Deck 20: Mergers and Acquisitions and Financial Distress

Question 1

Which of these makes the following a true statement? Diversification resulting from a merger can:

A) make the debt of the merged firm more risky, thus lowering the cost of capital.
B) make the debt of the merged firm less risky, thus lowering the cost of capital.
C) make the debt of the merged firm less risky, thus raising the cost of capital.
D) None of the options make the statement true.

Answer 1

make the debt of the merged firm less risky, thus lowering the cost of capital.

Question 2

Which of the following is NOT one of the sources of value enhancing synergy in a merger?

A) Revenue enhancement
B) Cost reduction
C) Tax considerations
D) Higher cost of capital

Answer 2

Higher cost of capital

Question 3

Which of the following is defined as a merged firm's ability to generate synergistic cost savings through the joint use of inputs in producing multiple products?

A) Economies of scale
B) Economies of scope
C) Economies of synergy
D) X-efficiencies

Answer 3

Economies of scope

Question 4

Which of the following is a type of merger in which two firms that sell the same products in different market areas are combined?

A) Vertical
B) Conglomerate
C) Product extension
D) Market extension

Question 5

Which of the following is a type of merger in which an entirely new firm is created?

A) Composition
B) Synergy
C) Consolidation
D) Assignment

Question 6

A type of horizontal merger that combines two firms that sell the same products in different market areas is a ________.

A) Product extension merger
B) Market extension merger
C) Vertical merger
D) Conglomerate merger

Question 7

Which of the following is defined as the purchase of one firm by another firm?

A) Merger
B) Synergy
C) Acquisition
D) Assignment

Question 8

Which of the following is NOT a tax consideration motive for a merger?

A) Tax gains from net operating losses
B) Tax gains from unused debt capacity
C) Tax gains from unused equity capacity
D) Tax gains from surplus funds

Question 9

Which of the following is defined as a merged firm's advantage over smaller firms if cuts associated with the merger lower the firm's operating costs of production?

A) Economies of scale
B) Economies of scope
C) Economies of synergy
D) X-efficiencies

Question 10

Which of the following is defined as a transaction in which two firms combine to form a single firm?

A) Merger
B) Synergy
C) Acquisition
D) Assignment

Question 11

Which of the following is the type of financial distress in which a firm's operating cash flows are not sufficient to pay its liabilities as they come due?

A) Business failure
B) Economic failure
C) Technical insolvency
D) Business extension

Question 12

Which of these terms is defined as the value of the combined firms being greater than the sum of the value of the two firms individually?

A) Composition
B) Synergy
C) Consolidation
D) Conglomerate

Question 13

The cost advantage when fixed costs are spread over a large number of units is ________.

A) Long-term effect
B) Economies of scope
C) Economies of synergy
D) Economies of scale

Question 14

Which of the following is the most extreme type of financial distress for a business?

A) Business failure
B) Economic failure
C) Technical insolvency
D) Business extension

Question 15

Which of the following is cost savings usually attributed to superior management skills and other difficult-to-measure managerial factors?

A) Economies of scale
B) Economies of scope
C) Economies of synergy
D) X-efficiencies

Question 16

A merger of two companies within the same industry is a ________.

A) Horizontal merger
B) Market extension merger
C) Vertical merger
D) Conglomerate merger

Question 17

Which of the following is a combination of firms that sell different, but somewhat related, products?

A) Vertical merger
B) Conglomerate merger
C) Product extension merger
D) Market extension merger

Question 18

Which of the following is the type of financial distress in which the return on a firm's assets is less than the firm's cost of capital?

A) Business failure
B) Economic failure
C) Technical insolvency
D) Business extension

Question 19

Which of the following is a combination of a firm with a supplier or distributor?

A) Vertical merger
B) Conglomerate merger
C) Product extension merger
D) Market extension merger

Question 20

Which of the following combines two companies that have no related products or markets?

A) Vertical merger
B) Conglomerate merger
C) Product extension merger
D) Market extension merger

Question 21

Suppose that the financial ratios of a potential borrowing firm took the following values: X₁ = Net working capital/Total assets = 0.35, X₂ = Retained earnings/Total assets = 0.50, X₃ = Earnings before interest and taxes/Total assets = 0.60, X₄ = Market value of equity/Book value of long-term debt = 1.50, X₅ = Sales/Total assets ratio = 3.65. Calculate the Altman's Z-score for this firm.

