15 – 19 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
a) NDA gains nothing and loses nothing on this deal.
b) NDA loses $0.5 billion on this deal.
c) NDA loses $1 billion on this deal.
d) None of the above.
53. Notre Dame Alliance Inc. (NDA) is worth $3 billion and wants to take over Vancouver
Company Inc. (VC), which is worth $1.5 billion. NDA expects the deal to result in $0.5 billion in
synergies. Supposing a bidding war arises and NDA ends up paying $2 billion in a stock swap
for VC, and then finds there are no synergies, how much have NDA shareholders gained or lost
on the deal?
a) NDA shareholders lose $0.33 billion on this deal.
b) NDA shareholders lose $0.3 billion on this deal.
c) NDA shareholders lose $0.5 billion on this deal.
d) None of the above.
54. When conducting shareholder value at risk (SVAR) analysis for acquisitions, it is found that:
a) Acquirers using cash bear all of the risk of the acquisition, while the risk in acquisitions using
share swaps is borne by both sets of shareholders.
b) Acquirers using stock swaps bear all of the risk of the acquisition, while the risk in
acquisitions using cash is borne by both sets of shareholders.
c) The risk of an acquisition is always borne equally between the acquiring firm and target firm
shareholders.
d) None of the above.
55. Which of the following is NOT true?
a) The beneficiaries of a tender offer are normally the shareholders of the target firm.
b) When management acts on its own authority, it does so mainly to further its own interests.
c) When payment for an acquisition is made through the issuance of securities, the value of
these new shares is a concern.
d) Mergers tend to decrease during periods of soaring stock prices.
56. Which of the following statements is true?
a) When a firm’s assets are acquired, the liabilities are transferred to the vendor.
b) The purchase of a target company’s shares as a method of acquiring a firm’s assets is
attractive when the target company has contingent liabilities outstanding.
c) With an acquisition, both assets and liabilities are taken over by the new parent.
d) The purchase of shares must take place soon after the announcement of the intent to merge,
thereby minimizing the premium over current market price that has to be paid.
57. Which one of the following is an example of economies of scope?
a) Acquiring a firm to improve bargaining power in price negotiations
b) Acquiring a firm to gain access to foreign markets
c) Acquiring a firm to improve the production process
d) Acquiring a firm to reduce the overall cost of production
58. Which one of the following is an example of complementary strengths?
a) A marketing-oriented firm acquires a production-oriented firm
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b) Acquiring a firm to gain access to foreign markets
c) Acquiring a firm to improve the production process
d) Acquiring a firm to reduce the overall cost of production
59. A merger that allows a firm to access a cheaper way of financing its projects is:
a) Financial economies of scope
b) Financial economies of scale
c) Financing synergy
d) Tax benefits
60. Use the following statements to answer this question:
I. Managers may abuse their position and increase the size of the company through
acquisitions.
II. It is usually good news for shareholders when their firm is targeted.
a) I is correct and II is correct.
b) I is incorrect and II is incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
61. Which of the following is NOT one of the requirements for the determination of fair market
value (FMV)?
a) Open and restricted markets
b) Informed and prudent parties
c) Arm’s length transaction
Mergers and Acquisitions 15 – 22
d) Neither party is under compulsion to transact
62. For acquisitions, which purchaser type values the resulting firm based on estimated cash
flows as they are at present, with only minor adjustments?
a) Strategic investors
b) Financials
c) Passive investors
d) Managers
63. A management buy–out is defined as:
a) Severance payments made by an acquiring firm to target firm managers.
b) Firm shareholders paying off management so that it can be replaced.
c) A buy-out in which the purchasers are a firm’s managers.
d) None of the above.
64. The valuation approach that uses ratios such as market-to-book (M/B), price-earnings (P/E),
and price-to–cash flow (P/CF) is called:
a) Liquidation valuation
b) Discounted cash flow (DCF) valuation
c) Multiples valuation
d) All of the above
65. The main difference between reactive and proactive valuation models is:
a) Reactive models determine what the value should be based on future values of cash flows
and earnings while proactive models use general rules of thumb and the pricing of other
securities.
b) Reactive models focus on management expectations while proactive models use analyst
forecasts.
c) Proactive models determine what the value should be based on future values of cash flows
and earnings while reactive models use general rules of thumb and the pricing of other
securities.
d) Reactive models are very ad hoc while proactive models are precise.
66. Which of the following is NOT a limitation of the liquidation valuation approach?
a) It leads to imprecise estimates.
b) The resulting value estimates are not forward-looking.
c) The estimates change frequently and require constant updating.
d) All of these are limitations of the liquidation valuation approach.
