Deck 22: Mergers and Acquisitions

Question 1

Which of the following statements regarding mergers and diversification is FALSE?

A) Because it may be easier to measure performance accurately in a conglomerate, agency costs may reduce and resources may be more efficiently allocated.
B) Because these employees are obligated to hold idiosyncratic risk, they benefit when the firm reduces that risk by conglomerating.
C) Like a large portfolio, large firms bear less idiosyncratic risk, so often mergers are justified on the basis that the combined firm is less risky.
D) Because most stockholders will already be holding a well-diversified portfolio, they get no further benefit from the firm diversifying through acquisition.

Answer 1

Because it may be easier to measure performance accurately in a conglomerate, agency costs may reduce and resources may be more efficiently allocated.

Question 2

On average, when a bid is announced, the stock price of the target drops.

Answer 2

False

Question 3

The fact that a large company can enjoy savings from producing goods in high volume that are not available to a small company is called ________.

A) economies of scale
B) horizontal integration
C) vertical integration
D) economies of scope

Answer 3

economies of scale

Question 4

Which of the following statements is FALSE?

A) There are two primary mechanisms by which ownership and control of a public corporation can change: Either another corporation or group of individuals can acquire the target firm, or the target firm can merge with another firm.
B) Merger activity is greater during economic contractions than during expansions.
C) Mergers and acquisitions are part of what is often referred to as "the market for corporate control."
D) The takeover market is also characterized by merger waves-peaks of heavy activity followed by quiet troughs of few transactions.

Question 5

Which of the following statements is FALSE?

A) In practice, most acquirers pay a substantial acquisition premium, which is the percentage difference between the acquisition price and the premerger price of the target firm.
B) When a bid is announced, the target shareholders enjoy a gain of 15% on average in their stock price.
C) In most U.S. states, the law requires that when existing shareholders of a target firm are forced to sell their shares, they receive the market price for their shares. In most cases, this concept is interpreted as the value inclusive of any value that arises because of the merger itself.
D) A bidder is unlikely to acquire a target company for less than its current market value.

Question 6

The synergies of a merger add so much value to the combined firm that, upon announcement of a merger, the stock prices of both the target and the acquirer increase substantially.

Question 7

Which of the following statements is FALSE?

A) Cost-reduction synergies are hard to predict and achieve.
B) Because the CEOs of small firms receive information so quickly, small firms are often able to react in timely way to changes in the economic environment.
C) Synergies usually fall into two categories: cost reductions and revenue enhancements.
D) There may also be costs associated with size.

Question 8

The justification for the benefits of diversification from mergers include all of the following EXCEPT ________.

A) tax loss benefits
B) lower cost of debt or increased debt capacity
C) direct risk reduction
D) liquidity enhancement

Question 9

Which of the following statements is FALSE?

A) All else being equal, larger firms, because they are more diversified, have an increased probability of bankruptcy.
B) To justify a takeover based on operating losses, management would have to argue that the tax savings are over and above what the firm would save using carryback and carryforward provisions.
C) It is possible to combine two companies with the result that the earnings per share of the merged company exceed the premerger earnings per share of either company, even when the merger itself creates no economic value.
D) When an acquirer buys a private target, it provides the target's owners with a way to reduce their risk exposure by cashing out their investment in the private target and reinvesting in a diversified portfolio.

Question 10

Which of the following statements regarding monopoly mergers is FALSE?

A) It is often argued that merging with or acquiring a major rival enables a firm to substantially reduce competition within the industry and thereby increase profits.
B) Financial researchers have found that the share prices of other firms in the same industry did not significantly increase following the announcement of a merger within the industry.
C) While only the merging company benefits when competition is reduced, all companies in an industry pay the associated costs.
D) Society as a whole bears the cost of monopoly strategies, so most countries have antitrust laws that limit such activity.

Question 11

The merger of two companies in the same industry that make products required at different stages of the production cycle is called ________.

A) economies of scope
B) vertical integration
C) economies of scale
D) horizontal integration

Question 12

The period of the ________ is known for hostile, "bust-up" takeovers, in which the acquirer purchased a poorly performing conglomerate and sold off its individual business units for more than the purchase price.

A) 1960s
B) 1970s
C) 1980s
D) 1990s

Question 13

The period of the ________ is known for known for "strategic" or "global" deals that were more likely to be friendly and to involve companies in related businesses; these mergers often were designed to create strong firms on a scale that would allow them to compete globally.