A) 7.65
B) 1.54
C) 6.60
D) 1.32

Question 22

Building Supplies is considering a merger with Tools and More. Building's total operating costs of producing services are $4 million for a sales volume of $20 million. Tools' total operating costs of producing services are $1 million for a sales volume of $5 million. Suppose that synergies in the production process result in a cost of production for the merged firms totalling $4.8 million with total sales remaining unchanged. Calculate the total average cost for the merged firm.

A) 9.6 percent
B) 40.0 percent
C) 19.2 percent
D) 20.0 percent

Question 23

Jan's Bakery is considering a merger with Tina's Cookies. Jan's total operating costs of producing services are $300,000 for a sales volume of $2 million. Tina's total operating costs of producing services are $75,000 for a sales volume of $600,000. If the two firms merge, calculate the total average cost for the merged firm assuming no synergies.

A) 12.5 percent
B) 11.54 percent
C) 14.42 percent
D) 13.75 percent

Question 24

An agreement in which creditors voluntarily reduce their claims on the firm, receiving only a partial payment for their claims, by reducing the principal amount or the interest rate on the debt or by taking equity in exchange for debt is a ________.

A) Extension
B) Composition
C) Workout
D) none of the above

Question 25

Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.20 (debt ratio) + 0.15 (profit margin)
A firm you are thinking of lending to has a debt ratio of 55 percent and a profit margin of 10 percent. Calculate the firm's expected probability of default, or bankruptcy.

A) 12.5 percent
B) 10.0 percent
C) 1.65 percent
D) 10.25 percent

Question 26

Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.15 (debt ratio) + 0.05 (profit margin)
A firm you are thinking of lending to has a debt ratio of 50 percent and a profit margin of 8 percent. Calculate the firm's expected probability of default, or bankruptcy.

A) 7.90 percent
B) 11.6 percent
C) 30.00 percent
D) 7.80 percent

Question 27

Which of the following involves a firm and its creditors agreeing to a private reorganization outside the formal bankruptcy process?

A) Consolidation bankruptcy
B) Prepackaged bankruptcy
C) Chapter 13
D) Chapter 7

Question 28

Which of these is the person who liquidates the firm's assets through a private sale or public auction and then distributes any proceeds from the sale to the firms' creditors and stockholders?

A) Assignor
B) Grantor
C) Trustor
D) Trustee

Question 29

Which of the following is a voluntary liquidation proceeding that passes the liquidation of the firm's assets to a third party that is designated as the assignee or trustee?

A) Liquidation
B) Assignment
C) Composition
D) Consolidation

Question 30

Suppose that the financial ratios of a potential borrowing firm took the following values: X₁ = Net working capital/Total assets = 0.30, X₂ = Retained earnings/Total assets = 0.40, X₃ = Earnings before interest and taxes/Total assets = 0.43, X₄ = Market value of equity/Book value of long-term debt = 0.65, X₅ = Sales/Total assets ratio = 0.95. Calculate the Altman's Z-score for this firm.

A) 3.679
B) 2.73
C) 10.23
D) 2.046

Question 31

Which of the following is a formal bankruptcy proceeding involving the reorganization of the corporation with some provision for repayment to the firm's creditors?

A) Chapter 7
B) Chapter 11
C) Chapter 13
D) Chapter 17

Question 32

Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.23 (debt ratio) + 0.08 (profit margin)
A firm you are thinking of lending to has a debt ratio of 60 percent and a profit margin of 12 percent. Calculate the firm's expected probability of default, or bankruptcy.

A) 14.76 percent
B) 22.32 percent
C) 10.30 percent
D) 13.25 percent

Question 33

A voluntary settlement in which a firm's creditors will arrange with the firm to help it recover and re-establish itself as a viable entity is a ________.

A) Extension
B) Composition
C) Workout
D) none of the above

Question 34

Flowers Galore is considering a merger with Balloons N More. Flowers Galore's total operating costs of producing services are $400,000 for a sales volume of $4 million. Balloons' total operating costs of producing services are $30,000 for a sales volume of $700,000. If the two firms merge, calculate the total average cost for the merged firm assuming no synergies.

