture usng a computer and a projector n front of the students. The Excel applcaton n ths paper acheves two goals: () enforces students understandng of normal returns and cumulatve abnormal returns, and (2) presents the typcal results of merger for the target and acqurng frms from the real world examples. As a result, the busness faculty and students mght carry on usng the event study methods ndependently for ther assgnments and projects. A Pedagogcal Excel Applcaton, Page 4

5 Journal of Fnance and Accountancy References Adar, Troy, Corporate Fnance wh Excel Tutor: Excel Applcatons, Rchard D. Irwn, Inc., Adar, Troy, Corporate Fnance wh Excel Tutor: Excel Applcatons, Rchard D. Irwn, Inc., Bennnga, Smon, Prncples of Fnance wh Excel, Oxford Unversy Press, Bode, Zv, Kane Alex, and Markus, Alan J., Essentals of Investments, 8 th Edon, McGraw-Hll Irwn, 200. Brown, Stephen J. and Jerold B. Warner, Usng Daly Stock Returns: The Case of Event Studes, Journal of Fnancal Economcs, 985(4): 3-3. Holden, Crag W., Excel Modelng n the Fundamentals of Corporate Fnance, 2 nd Edon, Prentce Hall, Jones, Charles P., Investments: Analyss and Management, th Edon, John Wley & Sons Inc., 200. Mayes, Tmothy and Todd Shank, Fnancal Analyss Usng Mcrosoft Excel, Cengage Learnng, 5th Edon, 200. Ross, Stephen A., Westerfeld, Randolph W., and Jaffe, Corporate Fnance, 8 th Edon, McGraw-Hll Irwn, A Pedagogcal Excel Applcaton, Page 5

6 Journal of Fnance and Accountancy Table : Recommended Lesson Plan for CARs Applcaton for 3Com SAMPLE LESSON PLAN: FINDING CUMULATIVE ABNORMAL RETURNS Use the followng data (copy and paste nto an Excel worksheet) to fnd Cumulatve Abnormal Returns (CARs) Frst, fnd abnormal returns (AR) based on the followng two defnons (please choose only one): Abnormal Returns (AR) = Actual Returns Normal Returns. Market Adjusted Abnormal Returns: AR = R - [ α + β RMt ] where R s the daly returns of 3com at tme t and β s the slope (and beta) of characterstc lne. R Mt s the daly returns of S&P500 at tme t, and α s the ntercept and 2. Mean Adjusted Cumulatve Abnormal Returns: = n CAR R R N n N The n R N n N s the arhmetc average of hstorcal returns for 229 tradng days, R. The event wndow s 2 days (-0, 0, +0 days), and n s -. The mnus sgn s assgned because s before the event. If you choose Method, run a smple regresson (follow Data/Data Analyss/Regresson steps) to fnd beta usng the sample perod (229 days). Then, derve ARs and CARs (see Tables 2 and 3). If you choose Method 2, fnd the arhmetc average based on the sample perod (229 days), and use to derve ARs and CARs (see Tables 4 and 5). Usng the coeffcents from the regresson estmaton and fnd cumulatve abnormal returns (CARs) for the whole year (start wh the oldest date to accumulate returns over tme). Graph the CARs aganst days for the event perod (2 days). Sample Data for 3com and HP A B C D E F DAYS DATE HPQ COMS S&P500 TOTAL 2 0 /25/ /2/ // /0/ /28/ /27/ // /28/ /26/ The meanng of the column labels: DAYS = days respect to the event at tme 0, DATE = calendar days, HPQ = stock prces of Hewlett-Packard Company, COMS = stock prces of 3Com Corporaton, S&P500 = ndex numbers of Standard & Poors 500, and TOTAL = total days ncludng the event perod [sample perod (239 days) + event perod (2 days)]. 2. The meanng of cell colors: blue= labels, yellow = days before and after the event, red = event day, and gray = sample perod of 239 days, and green = regresson coeffcents. 3. Hdden rows are at 3-0, 4-2, and A Pedagogcal Excel Applcaton, Page 6

7 Journal of Fnance and Accountancy Table 2: Calculatons of CARs for 3com usng Method : CAR = R [ α + β R ] Mt. The meanng of the column labels: DAYS RT EVENT = days respect to the event at tme 0, DATE = calendar days, HPQ = stock prces of Hewlett-Packard Company, COMS = stock prces of 3Com Corporaton, S&P500 = ndex numbers of Standard & Poors 500, RHPQ = daly returns of Hewlett-Packard Company, RCOMS = daly return of 3Com Corporaton, RS&P500 = daly returns of Standard & Poors 500 ndex, AR = daly abnormal returns, CAR = cumulatve abnormal returns, and TOTAL DAYS = total days ncludng the event perod [sample perod (239 days) + event perod (2 days)]. 2. The meanng of cell colors: blue= labels, yellow = days before and after the event, red = event day, and gray = sample perod of 239 days, and green = regresson coeffcents. 3. Hdden rows are at 3-0 and 4-2. A Pedagogcal Excel Applcaton, Page 7

8 Journal of Fnance and Accountancy Table 3: Calculatons of CARs for 3Com usng Method 2: CAR = R R. The meanng of the column labels: DAYS RT EVENT = days respect to the event at tme 0, DATE = calendar days, HPQ = stock prces of Hewlett-Packard Company, COMS = stock prces of 3Com Corporaton, S&P500 = ndex numbers of Standard & Poors 500, RHPQ = daly returns of Hewlett-Packard Company, RCOMS = daly return of 3Com Corporaton, RS&P500 = daly returns of Standard & Poors 500 ndex, AR = daly abnormal returns, CAR = cumulatve abnormal returns, and TOTAL DAYS = total days ncludng the event perod [sample perod (239 days) + event perod (2 days)]. 2. The meanng of cell colors: blue= labels, yellow = days before and after the event, red = event day, and gray = sample perod of 239 days, and green = regresson coeffcents. 3. Hdden rows are at 3-0 and 4-2. A Pedagogcal Excel Applcaton, Page 8

9 Journal of Fnance and Accountancy Table 4: CARs for 3com and HP at the Announcement Date A Pedagogcal Excel Applcaton, Page 9

10 Journal of Fnance and Accountancy Appendx: How to Run a Regresson wh Excel 200 Verson To run a regresson on Excel 200 verson, follow the steps from the menu:. Data/Data Analyss/Select Regresson opton/input frm s returns n Y-axs and nput market s returns n X-axs, and run regresson. 2. The next step should be to use the ntercept and slope numbers (or to lock on them wh F4 key) n the abnormal return generaton. 3. Inally, after the Data selecton f you do not see Data Analyss opton, follow these steps: a. Clck on Fle selecton from the top menu, b. Choose Excel Optons from the menu provded vertcally on the left, c. Choose Add-Ins, select Analyss ToolPak, clck on Go at the bottom of the wndow, d. Clck on Analyss ToolPak box, and clck on OK button and follow the steps above agan. A Pedagogcal Excel Applcaton, Page 0

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