Chapter 1: Introduction to Mergers, Acquisitions, and Other Restructuring Activities
Examination Questions and Answers
True/False: Answer True or False to the following questions:
1. A divestiture is the sale of all or substantially all of a company or product line to another party for cash or
securities. True or False
2. The target company is the firm being solicited by the acquiring company. True or False
3. A merger of equals is a merger framework usually applied whenever the merger participants are comparable in
size, competitive position, profitability, and market capitalization. True or False
4. A vertical merger is one in which the merger participants are usually competitors. True or False
5. Joint ventures are cooperative business relationships formed by two or more separate parties to achieve
common strategic objectives True or False
6. Operational restructuring refers to the outright or partial sale of companies or product lines or to downsizing by
closing unprofitable or non-strategic facilities. True or False
7. The primary advantage of a holding company structure is the potential leverage that can be achieved by
gaining effective control of other companies’ assets at a lower overall cost than would be required if the firm
were to acquire 100 percent of the target’s outstanding stock. True or False
8. Holding companies and their shareholders may be subject to triple taxation. True or False
9. Investment bankers offer strategic and tactical advice and acquisition opportunities, screen potential buyers and
sellers, make initial contact with a seller or buyer, and provide negotiation support for their clients.
True or False
10. Large investment banks invariably provide higher quality service and advice than smaller, so-called boutique
investment banks. True or False
11. Financial restructuring generally refers to actions taken by the firm to change total debt and equity structure.
True or False
12. An acquisition occurs when one firm takes a controlling interest in another firm, a legal subsidiary of another
firm, or selected assets of another firm. The acquired firm often remains a subsidiary of the acquiring
company. True or False
13. A leveraged buyout is the purchase of a company using as much equity as possible. True or False
14. In a statutory merger, both the acquiring and target firms survive. True or False
15. In a statutory merger, the acquiring company assumes the assets and liabilities of the target firm in accordance
with the prevailing federal government statutes. True or False
16. In a consolidation, two or more companies join together to form a new firm. True or False
17. A horizontal merger occurs between two companies within the same industry. True or False
18. A conglomerate merger is one in which a firm acquires other firms, which are highly related to its current core
business. True or False
19. The acquisition of a coal mining business by a steel manufacturing company is an example of a vertical
merger. True or False
20. The merger of Exxon Oil Company and Mobil Oil Company was considered a horizontal merger. True or
False
21. Most M&A transactions in the United States are hostile or unfriendly takeover attempts. True or False
22. Holding companies can gain effective control of other companies by owning significantly less than 100% of
their outstanding voting stock. True or False
23. Only interest payments on ESOP loans are tax deductible by the firm sponsoring the ESOP. True or False
24. A joint venture rarely takes the legal form of a corporation. True or False
25. When investment bankers are paid by a firm’s board to evaluate a proposed takeover bid, their opinions are
given in a so–called “fairness letter.” True or False
26. Synergy is the notion that the combination of two or more firms will create value exceeding what either firm
could have achieved if they had remained independent. True or False
27. Operating synergy consists of economies of scale and scope. Economies of scale refer to the spreading of
variable costs over increasing production levels, while economies of scope refer to the use of a specific asset to
produce multiple related products or services. True or False
28. Most empirical studies support the conclusion that unrelated diversification benefits a firm’s shareholders.
True or False
29. Deregulated industries often experience an upsurge in M&A activity shortly after regulations are removed.
True or False
30. Because of hubris, managers of acquiring firms often believe their valuation of a target firm is superior to the
market’s valuation. Consequently, they often end up overpaying for the firm. True and False
31. During periods of high inflation, the market value of assets is often less than their book value. This often
creates an attractive M&A opportunity. True or False
32. Tax benefits, such as tax credits and net operating loss carry-forwards of the target firm, are often considered
the primary reason for the acquisition of that firm. True or False
33. Market power is a theory that suggests that firms merge to improve their ability to set product and service
selling prices. True or False
34. Mergers and acquisitions rarely pay off for target firm shareholders, but they are usually beneficial to acquiring
firm shareholders. True or False
35. Pre-merger returns to target firm shareholders average about 30% around the announcement date of the
transaction. True or False
36. Post-merger returns to shareholders often do not meet expectations. However, this is also true of such
alternatives to M&As as joint ventures, alliances, and new product introductions. True or False
37. Overpayment is the leading factor contributing to the failure of M&As to meet expectations. True or False
38. Takeover attempts are likely to increase when the market value of a firm’s assets is more than their
replacement value. True or False
39. Although there is substantial evidence that mergers pay off for target firm shareholders around the time the
takeover is announced, shareholder wealth creation in the 3-5 years following a takeover is often limited.
