Deck 21: Mergers

Question 1

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

Answer 1

False

Question 2

Borrowing funds on terms that would require immediate repayment of all loans if the firm is acquired, selling off at bargain prices the assets that originally made the firm a desirable target, and granting huge "golden parachutes" that open if the firm is acquired are 3 procedures used to defend against hostile takeovers.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 2

True

Question 3

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.

Answer 3

True

Question 4

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 5

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

Question 6

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

Question 7

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

Question 8

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 9

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 10

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 shares in the company using large amounts of borrowed money.

Question 11

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

Question 12

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 13

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

Question 14

Post-merger control and the negotiated price paid by the acquirer are two of the most important issues in the terms to merger agreements.

Question 15

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 task.

Question 16

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

Question 17

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

Question 18

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

Question 19

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 20

The primary reason given by managers for most mergers is the acquisition of more assets so as to increase sales and market share.

Question 21

The distribution of synergistic gains between the stockholders of two merged firms is almost always based strictly on their respective market values before the announcement of the merger.

Question 22

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 23

Which of the following statements is most CORRECT?

A) The acquiring firm's required rate of return in most horizontal mergers will not be affected, because the two firms will have similar betas.
B) The goal of merger valuation is to value the target firm's total capital at the target firm's weighted average cost of capital because a firm is acquired from all of its investors--both shareholders and creditors.
C) The basic rationale for any financial merger is synergy and, thus, the estimation of pro forma cash flows is the single most important part of the analysis.
D) In most mergers, the benefits of synergy and the premium the acquirer pays over the market price are summed and then divided equally between the shareholders of the acquiring and target firms.
E) The primary rationale for most operating mergers is synergy.

Question 24

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

A) raising antitrust issues.
B) developing poison pills.
C) getting white knights to bid for the firm.
D) repurchasing their own stock.
E) engaging in risk arbitrage.

Question 25

Anacott Steel is acquiring Terafly Incorporated. Terafly is expected to provide Anacott with operating cash flows of $12, $21, $16, and $9 million over the next four years, respectively. In addition, the horizon value of all remaining cash flows at the end of Year 4 is estimated at $18 million. The merger will cost Anacott $45.0 million today. If the value of the merger is estimated at $9.00 per share and Anacott has 1,000,000 shares outstanding, what equity discount rate must the firm be using to value this acquisition?

A) 11.63%
B) 12.25%
C) 12.89%
D) 13.57%
E) 14.25%

Question 26

Gekko Properties is considering purchasing Teldar Properties. Gekko's analysts project that the merger will result in incremental after-tax cash flows of $2 million, $4 million, $5 million, and $10 million over the next four years. The horizon value of the firm's operations, as of Year 4, is expected to be $107 million. Assume all cash flows occur at the end of the year. The acquisition would be made immediately, if it is undertaken. Teldar's post-merger beta is estimated to be 2.0, and its post-merger tax rate would be 35%. The risk-free rate is 6%, and the market risk premium is 5.5%. What is the value of Teldar to Gekko Properties?

A) $66,680,846
B) $70,190,364
C) $73,699,883
D) $77,384,877
E) $81,254,121

Question 27

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) In a liquidation, the firm's existing stockholders are given new stock representing separate ownership rights in the division that was divested. The division establishes its own board of directors and officers, and it becomes a separate company.
E) If there are no synergistic benefits to be gained from a merger, the acquiring company will stop its plans for the merger. However, if synergistic gains are large, plans for the merger will continue. In fact, the greater the synergistic gains, the smaller the gap between the target's current price and the maximum the acquiring company could pay because of the acquiring company's upper hand in the merger.

Question 28

Which of the following statements is most CORRECT?

A) The high value of the U.S. dollar relative to Japanese and European currencies in the 1980s, made U.S. companies comparatively inexpensive to foreign buyers, spurring many mergers.
B) During the 1980s, the Reagan and Bush administrations tried to foster greater competition and they were adamant about preventing the loss of competition; thus, most large mergers were disallowed.
C) The expansion of the junk bond market made debt more freely available for large acquisitions and LBOs in the 1980s, and thus, it resulted in an increased level of merger activity.
D) Increased nationalization of business and a desire to scale down and focus on producing in one's home country has virtually halted cross-border mergers today.
E) Because strategic alliances and joint ventures are easy to form and enable firms to compete better in the global economy than would mergers, merger activity has virtually come to a halt in the 21st century.