A) 4.29 percent
B) 9.15 percent
C) 10.00 percent
D) 7.14 percent

Question 35

Suppose that the financial ratios of a potential borrowing firm took the following values: X₁ = Net working capital/Total assets = 0.25, X₂ = Retained earnings/Total assets = 0.30, X₃ = Earnings before interest and taxes/Total assets = 0.35, X₄ = Market value of equity/Book value of long-term debt = 0.50, X₅ = Sales/Total assets ratio = 0.9. Calculate the Altman's Z-score for this firm.

A) 2.30
B) 3.075
C) 9.8
D) 1.96

Question 36

Which of the following is a formal bankruptcy proceeding which outlines the process to be followed for liquidating a failed firm?

A) Chapter 7
B) Chapter 11
C) Chapter 13
D) Chapter 17

Question 37

Consider a market that has three firms with the following market shares:
Firm A 15 percent
Firm B 25 percent
Firm C 60 percent
Suppose Firm B wants to acquire Firm A so that the post-acquisition market would exhibit the following shares:
B + A = 40 percent
C = 60 percent
What is the change in the HHI resulting from the merger?

A) 750
B) 4,450
C) 5,200
D) No change

Question 38

Consider a market that has three firms with the following market shares:
Firm A 25 percent
Firm B 55 percent
Firm C 20 percent
Suppose Firm A wants to acquire Firm C so that the post-acquisition market would exhibit the following shares:
A + C = 45 percent
B = 55 percent
What is the change in the HHI resulting from the merger?

A) 1,000
B) 4,050
C) 5,050
D) No change

Question 39

Suppose that the financial ratios of a potential borrowing firm took the following values: X₁ = Net working capital/Total assets = 0.15, X₂ = Retained earnings/Total assets = 0.10, X₃ = Earnings before interest and taxes/Total assets = 0.15, X₄ = Market value of equity/Book value of long-term debt = 0.40, X₅ = Sales/Total assets ratio = 0.8. Calculate the Altman's Z-score for this firm.

A) 9.10
B) 1.60
C) 0.371
D) 1.855

Question 40

Which of the following is the termination of the firm as a going concern in which assets are sold and any proceeds go to pay off the firm's creditors?

A) Liquidation
B) Assignment
C) Composition
D) Consolidation

Question 41

The Justice Department has been asked to review a merger request for a market with the following four firms.
$$\begin{array} { c r } \text { Fim } & \text { Assets } \\\text { A } & \$ 10 \text { million } \\B & 20 \text { million } \\\text { C } & 100 \text { million } \\\text { D } & 30 \text { million }\end{array}$$
If Firm C acquires Firm D, what is the HHI for the new market?

A) 100
B) 160
C) 6,796.875
D) 17,400.00

Question 42

Blinds N Such is considering a merger with Window Supply Stores. Blinds' total operating costs of producing services are $750,000 for sales volume of $6 million. Window's total operating costs of producing services are $100,000 for a sales volume (JP) of $1 million. Calculate the average cost of production for the Blinds and Window firms, respectively.

A) 10 percent, 12.5 percent
B) 12.5 percent, 10 percent
C) 75 percent, 1.67 percent
D) 13.93 percent, 13.93 percent

Question 43

Tim's Fix It Shop, Inc., is asking a price of $50 million to be purchased by Taylor's Tire Hut Corp. The two firms currently have cumulative total cash flows of $4 million which are growing at 2 percent annually. Managers estimate that because of synergies the merged firm's cash flows will increase to 5 percent for the first four years following the merger. After the first four years cash flows will grow at a rate of 3 percent. The WACC for the merged firms is 12 percent. Calculate the NPV of the merger. Should Taylor's Tire Hut Corporation agree to acquire Tim's Fix It Shop, Inc., for the asking price of $50 million?

A) Yes, the NPV is ≥ $0
B) Yes, the NPV is ≤ $0
C) No, the NPV is ≥ $0
D) No, the NPV is ≤ $0

Question 44

Windows N Such, Inc., is asking a price of $195 million to be purchased by Curtain Rods Corp. The two firms currently have cumulative total cash flows of $15 million which are growing at 1 percent annually. Managers estimate that because of synergies the merged firm's cash flows will increase to 3 percent for the first four years following the merger. After the first four years cash flows will grow at a rate of 2 percent. The WACC for the merged firms is 10 percent. Calculate the NPV of the merger. Should Curtain Rods Corporation agree to acquire Windows N Such, Inc., for the asking price of $195 million?

