Deck 23: Mergers,Acquisitions,and Restructuring

Question 1

If the constant growth model is used to calculate the value of a target company,the terminal value is an insignificant cash flow analysis.

Answer 1

False

Question 2

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.

Answer 2

True

Question 3

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.

Answer 3

False

Question 4

Interest expense must be explicitly included in a merger incremental cash flow analysis.

Question 5

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 6

Three procedures used to defend against hostile takeovers are 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.These strategies are known as "poison pills."

Question 7

Since a manager's central goal is to maximize the firm's common share price,any merger offer that provides shareholders with significant gains over the current share price will be approved by the current management team.

Question 8

Since managers' central goal is to maximize stock price,managerial control issues do not interfere with mergers that would benefit the target firm's shareholders.

Question 9

Currently,mergers in Canada can be accounted for using either the purchase method or the pooling method.

Question 10

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

Question 11

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

Question 12

A merger will be financially justified only if a target firm's value is greater to the acquiring firm than its market value as a separate entity.

Question 13

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

Question 14

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 15

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

Question 16

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 17

In a carve-out,a majority interest in a corporate subsidiary is sold to new shareholders,so the parent gains new equity financing yet retains control.

Question 18

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 19

Foreign firms are interested in buying Canadian companies to gain entrance to Canada.A decline in the value of the dollar relative to most foreign currencies makes this competitive strategy especially attractive.

Question 20

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

Question 21

Which statement best describes mergers?

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)Financial theory says that the choice of how to pay for a merger is irrelevant because although it may affect the firm's capital structure, it will not affect its overall required rate of return.
C)The basic rationale for any consolidation is financial synergy and, thus, the estimation of pro forma cash flows is the single most important part of the analysis.
D)The primary rationale for most operating mergers is synergy.

Question 22

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 23

The income statement of the post-merger firm will be the same regardless of the accounting method used.

Question 24

Using the purchase accounting method to report mergers,goodwill is not amortized; rather,it is subject to an annual impairment test.

Question 25

Which of the following is NOT a valid reason for a company to seek external growth through mergers?

A)to avoid paying dividends
B)to achieve greater diversification
C)to take advantage of the tax-loss carryforwards
D)to maintain availability of raw materials

Question 26

What is NOT one of the defensive tactics firms use to fight off undesired mergers?

A)developing poison pills
B)getting white knights to bid for the firm
C)repurchasing their own stock
D)issuing new shares at low prices on the market

Question 27

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 28

Which statement best describes a merger concept?

A)A conglomerate merger is one where a firm combines with another firm in the same industry.
B)Regulations in Canada prohibit acquiring firms from using common shares to purchase another firm.
C)Defensive mergers are designed to make a company less vulnerable to a takeover.
D)The corporate valuation method and the equity residual method, even properly applied, produce different results.

Question 29

By examining stock prices around merger announcement dates,event studies provide inconclusive results that mergers benefit only targets,not acquirers.

Question 30

Which of the following is a valid,acceptable reason for a closely held firm proposing a merger activity?

A)synergistic benefits arising from mergers
B)reduction in competition resulting from mergers
C)attempts to stabilize earnings by diversifying
D)minimizing taxes when disposing of excess cash

Question 31

A shareholder rights plan allowing existing shareholders to buy or sell shares at very attractive prices provides the acquirer an inexpensive way for takeovers.

Question 32

Which of the following factors does NOT influence the consideration of a merger and an acquisition of stocks?

A)Shareholders are dealt with directly to bypass the target management and board of directors.
B)In a tender offer, usually some minority shareholders do not tender (offer) their shares. This can result in preventing the target firm from being completely absorbed
C)Target management may be unfriendly and resist an offer, which usually results in a higher stock price.
D)The target company's supplier has developed a new high-quality product.

Question 33

Which statement best describes mergers?

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, diversification benefits are generally not a valid motive for a publicly held firm.

Question 34

Under purchase accounting,the acquired assets must be written up or written down if the purchase price does not equal net asset value.

Question 35

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 36

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 37

A taxable merger offer is one where the acquiring company offers to purchase the target company with cash.However,the same deal is not taxable if the merger is paid by exchanging stocks.Such nontaxable bids should be more popular by far.

Question 38

Which statement best describes accounting for mergers?

A)Goodwill is amortized for shareholder reporting.
B)Goodwill is subject to impairment test for tax purposes.
C)Goodwill is no longer created in a merger.
D)Goodwill is subject to an amortization test and a majority vote of the board of directors.

