Deck 14: Mergers, Acquisitions, and the Valuation of Shares

Question 1

Which group most consistently benefits from the process of one business acquiring another business?

A) The shareholders of the company being taken over.
B) The shareholders of the bidding company.
C) The senior managers of the company being taken over.
D) The senior managers of the bidding company.
E) The customers/clients of the bidding company.

Answer 1

D

Question 2

Live in Colour! Inc. is a steadily growing regional company-owned chain of home decorating stores with two million shares outstanding. Its share price at the start of the year was $31.50 with a P/E of 10. The founder and president, an award winning designer, retained 15% of the shares. The rest traded sporadically on the TSX and were held principally in lots of less than 500 by small investors. Peri Paint and Wallpaper is a US-based chain looking for entry into Canada and at Live in Colour!'s mall locations. It purchased 20% of Live In Colour! shares causing a flurry on the TSX and a price gain to $42.25 a share. Live in Colour!'s president purchased another 100,000 shares and gained assurances from shareholders who own another 15% of shares that they would not sell or vote out the current Board of Directors who are opposed to the takeover. Assuming analysts are right and they believe that the P/E ratio will go to 25 before ownership of the company is decided, what would the maximum cash outlay that a white squire would have to be prepared to pay?

A) $47.25 million
B) $78.75 million
C) $13.52 million
D) $102.48 million
E) $23.60 million

Answer 2

E

Question 3

Granastein Grocers purchased Ridgway Food Warehousing and Logistics Inc. What is this type of merger?

A) Vertical
B) Conglomerate
C) Unilateral
D) Stratified
E) Horizontal

Answer 3

A

Question 4

Victorian Antiques Ltd. has a price/earnings ratio of 22 and is selling for $32.00 a share. Smith and Sons is a family held business not traded on the stock exchange. Which of the following characteristics of Victorian Antiques must be identical to Smith and Sons to allow a comparison with Victorian Antiques to determine the valuation of the unlisted company?

A) Accounting practices.
B) Earnings and tax rate.
C) Risk level and growth rate.
D) The value of total assets and liabilities.
E) Timing of fiscal year end.

Question 5

What type of merger occurs when a company eliminates a competitor by buying it?

A) Vertical
B) Conglomerate
C) Horizontal
D) Unilateral
E) Stratified

Question 6

What is the concept underlying the term "market for corporate control"?

A) Threat of takeover leads managers to adopt short term profit objectives rather than long-term development of shareholder wealth.
B) Management talent is a scare resource that can be extended through strategic acquisitions.
C) Competition by management teams for control of corporations deflects managers from their primary tasks of maximizing shareholder wealth.
D) Shareholders may resist beneficial mergers because of fears of diluting their control of a corporation.
E) Weak management teams will be eliminated through merger and acquisition and this activity helps to ensure maximum corporate profitability.

Question 7

When a large multinational packaged goods company purchased the advertising agency it has used for the past five years, its net savings after increases to salaries and overhead was equal to 12% of its media purchases and advertising production costs. There was no loss of the agency's client base and creative success increased as revenue-generation concerns diminished. What is this an example of?

A) Strategic Partnership.
B) Synergy.
C) Positive Integration.
D) Collective Utility.
E) Reciprocity.

Question 8

Dominion Brands Inc., a packaged goods firm, has ten factories, total value of $150 million, that have been operating at an average capacity of 54%. The net income before tax and amortization (EBITDA) is $36 million annually. The company is considering the purchase of a regional manufacturer that went up for sale for $110 million. The assets of the acquisition would be broken up and sold and the production rolled into the Dominion facilities. It would provide an overall improvement in capacity to 70% and increase annual income to $47 million. The sale of assets, net of all transactions cost, would yield $40 million. Considering an investment horizon of 10 years with no residual value at the end and a cost of capital for Dominion of 10%, should the company go forward with the acquisition?

A) Yes, because the purchase will yield a present value of $67.6 million to the company.
B) Yes, because the purchase will yield a present value of $27.6 million.
C) Yes, because the investment will provide a present value of $218.8 million.
D) No, because the investment will yield a negative $41.5 million to the company.
E) No, because the investment will yield a negative $2.4 million to the company.