A) 1960s
B) 1970s
C) 1980s
D) 1990s

Question 14

Which of the following statements regarding vertical integration is FALSE?

A) Vertically integrated companies may be large, but unlike other large corporations, since they remain focused in one industry they are easy to run.
B) A company might not be happy with how its products are being distributed, so it might decide to take control of its distribution channels.
C) A company might conclude that it can enhance its product if it has direct control of the inputs required to make the product.
D) The principal benefit of vertical integration is coordination. By putting two companies under central control, management can ensure that both companies work toward a common goal.

Question 15

The period of the ________ is known as the conglomerate wave because firms typically acquired firms in unrelated businesses.

A) 1960s
B) 1970s
C) 1980s
D) 1990s

Question 16

Savings that come from combining the marketing and distribution of different types of related products are called ________.

A) horizontal integration
B) vertical integration
C) economies of scale
D) economies of scope

Question 17

Which of the following statements regarding efficiency gains is FALSE?

A) Takeovers relying on the improvement of target management are difficult to complete, and post-takeover resistance to change can be great. Thus not all inefficiently run organizations are necessarily more efficient following a takeover.
B) Although identifying poorly performing corporations is relatively easy, fixing them is another matter entirely.
C) A justification that acquirers cite for paying a premium for a target is efficiency gains, which are often achieved through an elimination of duplication.
D) A chief executive of an inefficiently run corporation can be ousted by current shareholders voting to replace the board of directors, and in fact a large number of ineffective managers are replaced in this way.

Question 18

Which of the following statements regarding mergers and taxes is FALSE?

A) Carryback and carryforward provisions essentially deliver the benefits of conglomeration to a small firm with volatile earnings.
B) It might appear that a conglomerate has a tax advantage over a single-product firm simply because losses in one division can offset profits in another division.
C) Companies with current-year losses can also use them to offset earnings (carryback) for the twenty prior years.
D) The IRS will disallow a tax break if it can show that the principal reason for a takeover is tax avoidance, so it is unlikely that the tax advantage could, by itself, be a valid reason to acquire another firm.

Question 19

Which of the following statements is FALSE?

A) Chief among the costs associated with size is that larger firms are more difficult to manage.
B) For most investors an investment in the stock market is a zero-NPV investment.
C) Tax savings from operating profits are by far the most common justification that bidders give for the premium they pay for a target.
D) An acquirer might be able to add economic value, as a result of an acquisition, that an individual investor cannot add.

Question 20

Most acquirers pay an acquisition premium for a target. Upon announcement of the bid, the target's stock price increases, on average, so that the stock price is the same as the price bid by the acquirer.

Question 21

Use the information for the question(s) below.
Martin Manufacturing has earnings per share (EPS) of $3.00, 5 million shares outstanding, and a share price of $32. Martin is considering buying Luther Industries, which has earnings per share of $2.50, 2 million shares outstanding, and a share price of $20. Martin will pay for Luther by issuing new shares. There are no expected synergies from the transaction.
Assume that Martin pays no premium to acquire Luther. Calculate Martin's price-earnings (P/E) ratio both pre and post merger.

Question 22

Which of the following questions regarding risk arbitrage is FALSE?

A) Once a tender offer is announced, the uncertainty about whether the takeover will succeed reduces the volatility of the stock price. This uncertainty creates an opportunity for investors to speculate on the outcome of the deal without bearing the risk of volatility.
B) Traders known as risk-arbitrageurs, who believe that they can predict the outcome of a deal, take positions based on their beliefs.
C) A potential profit arises from the difference between the target's stock price and the implied offer price, and is referred to as the merger-arbitrage spread.
D) However, it is not a true arbitrage opportunity because there is a risk that the deal will not go through. If the takeover did not ultimately succeed, the risk-arbitrageur would eventually have to unwind his position at whatever market prices prevailed.

Question 23

A situation where every director serves a three-year term and the terms are staggered so that only one-third of the directors are up for election each year is called a ________.

A) white knight
B) classified board
C) poison pill
D) golden parachute

Question 24

KT corporation has announced plans to acquire MJ corporation. KT is trading for $25 per share and MJ is trading for $45 per share, with a premerger value for MJ of $3 billion dollars. If the projected synergies from the merger are $750 million, what is the maximum exchange ratio that KT could offer in a stock swap and still generate a positive NPV?

Question 25

Consider the following equation: <

The term A in this equation refers to ________.