67. When conducting discounted cash flow (DCF) valuation using free cash flow to equity, the
appropriate discount rate is:
a) Weighted average cost of equity
b) Risk-adjusted cost of equity
c) Cost of debt
d) Risk-adjusted cost of debt
68. An acquiring firm can increase its earnings per share (EPS) by:
a) Acquiring a firm with a lower P/E ratio than its own P/E ratio.
b) Acquiring a firm with a higher P/E ratio than its own P/E ratio.
c) Acquiring a firm with a higher leverage ratio than its own leverage ratio.
d) Acquiring a firm with a lower leverage ratio than its own leverage ratio.
69. A firm is evaluated using the liquidation valuation. Which one of the following would increase
the value of the firm?
a) High level of unrecoverable accounts receivable
b) Amortization technique undervalues tangible assets
c) Debt capacity of the firm is maximized
d) Bankruptcy of major firm clients
70. The information for Montreal Design Inc. (MD) is provided below. What is its P/E ratio?
($)
EBIT 5,000,000
Interest 1,250,000
EBT 3,750,000
Income Taxes (40%) 1,500,000
Net Income 2,250,000
Debt (Book value) 25,000,000
Equity (Book value) 25,000,000
Equity (Market value) 27,000,000
a) 12x
b) 6.7x
c) 5.4x
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d) 11.1x
71. The target company has sales of $2 million, earnings of $1 million, and cash flows to equity
of $1.1 million. The industry P/E ratio is 16.5. What is the valuation of the target company?
a) $16.5 million
b) $33 million
c) $18.15 million
d) $10 million
72. Beta Corporation and Gamma Ltd. are merging.
Beta Gamma
Annual earnings$800,000 $240,000
Shares outstanding400,000 200,000
Market price per share$30 $30
Earnings per share $2 $1.20
Price-earnings ratio 15 25
The basis for the merger will be a share-for-share exchange based on market prices, and the
share value of the combined firm is expected to remain unchanged. What would the earnings
per share and price-earnings ratio be after the merger?
a) 1.73 and 17.34
b) 1.35 and 22.22
c) 1.6 and 18.75
d) 2 and 15
73. Goodwill is an:
a) estimate of the excess of the purchase price over a target firm’s equity.
b) the difference between target firm’s book value of assets over the book value of debt.
c) increase due to collective synergies.
d) increase in the target’s stock price when a possible acquisition is announced.
74. If a firm has significant free cash flows (FCF) it could likely:
a) become a takeover target
b) see a drop in stock price
c) have an excessively low debt/equity ratio
d) reinvest more in itself by reducing its dividend payouts (plowback)
75. Goodwill is calculated as the excess of:
a) a target firm’s purchase price over the FMV of its equity.
b) a target firm’s book value of assets over the book value of debt.
c) the FMV of a target firm’s equity over its purchase price.
d) the FMV of the acquiring firm’s equity over the FMV of the target firm’s equity.
76. An acquirer has a book value for its current assets of $25,000 and market value of current
assets of $200,000. The target has a book value for its current assets of $3,500 and market
value of current assets of $7,200. What is the book value of current assets after acquisition?
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a) $25,000
b) $28,500
c) $203,500
d) $207,200
77. The industry P/E ratio is estimated to be 15.35 in which a target company has sales of $5.5
million, earnings of $2.75 million, and cash flows to equity of $1.12 million. Based on these
numbers, what is the valuation of the target company?
a) $17.192 million
b) $42.2125 million
c) $59.4045 million
d) $84.425 million
78. The book value of current assets of the bidder is $25,000, the book value of current assets
of the target is $3,500, and the fair market value of current assets of the target is $2,900. What
is the book value of current assets post acquisition?
a) $25,000
b) $28,500
c) $27,900
d) $2,900
Mergers and Acquisitions 15 – 28
PRACTICE PROBLEMS
79. Define and distinguish between acquisitions and amalgamations.
80. Define synergy and explain what effect it can have on a merged company.
81. List and briefly describe five possible sources of increased value when a merger or
acquisition takes place.
82. What is a tender offer?
83. List and briefly describe three defense strategies that the target firm may use against an
unfriendly acquiring firm.
84. You are a shareholder of a publicly traded firm. You are asked by the firm’s management to
vote on a proposal to change the company’s by–laws to “protect shareholders’ interests in the
event of an unfriendly takeover.” Should you vote in favour of the proposal or against it? Why?
