Deck 18: Cross-Border Mergers and Acquisitions:

Question 1

5. Discuss the various types of adjustments for risk that might be made to the global CAPM
before valuing a target firm in an emerging country. Be specific.

Answer 1

To estimate the cost of equity for a firm in an emerging economy (k_e,em), the domestic CAPM can be modified for specific country risk as follows:
k_e,em = R_f + ß_{emfirm,global} (R_country - R_f) + FSP + CRP
where
R_f = Local risk free rate or the U.S. Treasury bond rate converted to a local nominal
rate if cash flows are in the local currency; if cash flows are in dollars, the U.S.
Treasury bond rate.
(R_country - R_f) = Difference between expected return on a broadly defined equity index in the local
country or in a similar country and the risk free rate.
ß_{emfirm,global} = Emerging country firm's global beta
CRP = Specific country risk premium expressed as difference between the local
country's (or a similar country's) government bond rate and the U.S. Treasury
bond rate of the same maturity.
FSP = Firm size premium reflecting the additional return smaller firms must earn
relative to larger firms to attract investors
Note that the specific country risk premium should be added to the estimate of the cost of equity only if the U.S. Treasury bond rate is used as a proxy for the risk free rate. If the local country government rate were used, the risk free rate would already reflect risk specific to that country.

Question 2

is Actavis organized as a holding company in Ireland?

Answer 2

A holding company structure enables a foreign parent to offset gains from one subsidiary with losses generated by another, serves as a platform for future acquisitions, and provides the parent with additional legal protection in the event of lawsuits. Holding companies are natural platforms for making investments in other companies and managing those investments which may involve full control or minority investment positions. Organized as a holding company, Actavis could expand geographically through acquisition and apply the favorable corporate tax rates of Ireland to the earnings of firms it would acquire.

Question 3

Arbitrage should drive the prices in different markets to be the same, as investors sell those assets that are undervalued to buy those that are overvalued.

Answer 3

False

Question 4

4 Find an example of a recent cross-border transaction in the business section of a newspaper. Discuss the challenges an analyst might face in valuing the target firm.

Question 5

Speculate as to how Actavis's takeover of Forest Labs may have created shareholder value?

Question 6

1 Discuss the circumstances under which a non-U.S. buyer may choose a U.S. corporate
structure as its acquisition vehicle. A limited liability company? A partnership?

Question 7

alternatives to acquisition could Actavis have pursued? Speculate as to why a takeover was the
preferred option?

Question 8

Factors contributing to the integration of global capital markets include the reduction in trade barriers, removal of capital controls, the growing disparity in tax rates among countries, floating exchange rates, and the free convertibility of currencies.

Question 9

Globally integrated capital markets provide foreigners with unfettered access to local capital markets and local residents to foreign capital markets.

Question 10

2 What factors influence the selection of which tax rate to use (i.e., the target's or the
acquirer's) in calculating the weighted average cost of capital in cross-border transactions?

Question 11

3 Discuss adjustments commonly made in estimating the cost of debt in emerging countries.

Question 12

8 Give examples of economic and political risk that you could reasonably expect to encounter in acquiring a firm in an emerging economy.

Question 13

Speculate as to why investors for both firms responded so favorably when news of the deal was announced?

Question 14

globally integrated capital markets, segmented capital markets exhibit different bond and equity prices in different geographic areas for different assets in terms of risk and maturity.

Question 15

Using the common motives for cross-border deals discussed in this chapter, speculate as to the reasons Actavis acquired Forest Labs.

Question 16

are the primary factors contributing to the increasing integration of the global capital markets?

Question 17

9 During the 1980s and 1990s, changes in the S&P 500 (a broadly diversified index of U.S. stocks) were about 50 percent correlated with the MSCI EAFE Index (a broadly diversified index of European and other major industrialized countries stock markets). In recent years, the correlation has increased to more than 80 percent. Why? If an analyst wishes to calculate the cost of equity, which index should they use in estimating the equity risk premium?

Question 18

you believe firms should be allowed to engage in tax inversions?

Question 19

6 Do you see the growth in Sovereign Wealth Funds (SWFs) as important sources of capital to the
M&A market or as a threat to the sovereignty of the countries in which they invest? Explain your answer.

Question 20

10 Comment on the following statement: "The conditions for foreign buyers interested in U.S. targets
could not be more auspicious. The dollar is weak, M&A financing is harder to come by for financial sponsors (private equity firms), and many strategic buyers in the U.S. are hard-pressed to make acquisitions at a time when earnings targets are being missed."