A) Yes, the NPV is ≥ $0
B) Yes, the NPV is ≤ $0
C) No, the NPV is ≥ $0
D) No, the NPV is ≤ $0

Question 45

Blinds N Such is considering a merger with Window Supply Stores. Blinds' total operating costs of producing services are $750,000 for sales volume of $6 million. Window's total operating costs of producing services are $100,000 for a sales volume (JP) of $1 million. For a sales volume of $7 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 12 percent.

A) Decrease of $840,000
B) Decrease of $10,000
C) Decrease of $40,000
D) Decrease of $90,000

Question 46

Dee's Dry Cleaning is considering a merger with Larry's Laundry Supply Stores. Dee's total operating costs of producing services are $600,000 for sales volume of $4 million. Larry's total operating costs of producing services are $200,000 for a sales volume (JP) of $1 million. For a sales volume of $5 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 10 percent.

A) Decrease of $500,000
B) Decrease of $300,000
C) Decrease of $100,000
D) Decrease of $200,000

Question 47

Department Stores, Inc., is asking a price of $25 million to be purchased by Discount Stores Corp. The two firms currently have cumulative total cash flows of $2 million which are growing at 2.5 percent annually. Managers estimate that because of synergies the merged firm's cash flows will increase to 5 percent for the first four years following the merger. After the first four years cash flows will grow at a rate of 4.5 percent. The WACC for the merged firms is 13 percent. Calculate the NPV of the merger. Should Discount Stores Corporation agree to acquire Department Stores, Inc., for the asking price of $25 million?

A) Yes, the NPV is ≥ $0
B) Yes, the NPV is ≤ $0
C) No, the NPV is ≥ $0
D) No, the NPV is ≤ $0

Question 48

Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.25 (debt ratio) + 0.12 (profit margin)
A firm you are thinking of lending to has a debt ratio of 62 percent and a profit margin of 14 percent. Calculate the firm's expected probability of default, or bankruptcy.

A) 17.18 percent
B) 2.604 percent
C) 14.99 percent
D) 19.09 percent

Question 49

Jewelry Designs is considering a merger with Beads Supply Stores. Jewelry's total operating costs of producing services are $300,000 for sales volume of $2 million. Beads' total operating costs of producing services are $125,000 for a sales volume (JP) of $2.25 million. For a sales volume of $4.25 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 8 percent.

A) Decrease of $340,000
B) Decrease of $85,000
C) Decrease of $40,000
D) Decrease of $25,000

Question 50

The Justice Department has been asked to review a merger request for a market with the following four firms.
$$\begin{array} { c r } \text { Fim } & \text { Assets } \\\text { A } & \$ 10 \text { million } \\B & 20 \text { million } \\\text { C } & 100 \text { million } \\\text { D } & 30 \text { million }\end{array}$$
If Firm A acquires Firm D, what is the HHI for the new market?

A) 100
B) 625
C) 3,906.25
D) 4,687.50

Question 51

Dee's Dry Cleaning is considering a merger with Larry's Laundry Supply Stores. Dee's total operating costs of producing services are $600,000 for sales volume of $4 million. Larry's total operating costs of producing services are $200,000 for a sales volume (JP) of $1 million. Calculate the average cost of production for Dee's and Larry's firms, respectively.

A) 15 percent, 20 percent
B) 20 percent, 15 percent
C) 16 percent, 16 percent
D) 60 percent, 5 percent

Question 52

Jewelry Designs is considering a merger with Beads Supply Stores. Jewelry's total operating costs of producing services are $300,000 for sales volume of $2 million. Beads' total operating costs of producing services are $125,000 for a sales volume (JP) of $2.25 million. Calculate the average cost of production for the Jewelry and Beads firms, respectively.

A) 15 percent, 5.56 percent
B) 5.56 percent, 15 percent
C) 15 percent, 55.56 percent
D) 13.33 percent, 6.25 percent

Question 53

Baby Supplies is considering a merger with Tot Toy Stores. Baby's total operating costs of producing services are $450,000 for sales volume of $2.15 million. Tot's total operating costs of producing services are $250,000 for a sales volume (JP) of $975,000. Calculate the average cost of production for the Baby and Tot Toy firms, respectively.

A) 11.63 percent, 20.93 percent
B) 20.93 percent, 25.64 percent
C) 46.15 percent, 11.63 percent
D) 22.4 percent, 22.4 percent

Question 54

Crib World is considering a merger with Tots Supply Stores. Crib's total operating costs of producing services are $250,000 for sales volume of $1.25 million. Tots' total operating costs of producing services are $210,000 for a sales volume (JP) of $900,000. Calculate the average cost of production for the Crib and Tots firms, respectively.

