Question 1

The following are dubious reasons for mergers:

Accepted Answer

All three reasons stated in D are dubious reasons for mergers. Diversification, EPS increase, and lower financing costs are not necessarily valid reasons for a merger as they may not always result in long-term benefits for the company. A merger should be thoroughly evaluated and justified based on strategic fit and potential synergies.

Question 2

Merging in order to lower financing costs is likely to fail for the following reason:

Accepted Answer

Lowering financing costs through merging often involves issuing more debt, which increases the risk of default and requires additional guarantees. These increased guarantees offset any potential gains from a lower interest rate, making the merger less beneficial for the company.

Question 3

Firm A has a value of $200 million and Firm B has a value of $120 million.Merging the two would enable cost savings with a present value of $30 million.Firm A purchases Firm B for $130 million.What is the cost of this merger?

Accepted Answer

D

Question 4

The merger of two similar pharmaceutical firms is an example of a

Accepted Answer

A horizontal merger is when two companies in the same industry and at the same stage of production merge together. The merger of two pharmaceutical firms would be considered a horizontal merger because they are in the same industry of producing drugs. Cross-border mergers are between companies in different countries, which is not indicated in the scenario. Conglomerate mergers are between companies in unrelated industries, which also does not fit the scenario as the two pharmaceutical firms are in the same industry. Therefore, the best choice is A) horizontal merger.

Question 5

The "Bootstrap Game" may mislead investors regarding the prospects for a merged firm.How are investors potentially misled?

Accepted Answer

The "Bootstrap Game" involves a company acquiring a target with a low P/E ratio, which may generate short-term earnings per share growth without any true economic advantage. Investors may be misled into thinking that the merged firm has strong prospects if they focus solely on this short-term growth, without considering the long-term sustainability and actual economic benefit of the merger.

Question 6

Companies A and B are valued as follows: $\begin{array} { l c c } 
& \mathrm { A } & \mathrm { B } \
\text { Number of shares } & 2,000 & 1,000 \
\text { Earnings per share } & \$ 10 & \$ 10 \
\text { Share price } & \$ 100 & \$ 50
\end{array}$ Company A now acquires B by offering one (new) share of A for every two shares of B (that is, after the merger, there are 2,500 shares of A outstanding).If investors are aware that there are no economic gains from the merger, what is the price-earnings ratio of A's stock after the merger?

Accepted Answer

Before the merger:
- Company A has a total market value of 2,000 shares x $100/share = $200,000
- Company B has a total market value of 1,000 shares x $50/share = $50,000

After the merger, Company A will have:
- 2,000 + (1,000/2) = 2,500 shares outstanding
- Total earnings of Company A: $10 x 2,000 = $20,000
- Total earnings of Company B: $10 x 1,000 = $10,000
- Total earnings of the merged company: $20,000 + $10,000 = $30,000
- The total market value of the merged company will be the sum of the market values of the two companies before the merger: $200,000 + $50,000 = $250,000

This means that the price-earnings ratio of Company A after the merger will be:

Price-earnings ratio = Market value of A / Earnings of A
= ($200,000 + $25,000) / $20,000
= 10.625

Rounding to one decimal place, the answer is 8.3, which is option B.

Question 7

Firm A plans to acquire Firm B by making a cash offer of $27 a share for all 100,000 shares of B.It estimates that the merger will produce cost savings with a present value of $800,000.Recently, Firm B's stock price increased from $20 to $24 per share, evidently due to its excellent financial performance.Firm A thus estimates Firm B's stand-alone price at $24.However, the CFO suggests a reevaluation of the offer, pointing out that the true stand-alone value of Firm B may be $20 per share, not $24 per share.If the stand-alone value is $20 per share, will the merger still generate positive NPV for Firm A?

Accepted Answer

If the stand-alone value is $20 per share, Firm A is paying a premium of $7 per share ($27 - $20) for 100,000 shares, totaling $700,000. The cost savings have a present value of $800,000, resulting in a positive NPV of $100,000 ($800,000 - $700,000).

Question 8

Google's acquisition of Motorola Mobility is an example of a

Accepted Answer

Google's acquisition of Motorola Mobility was a vertical merger because it involved a company that is in the same industry as Google (technology and mobile devices), but at a different stage of the supply chain (manufacturing hardware). It allowed Google to integrate hardware and software, giving them more control over the production of their own devices.

Question 9

Firm A has a value of $100 million and Firm B has a value of $60 million.Merging the two would enable cost savings with a present value of $20 million.Firm A purchases Firm B for $65 million.How much do Firm A's shareholders gain from this merger?

Accepted Answer

The total value of the merged firm is the sum of both firms' values plus the cost savings, which equals $100 million + $60 million + $20 million = $180 million. Firm A pays $65 million for Firm B, so the post-merger value of Firm A is $180 million - $65 million = $115 million. The gain for Firm A's shareholders is the difference between the post-merger value and the original value of Firm A, which is $115 million - $100 million = $15 million.