Question 21

In common law countries (e.g., U.K., Canada, Australia, India, Pakistan, Hong Kong, Singapore, and other former British colonies), the acquisition vehicle will be a corporation-like structure.

Question 22

Acquiring businesses outside the U.S. involves additional obstacles atypical of domestic acquisitions.

Question 23

Licensing allows a firm to purchase the right to manufacture and sell another firm's products within a specific country or set of countries.

Question 24

To qualify as a U.S. corporation for tax purposes, the foreign firm must own at least 80% of the stock of the domestic subsidiary.

Question 25

Firms investing in industries or countries whose economic cycles are highly correlated may lower the overall volatility in their consolidated earnings and cash flows.

Question 26

A C corporation is the typical acquisition vehicle used by foreign buyers of U.S. businesses due to its flexibility.

Question 27

There is no limitation on non-U.S. persons or entities acting as shareholders in U.S. corporations, except for certain regulated industries.

Question 28

While a foreign buyer may acquire shares or assets directly, share acquisitions are generally the simplest form of acquisition.

Question 29

Quotas and tariffs on imports imposed by governments to protect domestic industries tend to discourage foreign direct investment.

Question 30

The forward triangular cash merger is the most common form of taxable transaction. The target company merges with a U.S. subsidiary of the foreign acquirer with shareholders of the target firm receiving acquirer shares as well as cash, although cash is the predominate form of payment.

Question 31

In civil law countries (which include Western Europe, South America, Japan, and Korea), the acquisition will generally be in the form of a share company or limited liability company.

Question 32

A tax- free reorganization or merger is one in which target shareholders receive acquirer stock in exchange for substantially all of the target's assets or shares. The target firm merges with a U.S. subsidiary of the foreign acquirer in a statutory merger under state laws.

Question 33

M&As can provide quick access to a new market; and, they are subject to fewer problems than domestic M&As.

Question 34

The disadvantages of exporting include high transportation costs, exchange rate fluctuations, and possible tariffs placed on imports into the local country.

Question 35

M&As represent by far the most profitable means of entering foreign markets.

Question 36

Target shareholders most often receive shares rather than cash in cross-border transactions.

Question 37

Firms with significant expertise, brands, patents, copyrights, and proprietary technologies seek to grow by exploiting these advantages in emerging markets.

Question 38

Appreciating foreign currencies relative to the dollar increase the overall cost of investing in the U.S.

Question 39

Investors in segmented markets will bear a lower level of risk by holding a disproportionately large share of their investments in their local market as opposed to the level of risk if they invested in a globally diversified portfolio.

Question 40

Excess capacity in many industries often drives M&A activity as firms strive to achieve greater economies of scale and scope, as well as pricing power with customers and suppliers.

Question 41

The Euroequity market reflects equity issues by a foreign firm tapping a larger investor base than the firm's home equity market.

Question 42

In emerging countries where financial statements may be haphazard and gaining access to the information necessary to adequately assess risk is limited, it may be impossible to perform an adequate due diligence. Under these circumstances, acquirers may protect themselves by including a put option in the agreement of purchase and sale. Such an option would enable the buyer to require the seller to repurchase shares from the buyer at a predetermined price under certain circumstances.

Question 43

The decision to buy political risk insurance depends on the size of the investment and the perceived level of political and economic risk.

Question 44

Despite accounting practices varying widely from country to country, the seller should not be required to confirm that their financial statements have been prepared in accordance with generally accepted accounting principles if to do so would endanger the deal.

Question 45

If the acquisition is structured as an asset purchase because the target is only a division of a foreign company or because the seller agrees to sell assets, the U.S. buyer of the assets must decide whether to acquire them directly or to use a new or existing foreign company to do so. The choice will affect future U.S. and non-U.S. tax consequences.

Question 46

As in the U.S., any representations and warranties in an acquisition agreement are intended to cause the seller to disclose significant information. However, because of local custom, they are often more extensive in foreign countries than in the U.S.

Question 47

Payment in transactions involving non-U.S. firms is most likely to be cash.

Question 48

Mergers are legal in all countries.

Question 49

Bonds of a non-U.S. issuer registered with the SEC for sale in the U.S. public bond markets are called "Yankee" bonds.

Question 50

It is easy to differentiate between political and economic risks, since they are generally unrelated.

Question 51

Employees receive far greater legal protection in many developed foreign countries than they do in the U.S.

Question 52

In choosing how to manage an acquisition in a new country, a manager with an in-depth knowledge of the acquirer's priorities, decision-making processes, and operations is appropriate, especially when the acquirer expects to make very large new investments.

Question 53

Product liability claims are generally more frequent and judgments are larger outside the U.S.