A) 20 percent, 23.33 percent
B) 23.33 percent, 20 percent
C) 27.78 percent, 16.8 percent
D) 21.4 percent, 21.4 percent

Question 55

Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.18 (debt ratio) + 0.35 (profit margin)
You know a particular firm has a debt ratio of 35 percent and a probability of default of 8 percent. Calculate the firm's profit margin.

A) 4.857 percent
B) 8.163 percent
C) 6.53 percent
D) 8.00 percent

Question 56

You own stock in Carpet City, Inc., which has just made a bid of $165 million to purchase Tile Corporation. The two firms currently have cumulative total cash flows of $25 million which are growing at 2 percent annually. Managers estimate that because of synergies the merged firm's cash flows will increase to 4 percent for the first three years following the merger. After the first three years cash flows will grow at a rate of 3 percent. The merged firms are expected to have a beta = 1.75, the risk-free rate is 5.5 percent, and the market risk premium is currently 7.5 percent. Calculate the NPV of the merger. Will you vote in favor of the merger?

A) Yes, the NPV is ≥ $0
B) Yes, the NPV is ≤ $0
C) No, the NPV is ≥ $0
D) No, the NPV is ≤ $0

Question 57

Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.20 (debt ratio) + 0.50 (profit margin)
You know a particular firm has a debt ratio of 60 percent and a probability of default of 15 percent. Calculate the firm's profit margin.

A) 6.00 percent
B) 12.00 percent
C) 19.50 percent
D) 15.00 percent

Question 58

Baby Supplies is considering a merger with Tot Toy Stores. Baby's total operating costs of producing services are $450,000 for sales volume of $2.15 million. Tot's total operating costs of producing services are $250,000 for a sales volume (JP) of $975,000. For a sales volume of $3.125 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 19.5 percent.

A) Decrease of $609,375
B) Decrease of $90,625
C) Decrease of $9,375
D) Decrease of $159,375

Question 59

Crib World is considering a merger with Tots Supply Stores. Crib's total operating costs of producing services are $250,000 for sales volume of $1.25 million. Tots' total operating costs of producing services are $210,000 for a sales volume (JP) of $900,000. For a sales volume of $2.15 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 17.5 percent.

A) Decrease of $376,250
B) Decrease of $83,750
C) Decrease of $127,500
D) Decrease of $87,500

Question 60

A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the equity multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.04 (equity multiplier) + 0.01 (total asset turnover)
A firm has an equity multiplier of 1.5 times and a probability of default of 7 percent. Calculate the firm's total asset turnover ratio.

A) 1.0
B) 4.5
C) 0.01
D) 2.0

Question 61

George's Dry Cleaning is considering a merger with Weezzie's Laundry Supply Stores. George's total operating costs of producing services are $590,000 for sales volume (SG) of $4.7 million. Weezzie's total operating costs of producing services are $152,000 for a sales volume (SW) of $2.3 million. For a sales volume of $7 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 9 percent.

A) $97,000
B) $101,000
C) $112,000
D) $128,000

Question 62

A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the equity multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.02 (equity multiplier) + 0.01 (total asset turnover)
A firm you are thinking of lending to has an equity multiplier of 3.2 times and a total asset turnover ratio of 1.95. Calculate the firm's expected probability of default, or bankruptcy.

A) 7.06 percent
B) 7.92 percent
C) 8.35 percent
D) 9.12 percent

Question 63

George's Dry Cleaning is considering a merger with Weezzie's Laundry Supply Stores. George's total operating costs of producing services are $790,000 for sales volume (SG) of $4.7 million. Weezzie's total operating costs of producing services are $202,000 for a sales volume (SW) of $2.3 million. For a sales volume of $7 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 12 percent.

A) $840,000
B) $710,000
C) $175,000
D) $152,000

Question 64

A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.03 (debt/equity) + 0.65 (profit margin)
A firm you are thinking of lending to has a debt-to-equity ratio of 105 percent and its expected probability of default, or bankruptcy, is estimated to be 7 percent. If sales are $3 million, calculate the firm's net income.