Question 39

Which statement best describes mergers?

A)The high Canadian dollar relative to foreign currencies makes Canadian companies comparatively inexpensive to foreign buyers, spurring many mergers.
B)The expansion of the junk bond market makes debt more freely available for large acquisitions and LBOs, resulting in an increased level of merger activity.
C)Increased nationalization of business and a desire to scale down and focus on producing in one's home country may virtually halt international mergers.
D)A high Canadian dollar results in a high cost of commodities, which results in mergers being more expensive in Canada.

Question 40

What is one of the actions that CANNOT 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)changing the voting procedures for the board election from a noncumulative to a cumulative one

Question 41

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%

Question 42

Which statement best describes mergers?

A)The purchase of Red Lobster Restaurants initiated by Remax Realty is an example of conglomerate mergers.
B)A merger can be blocked either by a firm's customers or its suppliers, not the government.
C)The existence of golden parachutes is one reason that the management of a target company tries to block a takeover.
D)In a hostile takeover, the target company's management makes a tender offer asking its shareholders to sell their shares to the acquiring company.

Question 43

Which statement best describes leveraged buyouts (LBOs)?

A)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 leveraged buyout.
D)The objective is to take the firm public again or to sell to others in a few years after boosting the firm's value through efficient management.

Question 44

Firms A and B,both all-equity financed,are merging.Prior to merge,Firm A,having 100 shares outstanding,is worth $15,000,while Firm B has 50 shares outstanding worth $10,000.The combined firm will be worth $30,000.Firm A pays $11,500 in cash for Firm B.What is the net benefit of the merger to Firm A?

A)$3,500
B)$5,000
C)$11,500
D)$18,500

Question 45

What is NOT a reason for a divestiture?

A)a firm's need for cash
B)the poor performance of a business unit
C)a change in a firm's strategic thinking
D)a reduction in tax burden

Question 46

MCorp,with a book value of $20 million and a market value of $30 million,has merged with NCorp,with a book value of $6 million and a market value of $8 million at a price of $9 million.Under the purchase method,what will be the total assets on the book of the new merged firm?

A)$26 million
B)$29 million
C)$38 million
D)$39 million

Question 47

The value of synergy can be estimated by which of the following equations?

A)V_AB - V_A - V_B
B)V_AB - V_B - taxes
C)V_A - V_B - costs
D)V_A + V_B - revenues

Question 48

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)9.7%

Question 49

MaritimeTV Emporium, a national retailer of flat panel screens, is investigating an opportunity to purchase Maritime TV and Sound Inc. An acquisition is expected to lower overhead costs, improve distribution efficiencies, and improve ordering volumes from the major manufacturers. If those improvements (synergies) are implemented, TV Emporium financial staff estimate the following incremental net cash flows to be $5 million, $5.6 million, and $6.9 million for the first three years. Cash flows would grow at 3% thereafter. Maritime TV and Sound's tax rate is 30%. Its cost of equity is 10%.
Refer to Scenario: Maritime.What is the horizontal value of Maritime's operation as of year 3?

A)$101.53 million
B)$98.57 million
C)$86.66 million
D)$71.07 million

Question 50

Brau Auto,a national auto parts 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?

A)$53.40 million
B)$61.96 million
C)$64.59 million
D)$76.96 million

Question 51

Two firms merge and no synergies occur.Which statement best explains this unlikely result?

A)The reduction in risk in the combined firm benefits the bondholders at the expense of the shareholders.
B)The value of the debt in the combined firm will likely be greater than the value of the debt in the two separate firms.
C)The size of the gain to the bondholders depends on the specific reductions in bankruptcy probabilities after the merger.
D)The share price of the acquiring or combined company increases substantially.

Question 52

DustvacMagiclean Corporation is considering the acquisition of Dustvac Company. Dustvac has a capital structure consisting of $5 million (market value) of 11% bonds and $10 million (market value) of common stock. Dustvac's pre-merger beta is 1.36. Magiclean's beta is 1.02, and both it and Dustvac face a 40% tax rate. Magiclean's capital structure is 40% debt and 60% equity. The free cash flows from Dustvac are estimated to be $3.0 million for each of the next 4 years and a horizon value of $10.0 million in Year 4. Tax savings are estimated to be $1 million for each of the next 4 years and a horizon value of $5 million in Year 4. New debt would be issued to finance the acquisition and retire the old debt, and this new debt would have an interest rate of 8%. Currently, the risk-free rate is 6.0% and the market risk premium is 4.0%.
Refer to Scenario: Dustvac.What is the value of Dustvac's equity to Magiclean? (Round your answer to the closest thousand dollars.)