True or False
40. A statutory merger is a combination of two corporations in which only one corporation survives and the
merged corporation goes out of existence. True or False
41. A subsidiary merger is a merger of two companies where the target company becomes a subsidiary of the
parent. True or False
42. Consolidation occurs when two or more companies join to form a new company. True or False
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43. An acquisition is the purchase of an entire company or a controlling interest in a company. True or False
44. A leveraged buyout is the purchase of a company financed primarily by debt. This is a term more frequently
applied to a firm going private financed primarily by debt. True or False
45. Growth is often cited as an important factor in acquisitions. The underlying assumption is that that bigger is
better to achieve scale, critical mass, globalization, and integration. True or False
46. The empirical evidence supports the presumption that bigger is always better when it comes to acquisitions.
True or False
47. The empirical evidence shows that unrelated diversification is an effective means of smoothing out the
business cycle. True or False
48. Individual investors can generally diversify their own stock portfolios more efficiently than corporate
managers who diversify the companies they manage. True or False
49. Financial considerations, such as an acquirer believing the target is undervalued, a booming stock market or
falling interest rates, frequently drive surges in the number of acquisitions. True or False
50. Regulatory and political change seldom plays a role in increasing or decreasing the level of M&A activity.
True or False
Multiple Choice: Circle only one.
1. Which of the following are generally considered restructuring activities?
a. A merger
b. An acquisition
c. A divestiture
d. A consolidation
e. All of the above
2. All of the following are considered business alliances except for
a. Joint ventures
b. Mergers
c. Minority investments
d. Franchises
e. Licensing agreements
3. Which of the following is an example of economies of scope?
a. Declining average fixed costs due to increasing levels of capacity utilization
b. A single computer center supports multiple business units
c. Amortization of capitalized software
d. The divestiture of a product line
e. Shifting production from an underutilized facility to another to achieve a higher overall operating rate
and shutting down the first facility
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4. A firm may be motivated to purchase another firm whenever
a. The cost to replace the target firm’s assets is less than its market value
b. The replacement cost of the target firm’s assets exceeds its market value
c. When the inflation rate is accelerating
d. The ratio of the target firm’s market value is more than twice its book value
e. The market to book ratio is greater than one and increasing
5. Which of the following is true only of a consolidation?
a. More than two firms are involved in the combination
b. One party to the combination disappears
c. All parties to the combination disappear
d. The entity resulting from the combination assumes ownership of the assets and liabilities of the
acquiring firm only.
e. One company becomes a wholly owned subsidiary of the other.
6. Which one of the following is not an example of a horizontal merger?
a. NationsBank and Bank of America combine
b. U.S. Steel and Marathon Oil combine
c. Exxon and Mobil Oil combine
d. SBC Communications and Ameritech Communications combine
e. Hewlett Packard and Compaq Computer combine
7. Buyers often prefer “friendly” takeovers to hostile ones because of all of the following except for:
a. Can often be consummated at a lower price
b. Avoid an auction environment
c. Facilitate post-merger integration
d. A shareholder vote is seldom required
e. The target firm’s management recommends approval of the takeover to its shareholders
8. Which of the following represent disadvantages of a holding company structure?
a. Potential for triple taxation
b. Significant number of minority shareholders may create contentious environment
c. Managers may have difficulty in making the best investment decisions
d. A, B, and C
e. A and C only
9. Which of the following are not true about ESOPs?
a. An ESOP is a trust
b. Employer contributions to an ESOP are tax deductible
c. ESOPs can never borrow
d. Employees participating in ESOPs are immediately vested
e. C and D
10. ESOPs may be used for which of the following?
a. As an alternative to divestiture
b. To consummate management buyouts
c. As an anti-takeover defense
d. A, B, and C
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e. A and B only
11. Which of the following represent alternative ways for businesses to reap some or all of the advantages of
M&As?