85. What would be the motivation behind protecting the firm from an acquisition using a white
knight strategy even though the deal increases the value for shareholders?
86. Beta Corporation is a manufacturing firm that is considering two acquisition targets. Gamma
is a computer firm, while Delta is a manufacturing company. The relevant data are as follows:
Beta Gamma Delta
Annual earnings$600,000 $240,000 $160,000
Shares outstanding400,000 200,000 80,000
Market price per share$30 $30 $30
Earnings per share $1.50 $1.20 $2.00
Price-earnings ratio 20.0 25.0 15.0
The basis for the merger will be a share-for-share exchange based on market prices, and the
share value of the combined firm is expected to remain unchanged. What would be the
immediate effect of the two mergers on Beta Corp.’s earnings per share and price–earnings
ratio? What other factors are important in Beta’s analysis of its merger possibilities?
87. An acquiring firm is considering buying Toronto Tailors Inc. (TT). The sales, income
statement, capital, and valuation ratios information for TT is provided below. Using this
information, estimate the value of TT’s equity:
a) using the industry averages for the first five valuation ratios presented below
b) using the five-year averages for TT for the first five valuation ratios presented below
c) using the forward P/E ratio based on the following assumptions:
8% is a reasonable cost of equity for TT;
TT maintains its present dividend payout ratio; and
TT’s earnings and dividends grow at an annual rate of 5 percent indefinitely
Sales and Income Statement Items
($ millions)
Sales 10
Volume = 2 million
Price per unit = $5
Costs (8.5)
Variable costs 3.5
Fixed cash costs 3.0
Depreciation 0.5
Interest 0.6
Income tax 0.9
Net Income 1.5
Dividends 0.5
Mergers and Acquisitions 15 – 32
CAPITAL:
Invested capital (book values): ($ millions)
Equity 8
Debt 8
Market value of equity: 24
Valuation Ratios Current 5-Yr Avg. Industry Avg.
Price-earnings (P/E) (trailing) 16x 15.5x 17.6x
Value/EBIT 10.67x 7.33x 10x
Value/EBITDA 9.14x 7.24x 9.05x
P/Sales 2.4x 2.16x 2.56x
P/Book value (P/B) (equity) 3x 3x 3.2x
Price per unit of output 12 11.6 12.8
Return on equity (ROE) 18.8% 15.5% 16.4%
88. Third Cup is considering purchasing Canadian Tea Inc. (CT). Third Cup, a high-end food
and beverage retailer, has been provided with the following information for Canadian Tea, for
the next year.
Expected values for CT next year: ($)
EBIT 7,440,000
Interest payments 744,000
Depreciation and amortization expense 372,000
Deferred taxes 186,000
Increase in net working capital 744,000
Net capital expenditures 558,000
Corporate tax rate 42%
Third Cup has asked you to conduct the following analysis:
a) Estimate Canadian Tea’s free cash flow to equity for next year.
b) Estimate the total value of Canadian Tea’s equity, as well as on a per-share basis. Assume
(i) a constant annual growth rate of free cash flow of 4.3% indefinitely, (ii) Canadian Tea has
650,000 shares outstanding, (iii) the appropriate beta is 1.12, (iv) the expected market return is
9.8 percent, and (v) the risk-free rate is 3.6 percent.
89. Sinatra Inc., a privately owned company, has 2015 after-tax earnings of $65 million, which
are expected to grow at 9 % annually into the foreseeable future. The firm is debt-free, capital
spending equals the firm’s rate of depreciation; and the annual change in working capital is
expected to be minimal. The firm’s beta is estimated to be 3.75, the 10-year Treasury bond is
5.5%, and the historical risk premium of stocks over the risk-free rate is 7.5%. Publicly traded
Cole Inc., a direct competitor of Sinatra’s, was sold recently at a purchase price of 7 times its
2015 after-tax earnings, which included a 40 percent premium over its current market price.
Aware of the premium paid for the purchase of Cole, Sinatra’s CFO wanted to estimate the
value of their firm, if they were approached by a possible acquirer. She chose to value the firm
using the discounted cash flow and comparable recent transactions methods. Given the nature
of Sinatra Inc., she expects the recent transactions method to be more accurate in gauging
Sinatra’s current market value, and thus weights it at 75% when arriving at a combined estimate
of the firm value from the two valuation methods used.
a) What is the value of Sinatra (including premium) using the DCF method?
b) What is the value using the comparable recent transactions method?
c) What would be the value of the firm if we combine the results of both methods?
d) What are some possible reasons the CFO places more trust in the comparable transactions
method of valuation?
Answer:
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