A)$16.019 million
B)$17.080 million
C)$18.916 million
D)$22.080 million

Question 53

DustvacMagiclean Corporation is considering the acquisition of Dustvac Company. Dustvac has a capital structure consisting of $5 million (market value) of 11% bonds and $10 million (market value) of common stock. Dustvac's pre-merger beta is 1.36. Magiclean's beta is 1.02, and both it and Dustvac face a 40% tax rate. Magiclean's capital structure is 40% debt and 60% equity. The free cash flows from Dustvac are estimated to be $3.0 million for each of the next 4 years and a horizon value of $10.0 million in Year 4. Tax savings are estimated to be $1 million for each of the next 4 years and a horizon value of $5 million in Year 4. New debt would be issued to finance the acquisition and retire the old debt, and this new debt would have an interest rate of 8%. Currently, the risk-free rate is 6.0% and the market risk premium is 4.0%.
Refer to Scenario: Dustvac.What Dustvac's pre-merger WACC?

A)9.02%
B)9.50%
C)9.83%
D)10.01%

Question 54

Kelly Tubes is considering a merger with Reilly Tires.Reilly's market-determined value is $3.75 million,and Kelly's market value as a stand-alone company is $4.50 million.Both firms are all equity-financed.Kelly acquires Reilly for $4.25 million because it believes the combined firm value will increase to $9.25 million.What will be the synergy from this merger?

A)$0.50 million
B)$1.00 million
C)$4.75 million
D)$5.00 million

Question 55

The DAB Corp.has unfortunately accumulated net operating losses of $70 million and is likely to go bankrupt.The CLC Corp.has earnings of $200 million and is in the 36% marginal tax bracket.CLC is considering buying DAB and liquidating the company and retaining a few of the assets.What is the minimum value of DAB to CLC?

A)$25.2 million
B)$70.0 million
C)$72.0 million
D)There is insufficient information provided.

Question 56

DustvacMagiclean Corporation is considering the acquisition of Dustvac Company. Dustvac has a capital structure consisting of $5 million (market value) of 11% bonds and $10 million (market value) of common stock. Dustvac's pre-merger beta is 1.36. Magiclean's beta is 1.02, and both it and Dustvac face a 40% tax rate. Magiclean's capital structure is 40% debt and 60% equity. The free cash flows from Dustvac are estimated to be $3.0 million for each of the next 4 years and a horizon value of $10.0 million in Year 4. Tax savings are estimated to be $1 million for each of the next 4 years and a horizon value of $5 million in Year 4. New debt would be issued to finance the acquisition and retire the old debt, and this new debt would have an interest rate of 8%. Currently, the risk-free rate is 6.0% and the market risk premium is 4.0%.
Refer to Scenario: Dustvac.What discount rate should you use to discount Dustvac's free cash flows and interest tax savings?

A)10.01%
B)10.06%
C)11.34%
D)11.44%

Question 57

Which statement best describes mergers?

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)Acquiring firms send a signal that their stock is overvalued if they choose to use cash and bonds to pay for the acquisition.

Question 58

Firm X is considering acquiring Firm Y by offering one share of its common stock for 0.8728 shares of Firm Y.Currently,the market price of Firm X is $48.What is the cash bidding price proposed for this deal?

A)$35
B)$42
C)$55
D)$63

Question 59

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

Question 60

Blazer Inc.is thinking of acquiring Laker Company.Blazer expects Laker's NOPAT to be $9 million the first year,with no net new investment in operating capital and no interest expense.For the second year,Laker is expected to have NOPAT of $25 million and interest expense of $5 million.Also,in the second year only,Laker will need $10 million of net new investment in operating capital.Laker's marginal tax rate is 40%.After the second year,the free cash flows and the tax shields from Laker to Blazer will both grow at a constant rate of 4%.Blazer has determined that Laker's cost of equity is 17.5%,and Laker currently has no debt outstanding.Assuming that all cash flows occur at the end of the year,Blazer must pay $45 million to acquire Laker.What it the NPV of the proposed acquisition? Note that you must first calculate the value to Blazer of Laker's equity.

