Deck 24: Mergers, Acquisitions, and Restructuring

Question 1

The appropriate discount rate to be used when calculating the NPV of a target company is the cost of equity of the target company.

Answer 1

True

Question 2

Since managers' central goal is to maximize stock price, managerial control issues do not interfere with mergers that would benefit the target firm's shareholders.

Answer 2

False

Question 3

In a merger with true synergies, the post-merger value exceeds the sum of the separate companies' pre- merger values.

Answer 3

True

Question 4

A conglomerate merger occurs when two firms with either a horizontal or a vertical business relationship combine.

Question 5

Leveraged buyouts (LBOs) occur when a firm's managers, generally backed by private equity groups, try to gain control of a publicly owned company by buying out the public shareholders using large amounts of borrowed money.

Question 6

The purchase of assets at below their replacement cost and tax considerations are two factors that motivate mergers.

Question 7

Since the primary rationale for any operating merger is synergy, in planning such mergers, the development of accurate pro forma cash flows is the single most important action.

Question 8

A spin-off is a type of divestiture in which the assets of a division are sold to another firm.

Question 9

A joint venture is one in which two, or sometimes more, independent companies agree to combine resources in order to achieve a specific objective, usually limited in scope.

Question 10

A company seeking to fight off a hostile takeover might employ the services of an investment banking firm to develop a defensive strategy.

Question 11

Foreign firms are interested in buying Canadian companies to gain entrance to Canada. A decline in the value of the dollar relative to most foreign currencies makes this competitive strategy especially attractive.

Question 12

Post-merger control and the negotiated price paid by the acquirer are two of the most important issues in agreeing on the terms of a merger.

Question 13

Merger activity is likely to heat up when interest rates are high because target firms can expect to receive an especially high premium over the pre-announcement stock price.

Question 14

Borrowing funds on terms that would require immediate repayment of all funds if the firm is acquired, selling off valuable assets, and granting huge "golden parachutes" that open if the firm is acquired are three procedures used to defend against hostile takeovers. These strategies are known as "poison pills."

Question 15

Currently, mergers can be accounted for using either the purchase method or the pooling method in
Canada.

Question 16

Synergistic benefits can arise from a number of different sources, including operating economies of scale, financial economies, and increased managerial efficiency.

Question 17

The primary reason managers give for most mergers is to acquire more assets so as to increase sales and market share.

Question 18

If the constant growth model is used to calculate the value of a target company, the terminal value is an insignificant cash flow analysis.

Question 19

Most defensive mergers occur as a result of managers' actions to maximize shareholders' wealth.

Question 20

In a carve-out, a majority interest in a corporate subsidiary is sold to new shareholders, so the parent gains new equity financing yet retains control.

Question 21

A taxable merger offer is one where the acquiring company offers to purchase the target company with cash. However, the same deal is not taxable if the merger is paid by exchanging stocks. Such non- taxable bids should be by far more popular.

Question 22

In a financial merger, the relevant post-merger cash flows are simply the sum of the expected cash flows of the 2 companies, measured as if they were operated independently.

Question 23

Using the purchase accounting method to report mergers, goodwill is not amortized, rather it is subject to an annual impairment test.

Question 24

Firms use defensive tactics to fight off undesired mergers. These tactics include which of the following?

A) developing poison pills
B) getting white knights to bid for the firm
C) repurchasing their own stock
D) developing poison pills, getting white knights to bid for the firm, and repurchasing their own stock

Question 25

The income statement of the post-merger firm will be the same regardless of the accounting method used.

Question 26

Only if a target firm's value is greater to the acquiring firm than its market value as a separate entity will a merger be financially justified.

Question 27

Coca-Cola's acquisition of Columbia Pictures and its announcement that it would operate its new subsidiary separately could be described as primarily a financial merger.

Question 28

A shareholder rights plan allowing existing shareholders to buy or sell shares at very attractive prices provides the acquirer an inexpensive way for takeovers.

Question 29

If a petrochemical firm that used oil as feedstock merged with an oil producer that had large oil reserves and a drilling subsidiary, this would be a vertical merger.