Question 9

When Tuscarora Transport was purchased by Domus Logistics Inc., Domus was able to reduce costs by using the larger customer base to ensure trucks filled to capacity on the routes, to increase utilization of salaried maintenance personnel in outlying regions to 80% from 60% and to more broadly allocate the costs of telecommunications hardware and administration. What is the term for these types of benefits to Domus of the Tuscarora acquisition?

A) Diversification.
B) Exerting market control.
C) Vertical integration.
D) Economies of scale.
E) Combining complementary resources.

Question 10

What are managers who pursue merger and acquisition activities for personal goals or interests at the expense of maximizing shareholder wealth demonstrating?

A) Executive arrogance.
B) The agency problem.
C) Priority dissonance.
D) Market for corporate control.
E) Corporate disutility.

Question 11

Shareholders of a company being merged with another may take bonds from the acquiring company in exchange for their shares instead of common shares in the new company. What advantage does this have for the acquired company shareholders?

A) Even in periods of low earnings, interest charges must be paid to lenders, dividends can be withheld from shareholders.
B) The return from holding debt is usually higher than from holding equity.
C) Interest from debt is only tax deferred until the instrument is sold and dividends are taxed in the year they are issued, providing greater net return from debt.
D) If the new company fails, all of the debt principle will be refunded.
E) Payout to common share holders is always capped at a maximum level. The amount of interest paid to lenders increases with company profitability.

Question 12

What is a disadvantage associated with replacement cost method of business valuation?

A) It does not realistically reflect the market value of the assets.
B) It does not account for intangible assets such as brand equity.
C) It does not impose an upper limit on the value of the business.
D) It does not always provide accurate costs for older assets.
E) It does not allow for a comparison between similar businesses.

Question 13

To avoid the situation where a localized economic downturn eliminates the income of the company, which type of diversification should a company practice?

A) Asset
B) Conglomerate
C) Revenue
D) Geographic
E) Investment capital

Question 14

Assiniboine Mills, incorporated ten years ago, shows on its year-end balance sheet net total assets of $30 million, current liabilities of $5 million, long term liabilities of $13 million and paid-in capital from common shares of $12 million at $15.00 each, now selling for $19.50. Of the assets, net realizable value of current assets and liabilities is 90% of book values, $9 million and $5 million, respectively. Land with a book value of $5 million, has appreciated steadily, averaging a 6% increase year-over-year. Building and equipment can be sold at net book value. Assiniboine issued 15-year bonds five years ago at par with an annual coupon rate of 6% and a face value of $12 million. Current interest rates are at 8%.What is the liquidation value per common share?

A) $7.53
B) $15.00
C) $19.50
D) $21.46
E) $22.71

Question 15

What is the business strategy involving a defensive tactic against a hostile takeover where severance packages involving enormous sums are approved by the Board of Directors to be paid to senior managers in the event of dismissal because of a takeover known as?

A) Poison pill
B) White knight
C) Golden parachute
D) Pac-man defense
E) Boomerang Liability

Question 16

What does the term "merger" indicate?

A) A larger business has absorbed a smaller business into its operations.
B) A larger business has taken control of a smaller one against the wishes of the smaller company's management.
C) Shareholders of a one business no longer have a financial stake in the combined enterprise.
D) There is mutual agreement between two businesses to combine.
E) The businesses being combined are run independently as separate business units.

Question 17

Bryceland Market Garden has current assets of $900,000, capital assets of $6 million, accumulated depreciation of $1.5 million, intangible assets of $250,000, current liabilities of $500,000, a mortgage for $1 million and a bank loan of $150,000. Common shares, at an issue price of $20 a share, provided $4 million of cash. Using the balance sheet (or net book value) method, what is the value of the business per share?