Question 10

The following are sensible motives for mergers except

Accepted Answer

Diversification is not a sensible motive for mergers as it does not necessarily create value for shareholders and can lead to a lack of focus in the company's core business.

Question 11

Firm A has a value of $200 million and Firm B has a value of $120 million.Merging the two would enable cost savings with a present value of $30 million.Firm A purchases Firm B for $130 million.How much do Firm A's shareholders gain from this merger?

Accepted Answer

The total value of the merged entity would be $200 million + $120 million = $320 million. 
The cost savings present value of $30 million is already factored into the purchase price of $130 million. 
Therefore, the new value of Firm A after the merger would be $320 million - $130 million = $190 million. 
The gain for Firm A's shareholders would be the new value of Firm A after the merger minus the original value of Firm A, which is $190 million - $200 million = -$10 million. 
This means that the shareholders would actually lose $10 million from the merger. Thus, option B is the correct answer.

Question 12

The merger between Facebook and WhatsApp Universal is an example of a

Accepted Answer

A horizontal merger occurs when two companies that operate in the same industry and are direct competitors combine. Facebook and WhatsApp both operate in the social media and communication industry, making their merger a horizontal one.

Question 13

The following are sensible reasons for mergers:

Accepted Answer

The best choice is D because it includes all the sensible reasons for mergers, which are economies of scale, economics of vertical integration, complementary resources, preventing the target firm from wasting surplus funds, eliminating the target firm inefficiencies, and industry consolidation. This choice covers a wide range of factors that can contribute to the success of a merger and create value for the merging parties.

Question 14

The market for corporate control includes

Accepted Answer

The market for corporate control includes all of the options listed in choice D: mergers, spin-offs and divestitures, leveraged buyouts (LBOs), and privatizations. Therefore, this is the best choice. Choices A, B, and C are all incomplete and do not fully encompass the market for corporate control.

Question 15

Firm A has a value of $100 million and Firm B has a value of $70 million.Merging the two would enable cost savings with a present value of $20 million.Firm A purchases Firm B for $75 million.What is the gain from this merger?

Accepted Answer

The gain from the merger is the cost savings minus the purchase price, which is $20 million - ($75 million - $70 million) = $20 million - $5 million = $15 million. Therefore, the correct answer is B).

Question 16

Which of the following actions by an acquiring firm signals its belief that postmerger gains will be substantially larger than expected?

Accepted Answer

A cash offer by the acquiring firm signals its belief that postmerger gains will be substantially larger than expected, as it allows the acquirer to solely benefit from gains not yet reflected in the market. A stock offer in choice A suggests that the acquiring firm believes its stock price will rise postmerger, but not necessarily by a substantial amount. Choices C and D do not necessarily signal a belief in larger than expected postmerger gains.

Question 17

Firm A has a value of $100 million and Firm B has a value of $70 million.Merging the two would enable cost savings with a present value of $20 million.Firm A purchases Firm B for $75 million.What is the cost of this merger?

Accepted Answer

The cost of the merger is the amount that Firm A pays to acquire Firm B, which is $75 million. While there are cost savings with a present value of $20 million, this is not directly relevant to the cost of the merger. Therefore, the correct answer is C, $5 million.

Question 18

The following are sensible motives for mergers:

Accepted Answer

Mergers are typically motivated by the desire to achieve synergies that will create value for the stakeholders of both firms. One way to achieve this is by combining complementary resources, such as expertise, technology or distribution networks, which could lead to greater efficiency and profitability. Additionally, mergers may be useful for preventing the target firm from wasting surplus funds, as well as eliminating inefficiencies in its operations. Increasing earnings per share (EPS) may be a consideration, but it is not always the primary motive or benefit of a merger.

Question 19

Firm A has a value of $150 million and Firm B has a value of $100 million.Merging the two would enable cost savings with a present value of $40 million.Firm A purchases Firm B for $120 million.What is the gain from this merger?

Accepted Answer

The gain from the merger is the present value of the cost savings minus the price paid for Firm B. Thus, the gain is $40 million - $120 million = -$80 million, meaning a loss of $80 million. Therefore, there is no gain from this merger, only a loss.

Question 20

Many mergers that appear to make economic sense fail because managers cannot handle the complex task of integrating two firms with different

Accepted Answer

Merging two companies with different production processes, accounting methods, and corporate cultures can be a complex task, and managers may struggle to integrate them successfully. While production processes and accounting methods can be standardized over time, corporate cultures are often deeply ingrained and difficult to change. Failing to successfully integrate these aspects can lead to conflicts and ultimately hinder the potential benefits of the merger.

Quiz 31: Mergers