Question 30

A congeneric merger is one where the merging firms operate in related businesses but do not necessarily produce the same products or have a producer-supplier relationship.

Question 31

If the capital structure is stable, and free cash flows are expected to be growing at a constant rate at the horizon date, then the horizon value is calculated by discounting the free cash flows plus the expected future tax shields at the weighted average cost of capital.

Question 32

By examining stock prices around merger announcement dates, event studies provide inconclusive results that mergers benefit only targets, not acquirers.

Question 33

Which of the following is a valid, acceptable reason for a closely held firm proposing a merger activity?

A) synergistic benefits arising from mergers
B) reduction in competition resulting from mergers
C) attempts to stabilize earnings by diversifying
D) minimizing taxes when disposing of excess cash

Question 34

Under purchase accounting, the acquired assets must be written up or written down if the purchase price does not equal net asset value.

Question 35

Which of the following actions can help managers defend against a hostile takeover?

A) establishing a poison pill provision
B) granting lucrative golden parachutes to senior managers
C) establishing a super-majority provision in the company's bylaws to raise the percentage of the board of directors that must approve an acquisition from 50% to 75%
D) establishing a poison pill provision, granting lucrative golden parachutes to senior managers, and establishing a super-majority provision in the company's bylaws to raise the percentage of the board of directors that must approve an acquisition from 50% to 75%

Question 36

Interest expense must be explicitly included in a merger incremental cash flow analysis.

Question 37

Since a manager's central goal is to maximize the firm's common share price, any merger offer that provides shareholders with significant gains over the current share price will be approved by the current management team.

Question 38

Which of the following statements best describes a merger concept?

A) A conglomerate merger is one where a firm combines with another firm in the same industry.
B) Regulations in Canada prohibit acquiring firms from using common share to purchase another firm.
C) Defensive mergers are designed to make a company less vulnerable to a takeover.
D) The corporate valuation method and the equity residual method, even properly applied, produce different results.

Question 39

The distribution of synergistic gains between the stockholders of 2 merged firms is almost always based strictly on their respective market values before the announcement of the merger.

Question 40

The present value of the free cash flows discounted at the unlevered cost of equity is the value of the firm's operations if it had no debt.

Question 41

Dunbar Hardware, a national hardware chain, is considering purchasing a smaller chain, Eastern Hardware. Dunbar's analysts project that the merger will result in incremental free flows and interest tax savings with a combined present value of $72.52 million, and they have determined that the appropriate discount rate for valuing Eastern is 16%. Eastern has 4 million shares outstanding and no debt. Eastern's current price is $16.25. What is the maximum price per share that Dunbar should offer?

A) $16.25
B) $16.97
C) $17.42
D) $18.13

Question 42

Which of the following statements best describes mergers?

A) If a company that produces military equipment merges with a company that manages a chain of motels, this is an example of a horizontal merger.
B) A defensive merger is one where the firm's managers decide to merge with another firm to avoid or lessen the possibility of being acquired through a hostile takeover.
C) Acquiring firms send a signal that their stock is undervalued if they choose to use stock to pay for the acquisition.

Question 43

Which of the following is not a valid reason for a company to seek external growth through mergers?

A) to avoid paying dividends
B) to achieve greater diversification
C) to take advantage of the tax-loss carryforwards
D) to maintain availability of raw materials

Question 44

The value of synergy can be estimated by the equation

A) VAB - VA - VB
B) VAB - VB - taxes
C) VA - VB - ?costs
D) VA + VB - ?revenues

Question 45

Which of the following statements best describes mergers?

A) The high Canadian dollar relative to foreign currencies makes Canadian companies comparatively inexpensive to foreign buyers, spurring many mergers.
B) The expansion of the junk bond market makes debt more freely available for large acquisitions and LBOs, resulting in an increased level of merger activity.
C) Increased nationalization of business and a desire to scale down and focus on producing in one's home country may virtually halt international mergers.

Question 46

Which of the following factors influences the consideration of a merger and an acquisition of stocks?

