Question 1

A capital structure argument (that leverage increases value)is often used to show that a large acquisition price premium is justified even though the target has little debt before the acquisition.

Accepted Answer

The capital structure argument suggests that increasing leverage can lead to an increase in value, which can in turn justify a higher acquisition price. This argument can be used even if the target company has little debt before the acquisition. Therefore, Option A is correct.

Question 2

Synergies are very good reasons for mergers. They're always easy to identify and implement and just about always turn out to be worth more than expected.

Accepted Answer

This statement is false. Synergies can be difficult to identify and implement, and their actual value may differ from initial expectations.

Question 3

Accelerated debt is an anti-takeover strategy in which the target's debt must be paid off in the event it is taken over.

Accepted Answer

Accelerated debt is a common anti-takeover strategy in which the target company's debt becomes due immediately in the event of a takeover, making it less desirable to potential buyers.

Question 4

Technical insolvency is a firm's inability to meet its current obligations. Legal insolvency means the firm's liabilities exceed its assets.

Accepted Answer

Technical insolvency refers to a situation where a firm is unable to pay its short-term obligations, while legal insolvency occurs when a firm's debts exceed its assets, meaning it is unable to meet its financial obligations.

Question 5

An LBO is a takeover but not a merger.

Accepted Answer

An LBO (leveraged buyout) is a form of takeover where a company is acquired using primarily debt financing, typically by a private equity firm or group of investors. It is not a merger, which involves the joining of two companies to form a new entity.

Question 6

The maximum purchase price acceptable to an acquiring firm in a merger is equal to the target's pre-merger value.

Accepted Answer

The maximum purchase price acceptable to an acquiring firm in a merger may be higher than the target's pre-merger value, depending on factors such as synergies, growth potential, and market conditions.

Question 7

Commercial failure (as opposed to economic failure)is an issue between a business and its owners rather than its creditors.

Accepted Answer

Commercial failure refers to a business's inability to remain competitive or financially viable in the market, affecting not just the owners but also creditors, employees, and other stakeholders. Economic failure, on the other hand, is a broader term that can encompass various aspects of an economy or business operations failing to meet expected outcomes.

Question 8

A leveraged buyout is a transaction in which a publicly traded company is converted into a privately held firm.

Accepted Answer

A leveraged buyout (LBO) typically involves a group of investors, including private equity firms, purchasing all outstanding shares of a publicly traded company and taking it private. The company then becomes privately held, with ownership shared among the investors. The purchase is often financed primarily through the use of debt, hence the term "leveraged" in the name.

Question 9

Greenmail is an attempt to stop a hostile takeover by offering to buy any stockholder's shares at a price above market.

Accepted Answer

Greenmail refers to the practice where a company buys back its own shares at a premium from a potential acquirer to prevent a hostile takeover, not from any stockholder.

Question 10

In a Chapter 11 bankruptcy, a firm voluntarily enters the procedure intending a reorganization under which it can continue in business. A Chapter 7 bankruptcy, on the other hand generally results in the firm's liquidation.

Accepted Answer

A Chapter 11 bankruptcy allows for the reorganization and continuation of the firm, while a Chapter 7 bankruptcy typically leads to liquidation of the firm.

Question 11

Acquiring firms rarely pay more than a small premium over their target's premerger market price, because to do so would be an irrational transfer of wealth to the target's stockholders.

Accepted Answer

Acquiring firms often pay a significant premium over their target's premerger market price in order to persuade target shareholders to sell their shares. This premium is intended to compensate the shareholders for the loss of control and potential future profits that would result from the merger.

Question 12

A common method of debt restructuring in bankruptcy is the conversion of debt into equity.

Accepted Answer

Debt restructuring in bankruptcy often involves converting debt into equity as a way to reduce the amount owed and provide a potential return for creditors. This can involve issuing stocks or other securities to creditors in exchange for forgiving or reducing their debt.

Question 13

When an acquiring firm pays too much for an acquisition the real losers are the acquirer's top management and board of directors.

Accepted Answer

The real losers are typically the shareholders of the acquiring firm, as overpayment can lead to a decrease in the firm's value, negatively affecting shareholder wealth.

Question 14

When an acquiring firm pays too much for an acquisition the real losers are the acquirer's stockholders.

Accepted Answer

When an acquiring firm pays too much for an acquisition, it can lead to a decreased value in the company and a reduction in stockholder returns. This is because the acquisition may not generate enough profits to cover the high cost, leading to a decrease in overall company value and ultimately negatively impacting the stockholders.

Question 15

Studies have shown that the high premiums paid in many mergers are just about always justified by increased post-merger cash flows that come from synergies and economies of scale.

Accepted Answer

Studies and empirical evidence often show that a significant number of mergers and acquisitions do not achieve their projected value or synergies, leading to the conclusion that the high premiums paid are not always justified by increased post-merger cash flows.

Question 16

Junk bonds became popular in the 1980s based on the idea that high risk firms failed only slightly more often than low risk firms.

Accepted Answer

This statement is true. Junk bonds, also known as high-yield bonds, were created in the 1980s as a way for high-risk firms to raise capital. The idea was that although these firms had a higher risk of defaulting on their debt, they failed only slightly more often than low-risk firms. Investors were willing to take on this higher risk in exchange for the potential for higher returns.

Question 17

Merger analysis is always a straightforward exercise in capital budgeting.

Accepted Answer

Merger analysis can be complex as it involves assessing the financial, operational, and strategic implications of combining two companies. Factors such as synergies, antitrust regulations, cultural fit, and integration costs must be considered. Additionally, estimating future cash flows and discount rates can be challenging. Therefore, merger analysis requires careful evaluation and is not always straightforward.

Question 18

A spinoff is a last resort effort to divest a badly failing business.

Accepted Answer

A spinoff can also be a strategic move to enhance focus on core businesses or to unlock shareholder value, rather than just a response to a failing business.

Question 19

There is virtually no distinction between economic and commercial business failures.

Accepted Answer

Economic failure refers to a situation where the economy of a country or region experiences a downturn or recession, while commercial failure refers to the inability of a specific business or company to be profitable. These are two distinct concepts, and a business can fail commercially without any direct impact on the overall economy.

Question 20

Golden parachutes are exorbitant severance packages offered to the target's top management should they be fired after a takeover.

Accepted Answer

This statement accurately describes what golden parachutes are.

Quiz 17: Corporate Restructuring