Deck 21: Mergers, Lbos, Divestitures, and Holding Companies

Question 1

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
3 procedures used to defend against hostile takeovers. These strategies are known as "poison pills."

Answer 1

True

Question 2

Post-merger control and the negotiated price paid by the acquirer are 2 of the most important issues in agreeing on the terms of a merger.

Answer 2

True

Question 3

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

Answer 3

False

Question 4

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

Question 5

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

Question 6

The two principal advantages of holding companies are (1) the holding company can control a great deal of assets with limited equity and (2) the dividends received by the parent from the subsidiary are not taxed if the parent holds at least 50% of the subsidiary's stock.

Question 7

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

Question 8

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

Question 9

One of the main reasons why foreign firms are interested in buying U.S. companies is to gain entrance to the U.S. market. A decline in the value of the dollar relative to most foreign currencies makes this competitive strategy especially attractive.

Question 10

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 11

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 12

A joint venture is one in which 2, or sometimes more, independent companies agree to combine resources in order to achieve a specific objective, usually limited in scope.

Question 13

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

Question 14

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

Question 15

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 16

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 17

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 18

Currently (2007), mergers can be accounted for using either the purchase method or the pooling method.

Question 19

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

Question 20

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

Question 21

Although goodwill created in a merger may not be amortized for shareholder reporting purposes, it may be amortized for Federal tax purposes.

Question 22

A two-tier merger offer is one where the acquiring company offers to purchase the target company in a two-part transaction. Cash is paid to some stockholders, bonds are issued to others, but the total values of each part of the transaction are equal.

Question 23

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 24

The rate used to discount projected merger cash flows should be the cost of capital of the new consolidated firm because it incorporates the actual capital structure of the new firm.

Question 25

Firms use defensive tactics to fight off undesired mergers. These tactics do not include

A) raising antitrust issues.
B) getting a white squire to purchase stock in the firm.
C) getting white knights to bid for the firm.
D) repurchasing their own stock.
E) changing the bylaws to eliminate supermajority voting requirements.

Question 26

Which of the following statements is most CORRECT?

A) A conglomerate merger is one where a firm combines with another firm in the same industry.
B) Regulations in the United States prohibit acquiring firms from using common stock to purchase another firm.
C) Defensive mergers are designed to make a company less vulnerable to a takeover.
D) Hostle mergers always create value for the acquiring firm.

Question 27

The 3 main advantages of holding companies are (1) control with fractional ownership, (2) taxation benefits, and (3) isolation of operating risks.

Question 28

a. ?True
b. False
a.
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 29

Discounted cash flow methods are not appropriate for evaluating mergers because the cash flows are uncertain and the discount rate can only be determined after the merger is consummated.

Question 30

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 31

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 32

Which of the following are legal and acceptable reasons for the high level of merger activity in the U.S. during the 1980s?

A) Synergistic benefits arising from mergers.
B) A profitable firm acquires a firm with large accumulated tax losses that my be carried forward.
C) Attempts to stabilize earnings by diversifying.
D) Purchase of assets below their replacement costs.
E) Reduction in competition resulting from mergers.

Question 33

Which of the following statements about valuing a firm using the APV approach is most CORRECT?

A) The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the levered cost of equity.
B) The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the cost of debt.
C) The horizon value is calculated by discounting the expected earnings at the WACC.
D) The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the WACC.
E) The horizon value must always be more than 20 years in the future.

Question 34

Which of the following statements is most CORRECT?

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.
E) Operating economies are never a motive for mergers.

Question 35

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 36

Which of the following statements about valuing a firm using the APV approach is most CORRECT?

A) The value of operations is calculated by discounting the horizon value, the tax shields, and the free cash flows at the cost of equity.
B) The value of equity is calculated by discounting the horizon value, the tax shields, and the free cash flows at the cost of equity.
C) The value of operations is calculated by discounting the horizon value, the tax shields, and the free cash flows before the horizon date at the unlevered cost of equity.
D) The value of equity is calculated by discounting the horizon value and the free cash flows at the cost of equity.
E) The APV approach stands for the accounting pre-valuation approach.

Question 37

Which of the following statements is most CORRECT?

A) Firms that are acquired usually have a market price below book value before the merger offer is made. However, once the initial offer is made, the price can rise above book value, but the purchase price, especially in large acquisitions, generally remains within 20% of book value.
B) When Texaco purchased Getty Oil, many financial analysts felt that the deal made sense because it increased Texaco's market share and expanded its shrinking oil reserves. This merger exemplified the belief among the natural resource companies that buying reserves through acquisitions was less costly than exploring and finding them in the field.
C) When Mobil Oil Company tried to acquire Conoco, which was another oil company, stockholders were concerned that the U.S. Justice Department would try to block the merger because it would lessen competition. Thus, antitrust considerations affected this proposed horizontal merger.
D) Answers b and c are correct.
E) All of the statements above are false.

Question 38

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

Question 39

Any goodwill created in a merger must be amortized over its expected life, usually 40 years, for shareholder reporting purposes.

Question 40

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 41

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
E) $22,916,000

Question 42

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%
E) 16.9%

Question 43

What Dustvac's pre-merger WACC?

A) 9.02%
B) 9.50%
C) 9.83%
D) 10.01%
E) 11.29%

Question 44

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
E) $19.00

Question 45

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%
E) 13.49%

Question 46

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) 9.6%
E) 9.7%

Question 47

Which of the following statements is most CORRECT?

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.
D) Cash payments are used in takeovers but never in mergers.

Question 48

A parent holding company sells shares in its subsidiary such that the parent now owns only 65% of the subsidiary and, thus, the tax returns of the parent and its subsidiary can't be consolidated. The parent receives annual dividends from the subsidiary of $2,500,000. If the parent's marginal tax rate is 34% and if the exclusion on intercompany dividends is 70%, what is the effective tax rate on the intercompany dividends, and how much net dividends are received?

A) 10.2%; $2,245,000
B) 10.2%; $2,135,000
C) 23.8%; $1,905,000
D) 10.2%; $1,750,000
E) 34.0%; $1,650,000