A) Shareholders are dealt with directly to bypass the target management and board of directors.
B) In a tender offer, usually some minority shareholders do not tender stopping complete firm absorption.
C) Target management may be unfriendly and resist an offer. Resistance usually makes the stock price higher.
D) Shareholders are dealt with directly to bypass the target management and board of directors; in a tender offer, usually some minority shareholders do not tender stopping complete firm absorption; and target management may be unfriendly and resist an offer. Resistance usually makes the stock price higher.

Question 47

The DAB Corp. has unfortunately accumulated net operating losses of $70 million and is likely to go bankrupt. The CLC Corp. has earnings of $200 million and is in the 36% marginal tax bracket. CLC is considering buying DAB and liquidating the company and retaining a few of the assets. What is the minimum value of DAB to CLC?

A) $25.2 million
B) $70.0 million
C) $72.0 million
D) There is insufficient information provided.

Question 48

Which of the following statements best describes LBOs?

A) Leveraged buyouts(LBOs) occur when a firm issues equity and uses the proceeds to take a firm public.
B) In a typical LBO, bondholders do well but shareholders see their value decline.
C) Firms are forbidden by law to sell any assets during the first 5 years following a leverage buyout.
D) None of the above.

Question 49

Two firms merge and no synergies occur. Which of the following statements best describes the result?

A) The reduction in risk in the combined firm benefits the bondholders at the expenses of the shareholders.
B) The value of the debt in the combined firm will likely be greater than the value of the debt in the two separate firms.
C) The size of the gain to the bondholders depends on the specific reductions in bankruptcy probabilities after the merger.
D) All of the above.

Question 50

What is a divestiture?

A) a firm's need for cash
B) the poor performance of a business unit
C) a change in a firm's strategic thinking
D) a firm's need for cash; the poor performance of a business unit; and a change in a firm's strategic thinking

Question 51

Kelly Tubes is considering a merger with Reilly Tires. Reilly's market-determined beta is 0.9, and the firm currently is financed with 20% debt, at an interest rate of 8%, and its tax rate is 25%. If Kelly acquires Reilly, it will increase the debt to 60%, at an interest rate of 9%, and the tax rate will increase to 35%. The risk-free rate is 6% and the market risk premium is 4%. What will Reilly's required rate of return on equity be after it is acquired?

A) 7.4%
B) 8.9%
C) 9.3%
D) 9.7%

Question 52

Firm X is considering acquiring Firm Y by offering one of its common stock for 0.8728 shares of Y. Currently, the market price of Firm X is $48. What is the cash bidding price proposed for this deal?

A) $35
B) $42
C) $55
D) $63

Question 53

Which of the following statements best describes mergers?

A) The purchase of Red Lobster Restaurant initiated by Remax Realty is an example of conglomerate mergers.
B) A merger can be blocked by either a firm's customers or suppliers, not the government.
C) The existence of golden parachutes is a reason that the management of a target company tries to block a takeover.
D) None of the above.

Question 54

Which of the following statements best describes mergers?

A) Tax considerations often play a part in mergers. If one firm has excess cash, purchasing another firm exposes the purchasing firm to additional taxes. Thus, firms with excess cash rarely undertake mergers.
B) The smaller the synergistic benefits of a particular merger, the greater the scope for striking a bargain in negotiations, and the higher the probability that the merger will be completed.
C) Since mergers are frequently financed by debt rather than equity, a lower cost of debt or a greater debt capacity are rarely relevant considerations when considering a merger.
D) Managers who purchase other firms often assert that the new combined firm will enjoy benefits from diversification, including more stable earnings. However, since shareholders are free to diversify their own holdings, and at what's probably a lower cost, diversification benefits is generally not a valid motive for a publicly held firm.

Question 55

Which of the following statements best describes mergers?

A) The acquiring firm's required rate of return in most horizontal mergers will not be affected, because the two firms will have similar betas.
B) Financial theory says that the choice of how to pay for a merger is irrelevant because, although it may affect the firm's capital structure, it will not affect its overall required rate of return.
C) The basic rationale for any consolidation is financial synergy and, thus, the estimation of pro forma cash flows is the single most important part of the analysis.
D) The primary rationale for most operating mergers is synergy.

