Principles of Managerial Finance, 15e (Zutter)
Chapter 18 Mergers, LBOs, Divestitures, and Business Failure
18.1 Merger fundamentals
1) A merger occurs when two or more firms are combined to form a completely new corporation.
2) In the broadest sense, activities involving expansion or contraction of a firm’s operations or changes in
its assets or ownership structure are called corporate restructuring.
3) A merger transaction endorsed by a target firm’s management, approved by its stockholders, and
easily consummated is called a friendly merger.
4) Holding companies are corporations that have voting control of one or more other corporations and
the companies they control are referred to as subsidiaries.
5) Subsidiary companies are corporations having no voting control on holding companies.
6) Consolidation involves the combination of two or more firms, and the resulting firm maintains the
identity of one of the firms.
7) The companies controlled by a holding company are normally referred to as its subsidiaries.
8) A tender offer is a formal offer to purchase a given number of shares of a firm’s stock at a specified
price.
9) Strategic mergers seek to achieve various economies of scale by eliminating redundant functions,
increasing market share, and improving raw material sourcing and finished product distribution.
10) A holding company is a corporation which is controlled by one or more other corporations.
11) Financial mergers involve merging firms in order to achieve various economies of scale by
eliminating redundant functions, increasing market share, and improving raw material sourcing and
finished product distribution.
12) A consolidated corporation has voting control of one or more other corporations.
13) A financial merger is a merger transaction undertaken to achieve economies of scale.
14) A strategic merger is a merger transaction undertaken with the goal of restructuring the acquired
company in order to improve its cash flow and unlock its hidden value.
15) A takeover target’s management will not support a proposed takeover due to a very high tender offer.
16) The overriding goal for merging is the maximization of the owners’ wealth as reflected in the
acquirer’s share price.
17) The synergy of mergers is the economies of scale resulting from the merged firm’s lower overhead.
18) Tax loss carryforward benefits can be used in mergers.
19) Primary motives for merging include growth or diversification, synergy, fund raising, increased
managerial skill or technology, tax considerations, increased ownership liquidity, and defense against
takeovers.
20) An acquisition of a “cash-rich” company immediately increases the acquiring firm’s borrowing power
by decreasing its financial leverage.
21) Firms’ motives to merge include growth or diversification, synergy, fund raising, tax considerations,
and defense against takeover.
22) A firm that wants to expand or extend its operations in existing or new product areas may avoid
many of the risks associated with the design, manufacture, and sale of additional or new product and
remove a potential competitor by acquiring a suitable going concern.
23) A conglomerate merger is a merger combining firms in unrelated businesses.
24) A congeneric merger is a merger combining firms in unrelated businesses.
25) Greater control over the acquisition of new materials or the distribution of finished goods is an
economic benefit of horizontal merger.
26) A vertical merger may result in expansion of operations in an existing product line and elimination of
a competitor.
27) A vertical merger is a merger of two firms in the same line of business.
28) A horizontal merger is a merger in which one firm acquires another firm in the same general industry
but neither in the same line of business nor a supplier or customer.
29) A congeneric merger is a merger in which a firm acquires a supplier or a customer.
30) The key benefit of a horizontal merger is its ability to reduce risk by merging firms that have different
seasonal or cyclic patterns of sales and earnings.
31) Business combinations are used by firms to externally expand in order to increase ________.
A) provision for doubtful accounts
B) common stock outstanding
C) production capacity
D) financial leverage
32) A corporation that has voting control of one or more other corporations is called a ________.
A) holding company
B) congeneric formation
C) subsidiary
D) target firm
33) The combination of two or more companies to form a completely new corporation is a ________.
A) congeneric formation
B) consolidation
C) spin-off
D) conglomerate merger
34) A combination of companies where the former corporations cease to exist is ________.
A) a congeneric formation
B) a consolidation
C) a merger
D) a holding company
35) A combination of two or more companies that results in a firm maintaining the identity of one of the
firms is ________.
A) amalgamation
B) consolidation
C) merger
D) a holding company
36) A firm in a merger transaction that attempts to merge or takeover another company is called the
________.
A) target company
B) holding company
C) acquiring company
D) consolidated company
37) A firm in a merger transaction that is being pursued as a takeover potential is called the ________.
A) acquiring company
B) target company
C) holding company
D) consolidated company
38) A firm undertakes a merger in order to eliminate redundant functions or increase market share. This
is an example of ________.