A) $14.25
B) $20.00
C) $18.78
D) $22.50
E) $16.75

Question 18

Craylon Corporation has net income after tax of $4.5 million, cash of $0.5 million, current liabilities of $3.4 million, debt of $6.8 million, retained earnings of $1.5 million, book value for its 5 million common shares of $30 million and a current price/earnings multiple of 18. It is considering the purchase of Dahlia Ltd. whose shares trade at $32.00 and at price/earnings multiple of 24. Craylon plans to offer two of its own shares for one of Dahlia's. What is the disadvantage to this offer?

A) It has higher risk to Craylon and may result in an increase in its cost of capital.
B) It impacts negatively on the company's liquidity and puts short term commitments at risk.
C) It is less attractive to Dahlia as it is implicitly asking shareholders in the target company to bear the risk of the merger's success.
D) It will impact negatively on earnings, diluting long-term shareholder wealth.
E) It is that Dahlia's share price is not as high as the bid price and given the usual premium for mergers, Craylon is paying too much.

Question 19

What is the Balance Sheet Method of business valuation most useful in determining?

A) The fair market value of the business.
B) The value that maximizes shareholder wealth.
C) The minimum value of the share price.
D) The highest realizable value of the business.
E) The most realistic value of the business.

Question 20

Central Electric Ltd. (CEL), cost of capital of 9%, net income after tax of $140 million and 10 million common shares outstanding. It wishes to spin off its higher risk Wi-Fi business unit. Earnings from the business unit represent 20% of CEL net income. The Wi-Fi unit has a cost of capital of 12% and would issue one million common shares. To accomplish the spin-off, what will CEL most likely have to do?

A) Provide one share for every 10 shares they hold in CEL.
B) Sell the business to a new set of shareholders for cash. Cash may be retained or distributed as dividends to CEL shareholders.
C) Provide current shareholders with one share from the new business for each of the shares they hold in CEL.
D) Provide one share from the new business for every five shares they hold in CEL.
E) Provide one share from the new business for every four shares they hold in CEL to cover their increased risk.

Question 21

Sask Potash Inc., a fertilizer producing company, was recently the recipient of a takeover offer from Australia's BHH Mining Ltd. Sask Potash fought back saying the bid significantly undervalued their shares and they urged shareholders not to tender their shares and the government to block the bid. What type of market efficiency does Sask's board of directors believe in and why might the government not allow the takeover to go forward?

A) Weak form of efficiency and government favoritism to fertilizer companies.
B) Semi-strong form of efficiency and rising potash prices.
C) Strong form of efficiency and a growing world population that needs fertilizer for food growth.
D) An inefficient market and no benefit to Canada.
E) A market that cannot be fooled and strong demand growth for fertilizer from farmers.

Question 22

Beryl Personnel Ltd. has a similar organizational structure, client base and growth as does Excel Temporary Services Inc. Both were established within six months of each other approximately five years ago. Book value for Beryl Personnel's 500,000 common shares is $750,000. The company's market capitalization is $2.25 million. Book value for Excel Temporary Services Inc.'s 100,000 shares is $600,000. Using the data provided and an appropriate ratio, what would Excel's market capitalization be?

A) $1,800,000
B) $2,250,000
C) $3,600,000
D) $4,500,000
E) $5,625,000

Question 23

PeopleLife's share price was below book value for about a year after the recent financial crisis. What circumstances would make this a good time for an investor to buy stock in PeopleLife?

A) If investors thought the permanent problems of the company would disappear during the recovery.
B) If investors thought the company's problems were temporary due to the economic downturn.
C) If investors thought the company's earnings per share could withstand sustained pressure from lowered expense ratios.
D) If investors thought the company's dividend policy would be amended to show growth.
E) If investors thought the company's retained earning could continue to grow during the recession.

Question 24

Why is the dividend valuation method based on the concept that the present value of the future stream of dividends is an appropriate measure of a business's value?

A) The amount of dividends paid to shareholders is not discretionary and, therefore, is an objective measure of the value of the company to the shareholder.
B) Shareholders purchase shares only for the returns represented by future dividends.
C) Ultimately all value inherent in the company will be distributed as dividends.
D) Companies usually offer a predictable payout of dividends and therefore dividends are the most reliable measure of wealth gained by the shareholder.
E) The only cash returns from holding a business's shares take the form of dividends.