Question 56

Brau Auto, a national autoparts chain, is considering purchasing a smaller chain, South Georgia Parts (SGP). Brau's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values: Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. What is the value of SGP to Brau?

A) $53.40 million
B) $61.96 million
C) $64.64 million
D) $76.96 million

Question 57

Firms A and B, both all-equity financed, are merging. Prior to merge, Firm A, having 100 shares outstanding, is worth $15,000 while Firm B, with 50 shares outstanding. The combined firm will be worth $30,000. Firm A pays $11,500 in cash for Firm B. What is the net benefit of the merger to Firm A?

A) $3,500
B) $5,000
C) $11,500
D) $18,500

Question 58

Great Subs Inc., a regional sandwich chain, is considering purchasing a smaller chain, Eastern Pizza, which is currently financed using 20% debt at a cost of 8%. Great Subs' analysts project that the merger will result in incremental free cash flows and interest tax savings of $2 million in Year 1, $4 million in Year 2, $5 million in Year 3, and $117 million in Year 4. (The Year 4 cash flow includes a horizon value of $107 million.) The acquisition would be made immediately, if it is to be undertaken. Eastern's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8%, and the market risk premium is 4%. What is the appropriate rate for use in discounting the free cash flows and the interest tax savings?

A) 12.0%
B) 13.9%
C) 14.4%
D) 16.0%

Question 59

Which of the following statements best describes accounting for mergers?

A) Goodwill is amortized for shareholder reporting.
B) Goodwill is subject to impairment test for tax purposes.
C) Goodwill is no longer created in a merger.

Question 60

Kelly Tubes is considering a merger with Reilly Tires. Reilly's market-determined value is $3.75 million, and Kelly's market value as a stand-alone company is $4.50 million. Both firms are all equity- financed. Kelly acquires Reilly for $4.25 million because it believes the combined firm value will increase to $9.25 million. What will be the synergy from this merger?

A) $0.50 million
B) $1.00 million
C) $4.75 million
D) $5.00 million

Question 61

What is the horizontal value of Maritime's operation as of year 3?

A) $101.53 million
B) $98.57 million
C) $86.66 million
D) $71.07 million

Question 62

Blazer Inc. is thinking of acquiring Laker Company. Blazer expects Laker's NOPAT to be $9 million the first year, with no net new investment in operating capital and no interest expense. For the second year, Laker is expected to have NOPAT of $25 million and interest expense of $5 million. Also, in the second year only, Laker will need $10 million of net new investment in operating capital. Laker's marginal tax rate is 40%. After the second year, the free cash flows and the tax shields from Laker to Blazer will both grow at a constant rate of 4%. Blazer has determined that Laker's cost of equity is 17.5%, and Laker currently has no debt outstanding. Assuming that all cash flows occur at the end of the year, Blazer must pay $45 million to acquire Laker. What it the NPV of the proposed acquisition? Note that you must first calculate the value to Blazer of Laker's equity.

A) $ 45.0 million
B) $ 68.2 million
C) $ 86.5 million
D) $113.2 million

Question 63

What is the value of Dustvac's equity to Magiclean? (Round your answer to the closest thousand dollars.)

A) $16,019,000
B) $17,111,000
C) $18,916,000
D) $22,111,000

Question 64

What Dustvac's pre-merger WACC?

A) 9.02%
B) 9.50%
C) 9.83%
D) 10.01%

Question 65

What discount rate should you use to discount Dustvac's free cash flows and interest tax savings?

A) 10.01%
B) 10.06%
C) 11.29%
D) 11.44%

Question 66

What is the highest price TV Emporium pays for Maritime?

A) $67.75 million
B) $76.28 million
C) $81.10 million
D) $90.64 million

Question 67

MCorp, with a book value of $20 million and a market value of $30 million, has merged with NCorp, with a book value of $6 million and a market value of $8 million at a price of $9 million. Under the purchase method, what will be the total assets on the book of the new merged firm?

A) $26 million
B) $29 million
C) $38 million
D) $39 million