A) the premerger, or standalone, value of the acquirer
B) new shares to pay for the target
C) the value of the synergies created by the merger
D) the premerger (standalone) value of the target

Question 26

For a hostile takeover to succeed, the acquirer must appeal to the target shareholders; this is usually done through ________.

A) a tender offer and a proxy fight
B) a tender offer and a poison pill
C) a white knight and a proxy fight
D) a staggered board and a white knight

Question 27

Which of the following questions is FALSE?

A) The method of payment (cash or stock) affects how the value of the target's assets is recorded for tax purposes and it affects the combined firm's financial statements for financial reporting.
B) The combined firm must mark up the value assigned to the target's assets on the financial statements by allocating the purchase price to target assets according to their fair market value.
C) Any goodwill created in a merger deal can be amortized for tax purposes over 15 years.
D) Many transactions are carried out as acquisitive reorganizations under the tax code. These structures allow the target shareholders to defer their tax liability on the part of the payment made in acquirer stock but they do not allow the acquirer to step up the book value of the target assets.

Question 28

An extremely lucrative severance package that is guaranteed to a firm's senior managers in the event that the firm is taken over and the managers are let go is called a ________.

A) golden parachute
B) white knight
C) poison pill
D) classified board

Question 29

Consider two firms, Thither and Yon. Both companies will either make $30 million or lose $10 million every year with equal probability. The companies' profits are perfectly negatively correlated. What are the expected after-tax profits of Thither in any year, assuming a corporate tax rate of 35% and no tax loss carry back or carry forward?

A) $19.5 million
B) $6.5 million
C) $4.75 million
D) -$6.5 million

Question 30

Consider two firms, Thither and Yon. Both companies will either make $30 million or lose $10 million every year with equal probability. The companies' profits are perfectly negatively correlated. What are the expected after-tax profits of the combined company (Thither and Yon) in any year, assuming a corporate tax rate of 35% and no tax loss carry back or carry forward?

A) $19.5 million
B) $6.5 million
C) $4.75 million
D) -$6.5 million

Question 31

Consider two firms, Bob Company and Cat Enterprises, both with earnings of $10 per share and 5 million shares outstanding. Cat is a mature company with few growth opportunities and a stock price of $25 per share. Bob is a new firm with much higher growth opportunities and a stock price of $40 per share. Assume Bob acquires Cat using its own stock and the takeover adds no value. In a perfect capital market, how many shares must Bob offer Cat's shareholders in exchange for their shares?

A) 1 share of new company after takeover for each share of Cat Enterprises.
B) 0.625 shares of new company after takeover for each share of Cat Enterprises.
C) 1.6 shares of new company after takeover for each share of Cat Enterprises.
D) 0.3846 shares of new company after takeover for each share of Cat Enterprises.

Question 32

A rights offering that gives existing target shareholders the right to buy shares in either the target or an acquirer at a deeply discounted price once certain conditions are met is called a ________.

A) golden parachute
B) poison pill
C) classified board
D) white knight

Question 33

Consider the following equation: <

The term S in this equation refers to ________.

A) the premerger (standalone) value of the target
B) the premerger, or standalone, value of the acquirer
C) the value of the synergies created by the merger
D) new shares to pay for the target

Question 34

Consider the following equation: <

The term x in this equation refers to ________.

A) the value of the synergies created by the merger
B) the premerger, or standalone, value of the acquirer
C) new shares to pay for the target
D) the premerger (standalone) value of the target

Question 35

When a hostile takeover appears to be inevitable, a target company will sometimes look for another, friendlier company to acquire it called a ________.

A) poison pill
B) classified board
C) golden parachute
D) white knight

Question 36

Use the information for the question(s) below.
Martin Manufacturing has earnings per share (EPS) of $3.00, 5 million shares outstanding, and a share price of $32. Martin is considering buying Luther Industries, which has earnings per share of $2.50, 2 million shares outstanding, and a share price of $20. Martin will pay for Luther by issuing new shares. There are no expected synergies from the transaction.
If Martin pays no premium to acquire Luther, what will the earnings per share be after the merger?

Question 37

Which of the following statements regarding poison pills is FALSE?