A) $177,692
B) $210,000
C) $193,846
D) $300,000

Question 65

A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the sales-to-total assets ratio. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.60 (debt/equity) + 0.02 (sales/total assets)
A firm you are thinking of lending to has a sales-to-assets ratio of 1.75 and its expected probability of default, or bankruptcy, is estimated to be 8.1 percent. Calculate the firm's debt-to-assets ratio.

A) 7.667 percent
B) 7.12 percent
C) 92.88 percent
D) 8.1 percent

Question 66

Jenny's Day Care is considering a merger with Lionel's Diaper Manufacturers. Jenny's total operating costs of producing services are $350,000 for sales volume of $1.4 million. Lionel's total operating costs of producing services are $300,000 for a sales volume of $1.3 million. For a sales volume of $2.7 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 20 percent.

A) $129,000
B) $110,000
C) $540,000
D) $103,000

Question 67

Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.15 (debt ratio) + 0.1 (profit margin)
A firm you are thinking of lending to has a debt ratio of 57 percent and a profit margin of 7.15 percent. Calculate the firm's expected probability of default, or bankruptcy.

A) 9.27 percent
B) 8.49 percent
C) 7.83 percent
D) 6.91 percent

Question 68

The managers of BSW Inc. have been approached by EAG Corp. for a possible merger. EAG Corp. is asking a price of $50 million to be purchased by BSW Inc. The two firms currently have cumulative total cash flows of $2.5 million that are growing at 2 percent annually. Managers of EAG estimate that because of synergies the merged firm's cash flows will increase to 5 percent for the first three years following the merger. After the first three years, managers of EAG have estimated that cash flows will grow at a rate of 2 percent. The WACC for the merged firms is 12 percent. Managers of BSW Inc. agree that cash flows should grow at an additional 5 percent for the first three years, but are unsure of the long-term growth rate in cash flows estimated by EAG. Calculate the minimum growth rate needed after the first three years such that BSW Inc. would see this merger as a positive NPV project.

A) 5.00 percent
B) 6.925 percent
C) 1.728 percent
D) 12.00 percent

Question 69

A survey of a local market provided the following average cost data: Johnson Construction Corp. (JCC) has assets of $5 million and an average cost of 15 percent; Anderson Architects (AA) has assets of $8 million and an average cost of 20 percent; Cole Home Builders (CHB) has assets of $8 million and an average cost of 17 percent. For each firm, average costs are measured as a proportion of assets. JCC is planning to acquire AA and CHB with the expectation of reducing overall average costs by eliminating the duplication of services. If JCC plans to reduce operating costs by $300,000 after the merger, what will the average cost be for the new firm?

A) 16.238 percent
B) 15.00 percent
C) 17.33 percent
D) 17.667 percent

Question 70

A survey of a local market provided the following average cost data: Johnson Construction Corp. (JCC) has assets of $4 million and an average cost of 10 percent; Anderson Architects (AA) has assets of $5 million and an average cost of 20 percent; Cole Home Builders (CHB) has assets of $5 million and an average cost of 15 percent. For each firm, average costs are measured as a proportion of assets. JCC is planning to acquire AA and CHB with the expectation of reducing overall average costs by eliminating the duplication of services. What should be the average cost after the acquisition for JCC to justify this merger?

A) 15.357 percent or lower
B) 15.357 percent or higher
C) 15.000 percent or lower
D) 10.000 percent or lower

Question 71

A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.02 (debt/equity) + 0.80 (profit margin)
A firm you are thinking of lending to has a debt-to-equity ratio of 110 percent and its expected probability of default, or bankruptcy, is estimated to be 8 percent. If sales are $2 million, calculate the firm's net income.

A) $145,000
B) $165,000
C) $160,000
D) $200,000

Question 72

A survey of a national market provided the following average cost data: Jackson County Construction (JCC) has assets of $2 million and an average cost of 30 percent; Arkansas Architects (AA) has assets of $1.5 million and an average cost of 20 percent; Colorado Home Builders (CHB) has assets of $500,000 and an average cost of 10 percent. For each firm, average costs are measured as a proportion of assets. JCC is planning to acquire AA and CHB with the expectation of reducing overall average costs by eliminating the duplication of services. If JCC plans to reduce operating costs by $200,000 after the merger, what will the average cost be for the new firm?

A) 18.75 percent
B) 19.74 percent
C) 20.00 percent
D) 16.67 percent

Question 73

A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the equity multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.05 (equity multiplier) + 0.02 (total asset turnover)
A firm has an equity multiplier of 1.9 times and a probability of default of 10 percent. Calculate the firm's total asset turnover ratio.