Question 25

Which of the following situations may make the business valuation by the dividend yield method unreliable?

A) Dividend policy governing payout is different for different companies.
B) An exchange traded business tends to pay out smaller dividends than an unlisted business.
C) Businesses that are not traded on the stock exchange do not pay out dividends.
D) Businesses listed on an exchange are traded more frequently and, therefore, reflect new information more efficiently than unlisted businesses.
E) Dividend payouts impact a business's income tax payable, and, therefore, the business valuation, differently in different provinces.

Question 26

Sagrium Ltd. tried for two years to acquire all the shares of Hunter Inc., upping the share price offer by 10% three different times. Hunter shareholders were not convinced and ere justified in not accepting Sagrium's offer when the price of Hunter's shares rose above the former's highest bid offer. As Sagrium prepared a fourth offer, Hunter finally lashed out and made a counter-offer to buy Sagrium. What is this takeover defence known as?

A) Converting to private status.
B) Poison pill.
C) Golden parachute.
D) White knight.
E) Pac-man.

Question 27

Open Ltd. is listed on the TSX, has a price-earnings ratio 20, earned $6 million in the year just ended, and has 4 million common shares outstanding. Closed Inc. is similar in many respects, but is not listed on any stock exchange and its shares are considered less marketable. What value might analysts put on Closed Ltd.'s shares?

A) $9.33
B) $13.33
C) $21.00
D) $30.00
E) $40.10

Question 28

Accounting rules now require that M&A investment banking and legal fees be expensed in the year they are incurred. These fees amount to 1% of the size of the deal, and at year end an all cash deal closed for $50 billion for Arch Ltd. to acquire Coal Inc. Arch has one billion shares outstanding and earned $2 billion excluding the merger costs mentioned above. How would this affect Arch's earnings per share?

A) Arch's EPS would be $(3.00 per share.
B) Arch's EPS would be $1.50 per share.
C) Arch's EPS would be $1.95 per share.
D) Arch's EPS would be $2.00 per share.
E) Arch's EPS would be $5.00 per share.

Question 29

The accounting authorities are considering changing the rules for accounting for pensions. Previously actuarial gains and losses in obligations and experience gains and losses in pension fund assets were amortized over many years. Current thinking is to require these gains and losses to be reported in the year incurred. How might this rule change affect a company's share price?

A) Share prices would increase due to improved earnings as gains are reported.
B) Share prices would become riskier due to increased earnings volatility.
C) Share prices would not be much affected by accounting changes.
D) Share prices would become more predictable without the amortization expenses.
E) Share prices would become more randomized as pension expenses are included the financials.

Question 30

Canadian Adventurers Ltd., an unlisted company, provides equipment and guides for out-trippers, resource companies and emergency crews into the Canadian wildness. The 500 shares at an initial price of $750 each were divided equally between the bush pilot and a former forest ranger who operated the company. A year after the company was incorporated, when business was beginning to break-even, and several long-term contracts had just been signed, one of the owners died. The other owner would like to purchase the shares from the estate to continue the business. What is the most appropriate share valuation method?

A) Dividend yield method.
B) Free cash flow method.
C) Balance sheet method.
D) Price/earnings method.
E) The original share value.

Question 31

Why are the values of past dividends not included in the dividend valuation method for the price of a share?

A) Because the dividends have already been spent by the shareholders.
B) Because the dividends may be recalled if they are cut in the future.
C) Because these dividends are already baked into the current price of the shares.
D) Because the dividends have often been paid in non-cash forms like stocks dividends.
E) Because the dividends are under control of the current Board of Directors, not previous Boards.

Question 32

Body Guards Ltd.'s (BG) balance sheets showed total assets of $100 million and total liabilites of $42 million. Fair values of assets and liabilities were equal to their book values except for a ten year old building whose appraised value was $5 million higher than book. BG has 10 million shares outstanding. BG earned $2.00 per share and paid a dividend of $0.50. Dividends grow at 6% per year. BG enjoys a P/E multiple of 5. BG's cost of capital is 12%. What is the value of a share using the balance sheet method, the liquidation method, the P/E ratio method, and the dividend growth method respectively?

