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

Question 1

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

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

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.

Answer 3

True

Question 4

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

Question 5

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

Question 6

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 7

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

Question 8

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

Question 9

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 10

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

Question 11

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 12

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.

Question 13

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 14

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

Question 15

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

Question 16

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

Question 17

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 18

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 19

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 20

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."

A) ?The excess market return, a size factor, and a book-to-market factor.
B) The excess market return, a debt factor, and a book-to-market factor.
C) The excess market return, a size factor, and a debt.
D) A debt factor, a size factor, and a book-to-market factor.

Question 21

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

Question 22

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 23

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 24

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 25

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

Question 26

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 27

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 28

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

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

Question 30

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 31

In a financial merger, the relevant post-merger cash flows are simply
1.
the sum of the expected cash flows of the 2 companies, measured as if they were operated independently.

Question 32

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 33

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 34

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 35

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 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

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 38

Although goodwill created in a merger may not be amortized for shareholder reporting purposes, it may be amortized for Federal tax
1.
purposes.

Question 39

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 40

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 41

Brau Auto, a national autoparts chain, is considering purchasing a smaller chain, South Georgia Parts (SGP). Brau's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values: Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 30% target level. The interest rate would remain the same.
SGP'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 value of SGP to Brau?
Hard:

A) ?True
B) False