Question 1

The LBO that is initiated by the target firm's incumbent management is called a management buyout.

Accepted Answer

A management buyout (MBO) is an LBO that is initiated by the target firm's incumbent management. Therefore, the statement is true.

Question 2

When a public company is subject to an LBO,it is said to be going private,because more than 50% of the equity of the firm has been purchased by a small group of investors and is no longer publicly traded.

Accepted Answer

The answer of When a public company is subject to...

Question 3

Bridge financing is usually expected to be replaced within two years after the closing date of the LBO transaction.

Accepted Answer

The answer of Bridge financing is usually expected to be...

Question 4

LBOs can be of an entire company or divisions of a company.

Accepted Answer

LBOs can be used to acquire an entire company or specific divisions or assets of a company.

Question 5

Limitations the lender imposes on the borrower on the amount of dividends that can be paid,the level of salaries and bonuses that may be given to the borrower's employees,the total amount of indebtedness that can be assumed by the borrower,and investments in plant and equipment and acquisitions are called affirmative covenants.

Accepted Answer

These are examples of negative covenants, not affirmative covenants. Negative covenants restrict the borrower from doing certain things, while affirmative covenants require the borrower to perform certain actions.

Question 6

LBO investors have become much more actively involved in managing target firms in recent years than they have in the past.

Accepted Answer

With the increased competition in the LBO market, many investors are taking a more hands-on approach to improve the operations and financial performance of their investment. This includes providing strategic guidance, making operational changes, and implementing cost-cutting measures.

Question 7

If the LBO is structured as a direct merger in which the seller receives cash for stock,the lender will make the loan to the buyer once the appropriate security agreements are in place and the target's stock has been pledged against the loan.The target then is merged into the acquiring company,which is the surviving corporation.

Accepted Answer

This is a description of a typical LBO structure where the buyer acquires the target company by merging it with the acquiring company using cash borrowed from lenders against the target company's assets as collateral.

Question 8

A common technique used during the 1990s was to wait for favorable periods in the stock market to sell a portion of the LBO's equity to the public.The proceeds of the issue would be used to repay debt,thereby reducing the LBO's financial risk.

Accepted Answer

This statement accurately describes a common technique used during the 1990s for LBOs to reduce financial risk.

Question 9

The growth in LBO activity is not simply a U.S.phenomenon.Western Europe has seen a veritable explosion in private equity investors taking companies private,reflecting ongoing liberalization in the European Union as well as cheap financing and industry consolidation.

Accepted Answer

The statement accurately describes the growth in LBO activity in Western Europe.

Question 10

Preferred stock often is issued in LBO transactions,because it provides investors a fixed income security,which has a claim that is junior to common stock in the event of liquidation.

Accepted Answer

Preferred stock actually has a claim on assets that is senior to common stock in the event of liquidation, providing investors with a more secure position than common stockholders.

Question 11

LBOs may be consummated by establishing a new subsidiary that merges with the target.This may be done to avoid any negative impact that the new company might have on existing customer or creditor relationships.

Accepted Answer

This statement is true. Creating a new subsidiary can help to shield the new company from any negative perceptions or consequences that may arise from the LBO.

Question 12

LBO firms seldom purchase a firm to use as a platform to undertake other leveraged buyouts in the same industry.

Accepted Answer

LBO firms often purchase a firm in a particular industry with the intention of using it as a platform to undertake other leveraged buyouts in that same industry. This allows them to leverage their knowledge, expertise, and relationships in the industry to acquire and improve other companies.

Question 13

The acquirer often is asked for a commitment letter from a lender,which commits the lender to providing financing for the transaction.

Accepted Answer

This is a common request in M&A deals to ensure that financing for the deal is secured before proceeding with the transaction.

Question 14

Because term loans are negotiated privately between the borrower and the lender,they are much more expensive than the costs associated with floating a public debt or stock issue.

Accepted Answer

Term loans can be less expensive because they avoid the underwriting fees, the extensive disclosure requirements, and the marketing expenses associated with floating a public debt or stock issue.

Question 15

There is some evidence that the Sarbanes-Oxley Act of 2002 has also been a factor in some firms going private as a result of the onerous reporting requirements of the bill.

Accepted Answer

Sarbanes-Oxley Act of 2002 imposed strict reporting requirements and increased the cost of compliance for public companies, making it more attractive for some firms to go private.

Question 16

An indenture is a contract between the firm that issues the long-term debt securities and the lenders.

Accepted Answer

An indenture is a contract between the issuer of the long-term debt securities and the lenders, outlining the terms of the bond agreement.

Question 17

If the borrower defaults on the loan or otherwise fails to honor the terms of the agreement,the lender can seize and sell the collateral to recover the value of the loan only if the borrower agrees that it is unlikely that the loan will be repaid.

Accepted Answer

The lender can seize and sell the collateral to recover the value of the loan even if the borrower doesn't agree that it is unlikely that the loan will be repaid. This is because the collateral acts as security for the loan and the lender has the right to take possession of it if the loan is not paid back.

Question 18

Debt issues not secured by specific assets are called debentures.

Accepted Answer

Debentures are unsecured debt instruments that are not backed by specific assets.

Question 19

Secured debt often is referred to as mezzanine financing.

Accepted Answer

Mezzanine financing is a type of subordinated debt that has characteristics of both debt and equity. It is not the same as secured debt.

Question 20

The promissory note commits the borrower to repay the loan,only if the assets when liquidated fully cover the unpaid balance.

Accepted Answer

The promissory note commits the borrower to repay the loan regardless of whether the assets when liquidated fully cover the unpaid balance.

Quiz 13: Financing the Deal: Private Equity, hedge Funds, and Other Sources of Funds