a. Joint ventures and strategic alliances
b. Strategic alliances, minority investments, and licensing
c. Minority investments, alliances, and licensing
d. Franchises, alliances, joint ventures, and licensing
e. All of the above
12. Which of the following are often participants in the acquisition process?
a. Investment bankers
b. Lawyers
c. Accountants
d. Proxy solicitors
e. All of the above
13. The purpose of a “fairness” opinion from an investment bank is
a. To evaluate for the target’s board of directors the appropriateness of a takeover offer
b. To satisfy Securities and Exchange Commission filing requirements
c. To support the buyer’s negotiation effort
d. To assist acquiring management in the evaluation of takeover targets
e. A and B
14. Arbitrageurs often adopt which of the following strategies in a share for share exchange just before or just after
a merger announcement?
a. Buy the target firm’s stock
b. Buy the target firm’s stock and sell the acquirer’s stock short
c. Buy the acquirer’s stock only
d. Sell the target’s stock short and buy the acquirer’s stock
e. Sell the target stock short
15. Institutional investors in private companies often have considerable influence approving or disapproving
proposed mergers. Which of the following are generally not considered institutional investors?
a. Pension funds
b. Insurance companies
c. Bank trust departments
d. United States Treasury Department
e. Mutual funds
16. Which of the following are generally not considered motives for mergers?
a. Desire to achieve economies of scale
b. Desire to achieve economies of scope
c. Desire to achieve antitrust regulatory approval
d. Strategic realignment
e. Desire to purchase undervalued assets
17. Which of the following are not true about economies of scale?
a. Spreading fixed costs over increasing production levels
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b. Improve the overall cost position of the firm
c. Most common in manufacturing businesses
d. Most common in businesses whose costs are primarily variable
e. Are common to such industries as utilities, steel making, pharmaceutical, chemical and aircraft
manufacturing
18. Which of the following is not true of financial synergy?
a. Tends to reduce the firm’s cost of capital
b. Results from a better matching of investment opportunities available to the firm with internally
generated funds
c. Enables larger firms to experience lower average security underwriting costs than smaller firms
d. Tends to spread the firm’s fixed expenses over increasing levels of production
e. A and B
19. Which of the following is not true of unrelated diversification?
a. Involves buying firms outside of the company’s primary lines of business
b. Involves shifting from a firm’s core product lines into those which are perceived to have higher
growth potential
c. Generally results in higher returns to shareholders
d. Generally requires that the cash flows of acquired businesses are uncorrelated with those of the firm’s
existing businesses
e. A and D only
20. Which of the following is not true of strategic realignment?
a. May be a result of industry deregulation
b. Is rarely a result of technological change
c. Is a common motive for M&As
d. A and C only
e. Is commonly a result of technological change
21. The hubris motive for M&As refers to which of the following?
a. Explains why mergers may happen even if the current market value of the target firm reflects its true
economic value
b. The ratio of the market value of the acquiring firm’s stock exceeds the replacement cost of its assets
c. Agency problems
d. Market power
e. The Q ratio
22. Around the announcement date of a merger or acquisition, abnormal returns to target firm shareholders
normally average
a. 10%
b. 30%
c. –3%
d. 100%
e. 50%
23. Around the announcement date of a merger, acquiring firm shareholders normally earn
a. 30% positive abnormal returns
b. –20% abnormal returns
c. Zero to slightly negative returns
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d. 100% positive abnormal returns
e. 10% positive abnormal returns
24. Which of the following is the most common reason that M&As often fail to meet expectations?
a. Overpayment
b. Form of payment
c. Large size of target firm
d. Inadequate post-merger due diligence
e. Poor post-merger communication
25. Post-merger financial performance of the new firm is often about the same as which of the following?
a. Joint ventures
b. Strategic alliances
c. Licenses
d. Minority investments
e. All of the above
26. Restaurant chain, Camin Holdings, acquired all of the assets and liabilities of Cheesecakes R Us. The
combined firm is known as Camin Holdings and Cheesecakes R Us no longer exists as a separate entity. The
acquisition is best described as a:
a. Merger
b. Consolidation
c. Tender offer
d. Spinoff
e. Divestiture
27. Pacific Surfware acquired Surferdude and as part of the transaction both of the firms ceased to exist in their
form prior to the transaction and combined to create an entirely new entity, Wildly Exotic Surfware. Which
one of the following terms best describes this transaction?
a. Divestiture
b. Tender offer
c. Joint venture
d. Spinoff
e. Consolidation
28. News Corporation of America announced its intention to purchase shares in another national newspaper chain.
Which one of the following terms best describes this announcement?
a. Divestiture
b. Spinoff
c. Consolidation
d. Tender offer
e. Merger proposal
29. Which one of the following statements accurately describes a merger?
a. A merger transforms the target firm into a new entity which necessarily becomes a subsidiary of the
acquiring firm
b. A new firm is created from the assets and liabilities of the acquirer and target firms
c. The acquiring firm absorbs only the assets of the target firm
d. The target firm is absorbed entirely into the acquiring firm and ceases to exist as a separate legal
entity.