A) 0.25
B) 25
C) 2.5
D) 0.75

Question 74

A survey of a local market provided the following average cost data: Johnson Construction Corp. (JCC) has assets of $5 million and an average cost of 15 percent; Anderson Architects (AA) has assets of $8 million and an average cost of 20 percent; Cole Home Builders (CHB) has assets of $8 million and an average cost of 17 percent. For each firm, average costs are measured as a proportion of assets. JCC is planning to acquire AA and CHB with the expectation of reducing overall average costs by eliminating the duplication of services. What should be the average cost after the acquisition for JCC to justify this merger?

A) 17.667 percent or lower
B) 17.667 percent or higher
C) 17.333 percent or lower
D) 15.00 percent or lower

Question 75

Peter's TV Supplies is considering a merger with Jan's Radio Supply Stores. Peter's total operating costs of producing services are $330,000 for a sales volume (SP) of $4.5 million. Jan's total operating costs of producing services are $60,000 for a sales volume (SJ) of $550,000. Suppose that synergies in the production process result in a cost of production for the merged firms totalling $360,000 for a sales volume of $5,050,000. Calculate the total average cost (TAC) for the merged firm.

A) 7.61 percent
B) 7.43 percent
C) 7.13 percent
D) 7.52 percent

Question 76

Suppose that the financial ratios of a potential borrowing firm took the following values: X₁ = Net working capital/Total assets = 0.05, X₂ = Retained earnings/Total assets = 0.12, X₃ = Earnings before interest and taxes/Total assets = 0.17, X₄ = Market value of equity/Book value of long-term debt = 0.42, X₅ = Sales/Total assets ratio = 0.6. Calculate and interpret the Altman's Z-score for this firm.

A) 1.64; High risk
B) 1.64; Indeterminate
C) 1.99; Low risk
D) 2.79; Indeterminate

Question 77

The managers of BSW Inc. have been approached by EAG Corp. for a possible merger. EAG Corp. is asking a price of $20.5 million to be purchased by BSW Inc. The two firms currently have cumulative total cash flows of $1 million that are growing at 3 percent annually. Managers of EAG estimate that because of synergies the merged firm's cash flows will increase to 4 percent for the first three years following the merger. After the first three years, managers of EAG have estimated that cash flows will grow at a rate of 2 percent. The WACC for the merged firms is 8 percent. Managers of BSW Inc. agree that cash flows should grow at an additional 4 percent for the first three years, but are unsure of the long-term growth rate in cash flows estimated by EAG. Calculate the minimum growth rate needed after the first three years such that BSW Inc. would see this merger as a positive NPV project.

A) 3.00 percent
B) 2.82 percent
C) 4.05 percent
D) 8.00 percent

Question 78

Cindy's Computer Corp. is considering a merger with Bobby's Computer, Inc. Cindy's total operating costs of producing services are $2.1 million for a sales volume (SC) of $13 million. Bobby's total operating costs of producing services are $2.5 million for a sales volume (SB) of $7 million. If the two firms merge, calculate the total average cost (TAC) for the merged firm assuming no synergies.

A) 23 percent
B) 17 percent
C) 19 percent
D) 21 percent

Question 79

A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the sales-to-total assets ratio. Based on past bankruptcy experience, the linear probability model is estimated as:
PD_i = 0.45 (debt/equity) + 0.01 (sales/total assets)
A firm you are thinking of lending to has a sales-to-assets ratio of 1.9 and its expected probability of default, or bankruptcy, is estimated to be 7 percent. Calculate the firm's debt-to-assets ratio.

A) 11.33 percent
B) 10.18 percent
C) 89.82 percent
D) 7.00 percent

Question 80

Suppose that the financial ratios of a potential borrowing firm took the following values: X₁ = Net working capital/Total assets = 0.15, X₂ = Retained earnings/Total assets = 0.27, X₃ = Earnings before interest and taxes/Total assets = 0.28, X₄ = Market value of equity/Book value of long-term debt = 0.68, X₅ = Sales/Total assets ratio = 0.9. Calculate and interpret the Altman's Z-score for this firm.

A) 1.92; Low risk
B) 2.01; Indeterminate
C) 2.79; Low risk
D) 2.79; Indeterminate