Corporate Finance, 3e (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 16% 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) $1.85
B) $1.90
C) $2.00
D) $2.25
2) 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
3) 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.
4) 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.
5) 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.
6) 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.
7) 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.
8) 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.
9) 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.
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.
11) 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.
12) 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.
13) 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.
14) 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.
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.
15) If Martin pays no premium to acquire Luther, what will the earnings per share be after the
merger?
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16) Assume that Martin pays no premium to acquire Luther. Calculate Martin’s price-earnings
(P/E) ratio both pre and post merger.