Question 29

In early 2011 Giant Inc.'s management was considering making an offer to buy Micro Corporation. Micro's projected operating income (EBIT) for 2011 was $30 million, but Giant believes that if the two firms were merged, it could consolidate some operations, reduce Micro's expenses, and raise its EBIT to $35 million. Neither company uses any debt, and they both pay income taxes at a 35% rate. Giant has a better reputation among investors, who regard it as very well managed and not very risky, so its stock has a P/E ratio of 12 versus a P/E of 9 for Micro. Since Giant's management would be running the entire enterprise after a merger, investors would value the resulting corporation based on Giant's P/E. If Micro has 10 million shares outstanding, by how much should the merger increase its share price, assuming all of the synergy will go to its stockholders?

A) $7.94
B) $8.36
C) $8.80
D) $9.26
E) $9.75

Question 30

In early 2011 Ham Inc.'s management was considering making an offer to buy Egg Corporation. Egg's projected operating income (EBIT) for 2011 was $30 million, but Ham believes that if the two firms were merged, it could consolidate some operations, reduce Egg's expenses, and raise its EBIT to $40 million. Neither company uses any debt, and they both pay income taxes at a 40% rate. Ham has a better reputation among investors, who regard it as better managed and also less risky, so Ham's stock has a P/E ratio of 15 versus a P/E of 12 for Egg. Since Ham's management will be running the entire enterprise after a merger, investors will value the resulting corporation based on Ham's P/E. Based on expected market values, how much synergy should the merger create?

A) $129.96
B) $136.80
C) $144.00
D) $151.20
E) $158.76

Question 31

Simpson Inc. is considering a vertical merger with The Lachey Company. Simpson currently has a required return of 11%, while Lachey's required return is 15%. The market risk premium is 5% and the risk-free rate is 5%. Assume the market is in equilibrium. If Simpson is going to make up 67% of the new firm (and Lachey will comprise the remaining 33%), what will be the beta of the new merged firm? There will be no additional infusion of debt in the merger.

A) 1.46
B) 1.54
C) 1.61
D) 1.69
E) 1.78

Question 32

Which of the following actions does NOT help managers defend against a hostile takeover?

A) Establishing a poison pill provision.
B) Granting lucrative golden parachutes to senior managers.
C) Establishing a super-majority provision in the company's bylaws to raise the percentage of the board of directors that must approve an acquisition from 50% to 75%.
D) Retiring long-term debt early to reduce total debt on the balance sheet which will increase the firm's financial position.
E) Finding a "white squire" that will buy enough of the target firm's shares to block the hostile takeover.

Question 33

In a financial merger, the relevant post-merger cash flows are simply the sum of the expected cash flows of the two companies, measured as if they were operated independently.

Question 34

Which of the following statements is most CORRECT?

A) Leveraged buyouts (LBOs) occur when a firm issues equity and uses the proceeds to take a firm public.
B) In a typical LBO, bondholders do well but shareholders see their value decline.
C) Firms are forbidden by law to sell any assets during the first five years following a leverage buyout.
D) Not all target firms are acquired by publicly traded corporations. In recent years, an increasing number of firms have been acquired by private equity firms. Private equity firms raise capital from wealthy individuals and look for opportunities to make profitable investments.
E) In an LBO sometimes the acquiring group plans to run the acquired company for a number of years, boost its sales and profits, and then take it public again as a stronger company. In other instances, the LBO firm plans to sell off divisions to other firms that can gain synergies. In either case, the acquiring group expects to make a substantial profit from the LBO, but the inherent risks are small due to the heavy use of venture capital and very little debt.

Question 35

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

Question 36

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, research of U.S. firms suggests that in most cases, diversification through mergers does not increase the firm's value.
E) Research of U.S. firms suggests that managers' personal motivations have had little, if any, impact on firms' decisions to merge.

Question 37

The value of the target firm is calculated by discounting residual cash flows that belong to the acquiring firm's shareholders at the target's cost of equity reflecting any changes to its capital structure as a result of the merger.

Question 38

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) The equity residual method values a target firm by discounting residual cash flows at the acquiring firm's overall cost of capital reflecting the combined firm's post-merger capital structure.
E) A financial merger occurs when the operations of the firms involved are integrated in the hope of achieving synergistic benefits.

Question 39

The text gives a number of valid, acceptable reasons for companies to merge. Which of the following is NOT acceptable?

A) Synergistic benefits arising from mergers.
B) Reduction in competition resulting from mergers.
C) Acquisition of assets at below replacement value.
D) Attempts to minimize taxes by acquiring a firm with large accumulated losses that can be used immediately.
E) Using surplus cash to acquire another firm and prevent unfavorable tax consequences for shareholders.