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e. A new firm is created holding the assets and liabilities of the target firm and its former assets only.
30. An investor group borrowed the money necessary to buy all of the stock of a company. Which of the following
terms best describes this transaction?
a. Merger
b. Consolidation
c. Leveraged buyout
d. Tender offer
e. Joint venture
31. A steel maker acquired a coal mining company. Which of the following terms best describes this deal?
a. Vertical
b. Conglomerate
c. Horizontal
d. Obtuse
e. Tender offer
32. Joe’s barber shop buys Jose’s Hair Salon. Which of the following terms best describes this deal?
a. Joint venture
b. Strategic alliance
c. Horizontal
d. Vertical
Case Study Short Essay Examination Questions:
Xerox Buys ACS to Satisfy Shifting Customer Requirements
In anticipation of a shift from hardware and software spending to technical services by their corporate customers, IBM
announced an aggressive move away from its traditional hardware business and into services in the mid-1990s. Having
sold its commodity personal computer business to Chinese manufacturer Lenovo in mid-2005, IBM became widely
recognized as a largely “hardware neutral” systems integration, technical services, and outsourcing company.
Because information technology (IT) services have tended to be less cyclical than hardware and software sales, the
move into services by IBM enabled the firm to tap a steady stream of revenue at a time when customers were keeping
computers and peripheral equipment longer to save money. The 2008–2009 recession exacerbated this trend as
corporations spent a smaller percentage of their IT budgets on hardware and software.
These developments were not lost on other IT companies. Hewlett-Packard (HP) bought tech services company EDS
in 2008 for $13.9 billion. On September 21, 2009, Dell announced its intention to purchase another IT services
company, Perot Systems, for $3.9 billion. One week later, Xerox, traditionally an office equipment manufacturer
announced a cash and stock bid for Affiliated Computer Systems (ACS) totaling $6.4 billion.
Each firm was moving to position itself as a total solution provider for its customers, achieving differentiation from
its competitors by offering a broader range of both hardware and business services. While each firm focused on a
somewhat different set of markets, they all shared an increasing focus on the government and healthcare segments.
However, by retaining a large proprietary hardware business, each firm faced challenges in convincing customers that
they could provide objectively enterprise-wide solutions that reflected the best option for their customers.
Previous Xerox efforts to move beyond selling printers, copiers, and supplies and into services achieved limited
success due largely to poor management execution. While some progress in shifting away from the firm’s dependence
on printers and copier sales was evident, the pace was far too slow. Xerox was looking for a way to accelerate
transitioning from a product-driven company to one whose revenues were more dependent on the delivery of business
services.
With annual sales of about $6.5 billion, ACS handles paper-based tasks such as billing and claims processing for
governments and private companies. With about one-fourth of ACS’s revenue derived from the healthcare and
government sectors through long-term contracts, the acquisition gives Xerox a greater penetration into markets which
should benefit from the 2009 government stimulus spending and 2010 healthcare legislation. More than two-thirds of
ACS’s revenue comes from the operation of client back office operations such as accounting, human resources, claims
management, and other business management outsourcing services, with the rest coming from providing technology
consulting services. ACS would also triple Xerox’s service revenues to $10 billion.
Xerox hopes to increases its overall revenue by bundling its document management services with ACS’s client back
office operations. Only 20 percent of the two firms’ customers overlap. This allows for significant cross-selling of each
firm’s products and services to the other firm’s customers. Xerox is also betting that it can apply its globally recognized
brand and worldwide sales presence to expand ACS internationally.
A perceived lack of synergies between the two firms, Xerox’s rising debt levels, and the firm’s struggling printer
business fueled concerns about the long–term viability of the merger, sending Xerox’s share price tumbling by almost
10 percent on the news of the transaction. With about $1 billion in cash at closing in early 2010, Xerox needed to
borrow about $3 billion. Standard & Poor’s credit rating agency downgraded Xerox’s credit rating to triple-B-minus,
one notch above junk.