A) financial merger
B) divestiture
C) spin-off
D) strategic merger
39) A merger transaction is not supported by the target firm’s management, forcing the acquiring
company to try to gain control of the firm by buying shares in the marketplace. This is an example of
________.
A) financial merger
B) hostile takeover
C) congeneric formation
D) strategic merger
40) A friendly merger is a ________.
A) merger in which the acquirer gains control of the target firm by buying sufficient shared through
private placement
B) merger in which the acquirer can attempt to gain control of the target firm by buying sufficient shares
of the target firm in the marketplace
C) merger transaction that is endorsed by the target firm’s management, approved by its stockholders,
and easily consummated
D) merger in which the target firm’s management acts to deter rather than facilitate the acquisition
41) When a firm undertakes a merger to improve its sources and supply of raw materials, this is an
example of a ________.
A) financial merger
B) hostile takeover
C) divestiture
D) strategic merger
42) A ________ occurs when the operations of the acquiring and target firms are combined in order to
achieve economies and thereby cause the performance of the merged firm to exceed that of the pre–
merged firm.
A) financial merger
B) hostile takeover
C) operating merger
D) strategic merger
43) A friendly merger transaction ________.
A) is a transaction in which merger is completed by forceful acquisition of the target’s shares from the
secondary market
B) requires a public announcement for its plan of acquisition
C) can be consummated through an exchange of the acquirer’s stock and cash
D) can only be completed by purchasing all the outstanding bonds of the target firm
44) A financial merger is undertaken to ________.
A) increase profit margin to enhance the retained earnings of the merged firm
B) improve raw material sourcing and finished product distribution
C) increase market share, which is used to maximize shareholder wealth
D) increase cash flows to service the debt incurred to finance the merger
45) A merger involving the purchase of a specific product line, rather than the whole company is
________.
A) an operating merger
B) a financial merger
C) a selective lines merger
D) a variation of the strategic merger
46) A hostile merger is accomplished through ________.
A) a cash purchase of stock
B) leveraged buyouts
C) a tender offer
D) divestitures
47) A(n) ________ is undertaken with the goal of restructuring the acquired company in order to improve
its cash flow and unlock its hidden value.
A) operating merger
B) strategic merger
C) financial merger
D) hostile takeover
48) An attempt to gain control of a target firm by buying sufficient shares of it in the marketplace is
known as a ________ and is typically accomplished through a ________.
A) friendly takeover; leveraged buyout
B) leveraged buyout; consolidation
C) friendly takeover; consolidation
D) hostile takeover; tender offer
49) A major impetus fueling financial mergers during the 1980s was ________.
A) high interest rates
B) high tax rates
C) high cash balances that could be utilized for takeovers
D) ready availability of junk bond financing
50) The combination of two or more companies that results in one of the corporations having a voting
control of one or more of the other companies is a ________.
A) congeneric formation
B) consolidation
C) spin-off
D) holding company
51) Motive for merging includes ________.
A) increased financial leverage
B) increased common stock outstanding
C) increased provision for doubtful accounts
D) increased liquidity
52) Which of the following is a reason for undertaking mergers?
A) increasing dividends
B) profit maximization
C) easy process
D) wealth maximization
53) One of the key motives for mergers is ________.
A) reducing the marginal tax rate
B) taking advantage of the other firm’s tax loss carryforward
C) to sell the assets of the target company to increase the cash balance
D) increasing additional recaptured depreciation
54) The overriding goal for merging is to ________.
A) develop monopoly control over the markets
B) maximize shareholders’ wealth as reflected in the acquirer’s share price
C) maximize shareholders’ profit as reflected in the share price of the target firm
D) maximize dividend payout ratio
55) Which of the following is a reason for mergers?
A) to reduce common stock outstanding
B) to gain monopoly control over the markets
C) to decrease the level of provision for doubtful accounts
D) to gain increased managerial skills
56) The acquisition of a “cash-rich” company allows the acquiring company ________.
A) to reap greater tax benefits
B) to reduce leverage and to increase borrowing power
C) to develop monopoly control over the markets
D) to achieve economies of scale in some phase of the business
57) A ________ results from the combination of firms in the same line of business.
A) congeneric merger
B) conglomerate diversification
C) horizontal merger
D) hostile takeover
58) A ________ is when a firm acquires a supplier or a customer.
A) congeneric merger
B) conglomerate merger
C) horizontal merger
D) vertical merger
59) Which of the following is true of a conglomerate merger?
A) It occurs when a firm acquires a supplier or a customer.
B) It involves the combination of firms in unrelated businesses.