A) Companies with poison pills are harder to take over, and when they are taken over, the premium that existing shareholders receive for their stock is higher.
B) Because a poison pill increases the cost of a takeover, all else equal, a target company must be in better shape to justify the expense of waging a takeover battle.
C) Poison pills also increase the bargaining power of the target firm when negotiating with the acquirer because poison pills make it difficult to complete the takeover without the cooperation of the target board.
D) By adopting a poison pill, a company effectively entrenches its management by making it much more difficult for shareholders to replace bad managers, thereby potentially destroying value.

Question 38

Consider the following equation: <

The term T in this equation refers to ________.

A) the premerger, or standalone, value of the acquirer
B) the value of the synergies created by the merger
C) the premerger (standalone) value of the target
D) new shares to pay for the target

Question 39

Which of the following questions is FALSE?

A) Once the acquirer has completed the valuation process, it is in the position to make a tender offer-that is, a public announcement of its intention to purchase a large block of shares for a specified price.
B) If we view the pre-bid market capitalization as the stand-alone value of the target, then from the bidder's perspective, the takeover is a positive-NPV project only if the synergies created do not exceed the premium it pays.
C) Purchasing a corporation usually constitutes a very large capital investment decision, so it requires a more accurate estimate of value that includes careful analysis of both operational aspects of the firm and the ultimate cash flows the deal will generate.
D) A stock-swap merger is a positive-NPV investment for the acquiring shareholders if the share price of the merged firm (the acquirer's share price after the takeover) exceeds the premerger price of the acquiring firm.

Question 40

Which of the following questions is FALSE?

A) Any acquirer shares received in full or partial exchange for target shares triggers an immediate tax liability for target shareholders.
B) In a friendly takeover, the target board of directors supports the merger, negotiates with potential acquirers, and agrees on a price that is ultimately put to a shareholder vote.
C) How the acquirer pays for the target affects the taxes of both the target shareholders and the combined firm.
D) If the acquirer purchases the target assets directly (rather than the target stock), then it can step up the book value of the target's assets to the purchase price.

Question 41

What is a white knight?

Question 42

Consider a case in which existing shareholders do not have to invest time and effort, but still participate in the gains from a takeover, while the bidder who puts in the time and effort is forced to give up substantial profits. This situation is called ________.

A) the free rider problem
B) a toehold
C) a leveraged buyout
D) a freezeout merger

Question 43

You work for a levered buyout firm and are evaluating a potential buyout of Boogle Inc. Boogle's stock price is $18, and it has 3 million shares outstanding. You believe that if you buy the company and replace its dismal management team, its value will increase by 50%. You are planning on doing a levered buyout of Boogle and will offer $25 per share for control of the company. Assuming you get 50% control, what will your gain from the transaction be?

Question 44

Mayo Corporation is currently trading at $30 per share. There are 10 million shares outstanding, and the company has no debt. You believe that the value of the company would increase by 50% if the management were replaced. How much would you need to offer in total to acquire 50% of Mayo's shares?

A) $300 million
B) $150 million
C) $100 million
D) $10 million

Question 45

Which of the following statements regarding recapitalization as a takeover defense is FALSE?

A) Another defense against a takeover is a recapitalization, in which a company changes its capital structure to make itself less attractive as a target.
B) Restructuring itself can produce efficiency gains, often removing the principal motivation for the takeover in the first place.
C) By increasing leverage on its own, the target firm can reap the benefit of the interest tax shields.
D) In many cases, a substantial portion of the synergy gains that an acquirer anticipates from a takeover are savings from a decrease in leverage as well as other cost reductions.

Question 46

Mayo Corporation is currently trading at $30 per share. There are 10 million shares outstanding, and the company has no debt. You believe that the value of the company would increase by 50% if the management were replaced. How much would you gain from acquiring 50% of Mayo's shares by borrowing, attaching the debt to the company and replacing the management?

A) $150 million
B) $225 million
C) $300 million
D) $10 million

Question 47

Which of the following statements is FALSE?

A) SEC rules make it difficult for investors to buy much more than about 10% of a firm in secret. After an acquirer acquires such an initial stake in the target, called a toehold, they would have to make their intentions public by informing investors of his large stake.
B) With the availability of both the freezeout merger and the leveraged buyout as acquisition strategies, most of the value added accrues to the acquiring shareholders.
C) The laws on tender offers allow the acquiring company to freeze existing shareholders out of the gains from merging by forcing non-tendering shareholders to sell their shares for the tender offer price.
D) Premiums in LBO transactions are often quite substantial-while they can avoid the free-rider problem acquirers must still get board approval to overcome other defenses such as poison pills, as well as outbid other potential acquirers.