A)$ 45.0 million
B)$ 68.2 million
C)$ 94.1. million
D)$139.1 million

Question 61

Ontario Ltd.is considering acquiring BC Corp.by offering one share of its common stock for 0.95 shares of BC Corp.Currently,the market price of BC Corp.is $108.What is the cash bidding price proposed for this deal (rounded up)?

A)$114
B)$95
C)$103
D)$163

Question 62

Which of the following best defines a joint venture?

A)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.
B)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 expansive in scope.
C)A joint venture is one in which two, or sometimes more, independent companies agree to merge into a single firm, usually wider in scope.
D)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 63

Alberta Corp.,with a book value of $40 million and a market value of $45 million,has merged with Ontario Corp.,with a book value of $26 million and a market value of $28 million at a price of $30 million.Under the purchase method,what will be the total assets on the book of the new merged firm?

A)$70 million
B)$66 million
C)$88 million
D)$89 million

Question 64

PEI Ltd.is considering acquiring Sask Corp.by offering one share of its common stock for .56 shares of Sask Corp.Currently,the market price of Quebec Corp.is $38.What is the cash bidding price proposed for this deal (rounded up)?

A)$89
B)$97
C)$90
D)$68

Question 65

Which of the following best describes a merger with true synergies?

A)In a merger with true synergies, the pre-merger value exceeds the sum of the separate companies' pre-merger values and the dollar cost of the firms' capital.
B)In a merger with true synergies, the post-merger value exceeds the sum of the separate companies' pre-merger values
C)In a merger with true synergies, the post-merger value exceeds the sum of the separate companies' pre-merger values plus a risk adjusted cash flow relative to the risk of the combined firm.
D)In a merger with true synergies, the post-merger value is less than the sum of the separate companies' pre-merger values.

Question 66

Which of the following are the most important issues in merger negotiations?

A)post-merger control of the firm
B)post-merger control and the severance packages of laid-off staff
C)the negotiated price paid by the acquiring firms
D)both a and c

Question 67

Which of the following are synergistic benefits of a merger?

A)operating economies of scale
B)financial economies
C)improved managerial efficiency
D)all of the above

Question 68

Saskatchewan Corp.,with a book value of $10 million and a market value of $12 million,has merged with Alberta Corp.,with a book value of $10 million and a market value of $11 million and a price of $11 million.Under the purchase method,what will be the total assets on the book of the new merged firm?

A)$26 million
B)$19 million
C)$20 million
D)$39 million

Question 69

Which of the following best describes why defensive mergers typically occur?

A)Defensive mergers occur as a result of shareholders' needs to maximize personal wealth.
B)Defensive mergers occur as a result of unions' actions to maximize shareholders' wealth.
C)Defensive mergers occur as a result of government policies to maximize shareholders' wealth.
D)Defensive mergers occur as a result of managers' actions to maximize shareholders' wealth.

Question 70

Canada Ltd.is considering acquiring Quebec Corp.by offering one share of its common stock for 1.01 shares of Quebec Corp.Currently,the market price of Quebec Corp.is $98.What is the cash bidding price proposed for this deal (rounded up)?

A)$99
B)$97
C)$90
D)$103

Question 71

MaritimeTV Emporium, a national retailer of flat panel screens, is investigating an opportunity to purchase Maritime TV and Sound Inc. An acquisition is expected to lower overhead costs, improve distribution efficiencies, and improve ordering volumes from the major manufacturers. If those improvements (synergies) are implemented, TV Emporium financial staff estimate the following incremental net cash flows to be $5 million, $5.6 million, and $6.9 million for the first three years. Cash flows would grow at 3% thereafter. Maritime TV and Sound's tax rate is 30%. Its cost of equity is 10%.
Refer to Scenario: Maritime.What is the highest price TV Emporium pays for Maritime?

A)$67.75 million
B)$76.28 million
C)$81.10 million
D)$90.64 million

Question 72

Which of the following is correct regarding the most appropriate discount rate to be used in valuing the targeted firm?

A)The appropriate discount rate to be used when calculating the NPV of a target company is the cost of equity of the acquiring firm.
B)The appropriate discount rate to be used when calculating the NPV of a target company is the cost of debt of the target company.
C)The appropriate discount rate to be used when calculating the NPV of a target company is the cost of equity of the target company.
D)The appropriate discount rate to be used when calculating the NPV of a target company is the cost of junk bond debt of the target company.