A) $4.80, $5.30, $9.00, and $10.83.
B) $6.80, $6.70, $11.00, and $8.42.
C) $5.80, $7.50, $4.23, and $7.52.
D) $7.47, $3.66, $12.30, and $6.77.
E) $5.80, $6.30, $10.00, and $8.83.

Question 33

Halifax Hatcheries Inc., an unlisted company, operates in the same sector, has common operational characteristics, and the same dividend payout policy, as Saleem Fingerlings Ltd. Saleem's payout ratio is 32%. Salem's year-end earnings were $12,150,000, at which time shares were priced at $10.80 per share with 2.4 million common shares outstanding. Using the dividend yield ratio method, what would be a reasonable estimation of the value of one Halifax Hatcheries Inc.'s common share if it has 1.5 million shares and earnings of $172,500,000?

A) $10.80
B) $77.54
C) $153.15
D) $200.29
E) $245.33

Question 34

Reid Fittings and Fixtures Ltd. has forecasted free cash flows of $9.8 million, $10.2 million, $11.0 million, $11.4 million and $12.6 million over the next five years. Market value of bonds is $4.8 million and current value of the mortgage is $1.2 million. Reid has four million common shares outstanding and a discount rate of 7%. Using terminal value with a growth factor of 4% to account for cash flows beyond the planning horizon, what is the value of a Reid Fittings and Fixtures share?

A) $9.68
B) $41.77
C) $84.55
D) $123.87
E) $186.05

Question 35

Haliburton Galleries Ltd. (HGL) is a small, but well established, fine art store. Unlisted and closely held, the company has 2,500 shares outstanding at an issue price of $350 and uses EVA for rewarding performance. The Board of Directors would like to determine the current value of the company's shares as a guide to projecting the potential cash flow from a planned share issue. Year-end adjusted EBIT after tax equals $850,000, adjusted net assets equal $2.6 million, market value of debt is $900,000, retained earnings equal $940,000 and the company's cost of capital is 14%. What is the value of a share in HGL?

A) $215.20
B) $451.14
C) $497.14
D) $1,177.14
E) $1,537.14

Question 36

Kiromi Inc. has reported income after tax of $3.2 million. It has 500,000 preferred shares outstanding at a value of $21.30 each and paying a dividend of $1.40. The company has one million common shares outstanding currently trading at $48.00 each. Breeson-Lee is not traded on the stock exchange but is comparable to Kiromi. If Breeson-Lee's year-end earnings are $2.8 million, using P/E ratios as a guide, what is the company's market value?

A) $42.0 million
B) $53.8 million
C) $64.0 million
D) $84.3 million
E) $92.1 million

Question 37

An unlisted company has sales revenue of $456 million and 2 million common shares outstanding. Another company with similar characteristics, sales of $360 million and five million shares, trades on the Toronto Stock exchange for $12.50. Using the information from the question in an appropriate ratio, what is the share price of the unlisted company?

A) $6.33
B) $15.26
C) $30.41
D) $39.58
E) $136.89

Question 38

Free cash flows for next year are expected to be $500 million at Banana Inc. They are expected to grow at 4% per year. Banana's cost of capital is 11%. What is terminal value of Banana?

A) $0.5 billion.
B) $0.6 billion.
C) $4.5 billion.
D) $7.1 billion.
E) $12.5 billion.

Question 39

Aggressive Capital Inc. is known as an asset stripper. How should Aggressive value potential target companies?

A) Determine its liquidation value.
B) Calculate present value of EVA.
C) Use the free cash flow method.
D) Analyse the terminal value for the business.
E) Evaluate the price earnings value.

Question 40

Sarasota Co. Ltd. is an unlisted company with ownership concentrated in relatively few hands. It has experienced steady growth and forecasts dividend paid out to its 75,000 shareholders to grow by 5% per year from the base of $558,000 this year. If the company's cost of capital is 9%, what is the value of a Sarasota share?

A) $195.30
B) $148.00
C) $82.68
D) $14.80
E) $7.44