C) It is achieved by acquiring a firm that is in the same general industry but neither in the same line of
business nor a supplier or customer.
D) It results in the expansion of a firm’s operations in a given product line and at the same time
eliminates a competitor.
60) Which of the following is true of a horizontal merger?
A) The key benefit of this merger stems from the merged firm’s increased control over the acquisition of
raw materials or the distribution of finished goods.
B) The key benefit of this form of merger is its ability to reduce risk by merging firms that have different
patterns of sales and earnings.
C) This form of merger results when two firms in the same line of business are merged.
D) This form of merger occurs when a firm acquires a supplier or a customer.
61) The combination of a dress manufacturer and a credit bureau is an example of ________.
A) congeneric merger
B) conglomerate merger
C) horizontal merger
D) vertical merger
62) Greater control over the acquisition of raw materials or the distribution of finished goods is an
economic benefit of a ________.
A) congeneric merger
B) conglomerate merger
C) horizontal merger
D) vertical merger
63) A ________ may result in the expansion of a firm’s operations in an existing product line and
elimination of a competitor.
A) congeneric merger
B) conglomerate merger
C) horizontal merger
D) vertical merger
64) A ________ is achieved by acquiring a company in the same general industry, but neither in the same
line of business nor a supplier or a customer.
A) congeneric merger
B) conglomerate merger
C) horizontal merger
D) vertical merger
65) The ability to use the same sales and distribution channels to reach customers of both businesses is a
benefit of ________.
A) congeneric merger
B) conglomerate merger
C) horizontal merger
D) vertical merger
66) A merger of a paper manufacturer and a logging company is an example of ________.
A) congeneric merger
B) conglomerate merger
C) horizontal merger
D) vertical merger
67) The reduction of risk resulting from combining firms with differing seasonal or cyclical patterns of
sales or earnings is a key benefit of ________.
A) congeneric merger
B) conglomerate merger
C) horizontal merger
D) vertical merger
18.2 LBOs and divestitures
1) LBOs are an example of a financial merger undertaken to create a high-debt private corporation with
improved cash flow and value.
2) An attractive candidate for acquisition through leveraged buyout must have a good position in its
industry with a solid profit history and reasonable expectation for growth.
3) An attractive candidate for acquisition through leveraged buyout usually has a relatively high level of
debt and a low level of “bankable” assets.
4) The sale of a unit of a firm to existing management is often achieved through a leveraged buyout.
5) In an LBO, 90 percent or more of the purchase price is financed with debt.
6) One of the key attributes that makes a firm a good candidate for an LBO is that it has stable and
predictable cash flows that are adequate to meet interest and principal payments on the debt.
7) One of the key attributes that makes a firm a good candidate for an LBO is that it has a relatively low
level of debt and a high level of liquid assets that could be used as loan collateral.
8) One of the key attributes that makes a firm a good candidate for an LBO is that it has a relatively high
level of debt and a low level of liquid assets.
9) One of the key attributes that makes a firm a good candidate for an LBO is that it has a solid position in
the industry with reasonable expectations for future growth.
10) Unlike business bankruptcy and business failure, divestiture is often undertaken for positive motives
in a manner that is consistent with the firm’s strategic goals.
11) Like business bankruptcy and business failure, divestiture is most often undertaken to relieve
pressure by creditors such as bondholders and banks due to the firm’s relatively high debt levels.
12) The motive for divestiture is often to get rid of a poorly performing operation in order to generate
cash for expansion of other product lines.
13) The selling of some of a firm’s assets for various strategic motives is called divestiture.
14) A spin-off is a form of divestiture in which an operating unit becomes an independent company by
issuing shares in it, on a pro rata basis to the parent company’s shareholders.
15) Methods of divestiture include the sale of a product line to another firm, the sale of a unit to existing
management, spin-offs, and the liquidation of assets.
16) Recent divestitures seem to suggest that many operating units are worth much more to others than to
the firm itself.
17) The value of a firm measured as the sum of the values of its operating units if each were sold
separately is known as a firm’s part and parcel value.
18) The value of a firm measured as the sum of the values of its operating units if each were sold
separately is known as a firm’s breakup value.
19) The use of a large amount of debt to finance the acquisition of other firms is a ________.
A) conglomerate merger
B) leveraged buyout
C) hostile merger
D) congeneric buyout
20) The sale of a unit of a firm to existing management is often achieved through ________.
A) a limited partnership
B) a leveraged buyout
C) an employee stock option
D) a cash exchange