Corporate Finance, 4e, Global Edition (Berk / DeMarzo)
Chapter 28 Mergers and Acquisitions
28.1 Background and Historical Trends
1) This period is known as the conglomerate wave because firms typically acquired firms in unrelated
businesses:
A) 1960s
B) 1970s
C) 1980s
D) 1990s
2) This period 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
3) This period 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
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.
5) In a ________ merger, the target and the acquirer operate in unrelated industries.
A) conglomerate
B) vertical
C) horizontal
D) diagonal
6) In a ________ merger, the target and the acquirer operate in the same industry.
A) conglomerate
B) vertical
C) horizontal
D) diagonal
7) In a ________ merger, the target’s industry buys or sells to the acquirer’s industry.
A) conglomerate
B) vertical
C) horizontal
D) diagonal
8) If Wal-Mart and Target were to merge, this would be an example of a ________ merger.
A) conglomerate
B) vertical
C) horizontal
D) diagonal
9) If Ford Motor Company bought The Goodyear Tire & Rubber Company, this would be an example of
a ________ merger.
A) conglomerate
B) vertical
C) horizontal
D) diagonal
10) If Microsoft merged with the Coca-Cola Company, this would be an example of a ________ merger.
A) conglomerate
B) vertical
C) horizontal
D) diagonal
11) When target shareholders exchange their old stock for new stock in the acquiring firm, this is known
as a(n):
A) exchange swap.
B) stock exchange.
C) term swap.
D) stock swap.
12) The structure of a merger transaction is summarized in a(n):
A) swap sheet.
B) term sheet.
C) exchange sheet.
D) merger sheet.
28.2 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 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.
2) What is the market reaction to a takeover announcement?
A) The price of the target increases by 15%, while the price of the acquirer decreases by 1%.
B) The price of the target increases by 15%, while the price of the acquirer increases by 1%.
C) The price of the target and acquirer both increase by 15%.
D) The price of the target increases by 1%, while the price of the acquirer increases by 15%.
28.3 Reasons to Acquire
Use the following information to answer the question(s) below.
Rearden Metal has earnings per share of $2. It has 10 million shares outstanding and is trading at $20
per share. Rearden Metal is thinking of buying Associated Steel, which has earnings per share of $1.25, 4
million shares outstanding, and a price per share of $15. Rearden Metal will pay for Associated Steel by
issuing new shares. There are no expected synergies from the transaction.
1) If Rearden pays no premium to buy Associated Steel, then Rearden’s earnings per share after the
merger will be closest to:
A) 10
B) 10.42
C) 12
D) 7.8
2) What is Reardon’s price–earnings ratio after the takeover?
A) $1.85
B) $1.90
C) $2.00
D) $2.25
3) If Rearden offers an exchange ratio such that, at current pre-announcement share prices for both
firms, the offer represents a 20% premium to buy Associated Steel, then Rearden’s earnings per share
after the merger will be closest to:
A) $1.85
B) $1.90
C) $2.00
D) $2.25
4) The savings that a large company can enjoy 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.
5) 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.
6) 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.
7) 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.
8) 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) Diversification benefits 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.
9) 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.
10) 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.
11) 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.
12) 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.
13) 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.
14) Which of the following statements regarding mergers and taxes is FALSE?
A) Because it may be easier to measure performance accurately in a conglomerate, agency costs may be
reduced 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.
15) 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.
16) Consider two firms, Zoe Corporation and Marley Company. Both corporations will either make
$20,000 or lose $5,000 every year with equal probability. The firms’ profits are perfectly negatively
correlated. If the corporate tax rate is 35%, what are the total expected after-tax profits of both firms
when they are two separate firms, assuming no tax-loss carryforwards or carrybacks?
A) $15,000
B) $8,000
C) $9,750
D) $4,000
17) Consider two firms, Zoe Corporation and Marley Company. Both corporations will either make
$20,000 or lose $5,000 every year with equal probability. The firms’ profits are perfectly negatively
correlated. If the corporate tax rate is 35%, what are the total expected after-tax profits if the two firms
are combined into one corporation, assuming no tax-loss carryforwards or carrybacks?
A) $15,000
B) $8,000
C) $9,750
D) $4,000
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. Marin will pay for Luther by issuing new shares.
There are no expected synergies from the transaction.
18) If Martin pays no premium to acquire Luther, what will the earnings per share be after the merger?