Integration is Xerox’s major challenge. The two firms’ revenue mixes are very different, as are their customer bases,
with government customers often requiring substantially greater effort to close sales than Xerox’s traditional
commercial customers. Xerox intends to operate ACS as a standalone business, which will postpone the integration of
its operations consisting of 54,000 employees with ACS’s 74,000. If Xerox intends to realize significant incremental
revenues by selling ACS services to current Xerox customers, some degree of integration of the sales and marketing
organizations would seem to be necessary.
It is hardly a foregone conclusion that customers will buy ACS services simply because ACS sales representatives
gain access to current Xerox customers. Presumably, additional incentives are needed, such as some packaging of Xerox
hardware with ACS’s IT services. However, this may require significant price discounting at a time when printer and
copier profit margins already are under substantial pressure.
Customers are likely to continue, at least in the near term, to view Xerox, Dell, and HP more as product than service
companies. The sale of services will require significant spending to rebrand these companies so that they will be
increasingly viewed as service vendors. The continued dependence of all three firms on the sale of hardware may retard
their ability to sell packages of hardware and IT services to customers. With hardware prices under continued pressure,
customers may be more inclined to continue to buy hardware and IT services from separate vendors to pit one vendor
against another. Moreover, with all three firms targeting the healthcare and government markets, pressure on profit
margins could increase for all three firms. The success of IBM’s services strategy could suggest that pure IT service
companies are likely to perform better in the long run than those that continue to have a significant presence in both the
production and sale of hardware as well as IT services.
Discussion Questions:
1. Discuss the advantages and disadvantages of Xerox’s intention to operate ACS as a standalone business.
As an investment banker supporting Xerox, would you have argued in support of integrating ACS
immediately, at a later date, or to keep the two businesses separate indefinitely? Explain your answer.
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2. How are Xerox and ACS similar and how are they different? In what way will their similarities and
differences help or hurt the long-term success of the merger?
3. Based on your answers to questions 1 and 2, do you believe that investors reacted correctly or incorrectly
to the announcement of the transaction?
the limited near-term synergies, the additional debt, and the increasingly competitive IT services market.
Dell Moves into Information Technology Services
Dell Computer’s growing dependence on the sale of personal computers and peripherals left it vulnerable to economic
downturns. Profits had dropped more than 22 percent since the start of the global recession in early 2008 as business
spending on information technology was cut sharply. Dell dropped from number 1 to number 3 in terms of market
share, as measured by personal computer unit sales, behind lower-cost rivals Hewlett-Packard and Acer. Major
competitors such as IBM and Hewlett-Packard were less vulnerable to economic downturns because they derived a
larger percentage of their sales from delivering services.
Historically, Dell has grown “organically” by reinvesting in its own operations and through partnerships targeting
specific products or market segments. However, in recent years, Dell attempted to “supercharge” its lagging growth
through targeted acquisitions of new technologies. Since 2007, Dell has made ten comparatively small acquisitions
(eight in the United States), purchased stakes in four firms, and divested two companies. The largest previous
acquisition for Dell was the purchase of EqualLogic for $1.4 billion in 2007.
The recession underscored what Dell had known for some time. The firm had long considered diversifying its
revenue base from the more cyclical PC and peripherals business into the more stable and less commodity-like
computer services business. In 2007, Dell was in discussions about a merger with Perot Systems, a leading provider of
information technology (IT) services, but an agreement could not be reached.
Dell’s global commercial customer base spans large corporations, government agencies, healthcare providers,
educational institutions, and small and medium firms. The firm’s current capabilities include expertise in infrastructure
consulting and software services, providing network-based services, and data storage hardware; nevertheless, it was still
largely a manufacturer of PCs and peripheral products. In contrast, Perot Systems offers applications development,
systems integration, and strategic consulting services through its operations in the United States and ten other countries.
In addition, it provides a variety of business process outsourcing services, including claims processing and call center
operations. Perot’s primary markets are healthcare, government, and other commercial segments. About one-half of
Perot’s revenue comes from the healthcare market, which is expected to benefit from the $30 billion the U.S.
government has committed to spending on information technology (IT) upgrades over the next five years.