Question 54

Unanticipated changes in exchange rates rarely influence the competitiveness of products produced in the local market for export to the global marketplace.

Question 55

A sometimes overlooked challenge is the failure of the legal system in an emerging country to honor contracts.

Question 56

The American Depository Receipt (ADR) market evolved as a means of enabling foreign firms to raise funds in the U.S. equity markets.

Question 57

Language barriers, different customs, working conditions, work ethics, and legal structures create a new set of challenges in integrating cross-border transactions.

Question 58

International transactions tend to be highly challenging, as they typically involve multiple tax and legal jurisdictions.

Question 59

In cross-border M&As, acquirer shares often are less attractive to potential targets because of the absence of a liquid market for resale or because the acquirer is not widely recognized by the target firm's shareholders.

Question 60

With tax avoidance and fraud common in many countries, the buyer may find that some assets will transfer encumbered by tax liens.

Question 61

Developed economies seem to exhibit significant differences in the cost of equity due to the relatively high integration of their capital markets in the global capital market.

Question 62

The interest rate parity theory relates forward or future spot exchange rates to differences in interest rates between two countries adjusted by the spot rate.

Question 63

Nominal or real cash flows should give different net present values if the expected rate of inflation used to convert future cash flows to real terms is the same inflation rate used to estimate the real discount rate.

Question 64

Firms are likely to achieve significant diversification by investing in all of the following except for

A) Different but uncorrelated industries in the same country
B) Different companies in the same industry in the same country
C) The same industries in different countries
D) Different industries in different countries.
E) Different companies in different industries in the different countries

Question 65

Due to absence of historical data in many emerging economies, the equity risk premium often is estimated using the prospective method implied in the constant growth valuation model.

Question 66

Whenever the target firm's projected cash flows are in local currency, the risk free rate is the local country's government bond rate.

Question 67

Which of the following is generally not a motive for firms to expand internationally?

A) Desire to achieve geographic diversification
B) Desire to accelerate growth
C) Desire to consolidate industries
D) Desire to avoid entry barriers
E) Desire to enter countries with less favorable tax rates

Question 68

The purchasing power parity theory states that one currency will appreciate (depreciate) with respect to another currency according to the expected relative rates of inflation between the two countries.

Question 69

M&A practitioners utilize nominal cash flows except in circumstances of high rates of inflation, when real cash flows are preferable.

Question 70

In general, the appropriate marginal tax rate used in calculating cash flows and the discount rate should be that applicable to the country in which the cash flows are produced.

Question 71

Which of the following is true about segmented capital markets?

A) Exhibit different bond and equity prices in different geographic areas for identical assets in terms of risk and maturity.
B) Exhibit the same bond and equity prices in different geographic areas for identical assets in terms of risk and maturity.
C) Exhibit different bond and equity prices in the same geographic areas for identical assets in terms of risk and maturity.
D) Exhibit different bond prices but the same equity prices in different geographic areas for identical assets in terms of risk and maturity.
E) None of the above

Question 72

Interest rates and expected inflation in one country compared to another country seldom affect exchange rates between the two countries.

Question 73

For developed countries, such as Western Europe, the interest rate parity theory provides a useful framework for estimating forward currency exchange rates (i.e., future spot exchange rates).

Question 74

If cash flows are in terms of local currency and the U.S. Treasury bond rate is used to estimate the risk free rate, the analyst should add the expected inflation rate in the local country relative to that in the U.S. to convert the U.S. Treasury bond rate to a local country nominal rate.

Question 75

The methodology for valuing cross-border transactions using discounted cash flow analysis is substantially different from that employed when both the acquiring and target firms are within the same country. True of False

Question 76

An analyst can determine if a country's equity market is likely to be segmented from the global equity market if the ß derived by regressing returns in the foreign market with returns on the global equity market is significantly different from one.

Question 77

The basic differences between within-country and cross-border valuation methods is that the latter involves converting cash flows from one currency into another and adjusting the discount rate for risks not generally found when the acquirer and target firms are within the same country.

Question 78

If individual country's capital markets are segmented, the global capital asset pricing model must not be adjusted to reflect the tendency of investors in individual countries to hold local country rather than globally diversified equity portfolios.

Question 79

In globally integrated markets, it makes little difference whether the ß is calculated by regressing the target firm's (or a similar firm's) historical returns against the returns for a broadly defined global index, U.S. equity market index, or a broadly defined equity index in the target's country.

Question 80

Which of the following factors contribute to the integration of the global capital markets?

A) The reduction in trade barriers
B) The removal of capital controls
C) The harmonization of tax laws
D) Floating exchange rates
E) All of the above