Fundamentals of Corporate Finance, 3e (Berk/DeMarzo/Harford)
Chapter 22 Mergers and Acquisitions
22.1 Background and Historical Trends
1) The period of the ________ is known as the conglomerate wave because irms typically
acquired irms in unrelated businesses.
A) 1960s
B) 1970s
C) 1980s
D) 1990s
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
2) The period of the ________ is known for hostile, “bust-up” takeovers, in which the
acquirer purchased a poorly performing conglomerate and sold of its individual business
units for more than the purchase price.
A) 1960s
B) 1970s
C) 1980s
D) 1990s
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
3) 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 irms on a scale that would allow them to compete
globally.
A) 1960s
B) 1970s
C) 1980s
D) 1990s
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
1
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 irm, or the target irm can merge with another irm.
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.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
22.2 Market Reaction to a Takeover
1) Which of the following statements is FALSE?
A) In practice, most acquirers pay a substantial acquisition premium, which is the
percentage diference between the acquisition price and the premerger price of the target
irm.
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 irm 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.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
2) On average, when a bid is announced, the stock price of the target drops.
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
2
3) 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.
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
4) The synergies of a merger add so much value to the combined irm that, upon
announcement of a merger, the stock prices of both the target and the acquirer increase
substantially.
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
22.3 Reasons to Acquire
1) 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
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
2) Savings that come from combining the marketing and distribution of diferent types of
related products are called ________.
A) horizontal integration
B) vertical integration
C) economies of scale
D) economies of scope
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
3
3) The merger of two companies in the same industry that make products required at
diferent stages of the production cycle is called ________.
A) economies of scope
B) vertical integration
C) economies of scale
D) horizontal integration
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
4) The justiication for the beneits of diversiication from mergers include all of the
following EXCEPT ________.
A) tax loss beneits
B) lower cost of debt or increased debt capacity
C) direct risk reduction
D) liquidity enhancement
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
5) Which of the following statements is FALSE?
A) Chief among the costs associated with size is that larger irms are more diicult to
manage.
B) For most investors an investment in the stock market is a zero-NPV investment.
C) Tax savings from operating proits are by far the most common justiication 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.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
6) Which of the following statements is FALSE?
A) Cost-reduction synergies are hard to predict and achieve.
B) Because the CEOs of small irms receive information so quickly, small irms 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.
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AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
7) 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 beneit of vertical integration is coordination. By putting two companies
under central control, management can ensure that both companies work toward a
common goal.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
5
8) 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 irm to
substantially reduce competition within the industry and thereby increase proits.
B) Financial researchers have found that the share prices of other irms in the same
industry did not signiicantly increase following the announcement of a merger within the
industry.
C) While only the merging company beneits 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.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
9) Which of the following statements regarding eiciency gains is FALSE?
A) Takeovers relying on the improvement of target management are diicult to complete,
and post-takeover resistance to change can be great. Thus not all ineiciently run
organizations are necessarily more eicient following a takeover.
B) Although identifying poorly performing corporations is relatively easy, ixing them is
another matter entirely.
C) A justiication that acquirers cite for paying a premium for a target is eiciency gains,
which are often achieved through an elimination of duplication.
D) A chief executive of an ineiciently run corporation can be ousted by current
shareholders voting to replace the board of directors, and in fact a large number of
inefective managers are replaced in this way.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
6
10) Which of the following statements regarding mergers and taxes is FALSE?
A) Carryback and carryforward provisions essentially deliver the beneits of
conglomeration to a small irm with volatile earnings.
B) It might appear that a conglomerate has a tax advantage over a single-product irm
simply because losses in one division can ofset proits in another division.
C) Companies with current-year losses can also use them to ofset 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 irm.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
11) Which of the following statements regarding mergers and diversiication is FALSE?
A) Because it may be easier to measure performance accurately in a conglomerate, agency
costs may reduce and resources may be more eiciently allocated.
B) Because these employees are obligated to hold idiosyncratic risk, they beneit when the
irm reduces that risk by conglomerating.
C) Like a large portfolio, large irms bear less idiosyncratic risk, so often mergers are
justiied on the basis that the combined irm is less risky.
D) Because most stockholders will already be holding a well-diversiied portfolio, they get
no further beneit from the irm diversifying through acquisition.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
7
12) Which of the following statements is FALSE?
A) All else being equal, larger irms, because they are more diversiied, 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 irm 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 diversiied portfolio.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
13) Consider two irms, Thither and Yon. Both companies will either make $30 million or
lose $10 million every year with equal probability. The companies’ proits are perfectly
negatively correlated. What are the expected after-tax proits 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
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
8
14) Consider two irms, Thither and Yon. Both companies will either make $30 million or
lose $10 million every year with equal probability. The companies’ proits are perfectly
negatively correlated. What are the expected after-tax proits 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
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
15) Consider two irms, 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 irm 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 ofer 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.
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
9
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.
16) If Martin pays no premium to acquire Luther, what will the earnings per share be after
the merger?
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
17) Assume that Martin pays no premium to acquire Luther. Calculate Martin’s price-
earnings (P/E) ratio both pre and post merger.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
22.4 The Takeover Process
1) Consider the following equation:
10