21) A ________ is a method of structuring a financial merger, whereas a ________ involves the sale of the
firm’s assets.
A) leveraged buyout; bankruptcy
B) congeneric buyout; divestiture
C) horizontal merger; leveraged divestiture
D) leveraged buyout; divestiture
22) Leveraged buyouts are clear examples of ________.
A) strategic mergers
B) vertical mergers
C) financial mergers
D) congeneric mergers
23) The creation of a high-debt, private corporation with improved cash flow and value is the goal in
________.
A) a spin-off
B) a divestiture
C) a conglomerate merger
D) a leveraged buyout
24) Which of the following is true of a leveraged buyout?
A) It is a type of a strategic merger.
B) It is used to increase market share, which is used to maximize shareholder wealth.
C) It aims at developing monopoly control over the markets.
D) It involves the use of a large amount of debt to purchase a firm.
25) Leveraged buyouts require a target firm ________.
A) to have low level of investments in fixed assets
B) to possess high leverage in its capital structure
C) to maintain relatively high provision for doubtful accounts
D) to have a high level of bankable assets
26) An attractive candidate for acquisition through a leveraged buyout should ________.
A) possess a relatively high leverage
B) have a solid profit history
C) have a high level of provision for doubtful accounts
D) have a low level of investment in fixed assets
27) A leveraged buyout needs to be carried out through ________.
A) a hostile takeover
B) a friendly merger
C) a vertical merger or a hostile takeover
D) a conglomerate merger
28) The motive for divestiture includes ________.
A) employee stock option
B) additional debt by the parent company
C) cash generation for expansion
D) additional stock to the parent company
29) The selling of some of a firm’s assets is called ________.
A) leverage buyout
B) consolidation
C) reverse merger
D) divestiture
30) A divestiture that results in an operating unit becoming an independent company is a ________.
A) sale of a line of business
B) strategic merger
C) spin-off of an operating unit
D) leveraged buyout
31) A spin-off means ________.
A) a subsidiary being sold to existing management resulting in a new company
B) a subsidiary merging completely with its holding company
C) a subsidiary becoming an independent company
D) a subsidiary being taken over by the federal government due to its incapabilities to survive on its own
32) The result of spin-off to the parent company is ________.
A) additional stock to the parent through stock dividend
B) additional cash from the sale
C) additional debt by the parent through issue of bonds
D) no additional cash to the subsidiary
33) One of the main goals of divestiture is ________.
A) expanding operations
B) economies of scale
C) employee stock option
D) raising funds
34) 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 is called ________.
A) leveraged buyout
B) employee stock option
C) spin-off
D) strategic takeover
18.3 Analyzing and negotiating mergers
1) The basic difficulty in applying the capital budgeting approach to an acquisition of a going concern is
the estimation of initial cash flows and certain risk consideration.
2) A stock swap transaction is an acquisition method in which an acquiring firm exchanges its shares for
shares of the target company according to a predetermined ratio.
3) The ratio of exchange in market price indicates the market price per share of an acquiring firm paid for
each dollar of market price per share of the target firm.
4) The actual ratio of exchange in a stock-exchange acquisition is the ratio of the amount paid per share of
the target company to the per-share market price of the acquiring firm.
5) The earnings per share of a merged firm are generally above the premerger earnings per share of one
firm and below the premerger earnings per share of the other, after making the necessary adjustment for
the ratio of exchange.
6) If the P/E paid is greater than the P/E of the acquiring company, on a postmerger basis the target firm’s
EPS increases and the acquiring firm’s EPS decreases.
7) A method of acquisition in which the acquiring firm exchanges its shares of stock for shares of the
target company according to a predetermined ratio is called a stock swap transaction.
8) A method of acquisition in which the acquiring firm exchanges its debt for shares of the target
company according to a predetermined ratio is called a leveraged buyout.
9) Acquisitions are especially attractive when a target firm’s stock price is high, because fewer shares
must be exchanged to acquire the firm.
10) Acquisitions are especially attractive when an acquiring firm’s stock price is high, because fewer
shares must be exchanged to acquire the firm.
11) Cash acquisitions of going concerns are best analyzed using ________.
A) an investment opportunity schedule
B) ratio analysis
C) capital budgeting techniques
D) the weighted marginal cost of capital theory
12) Markepta, Inc. is considering the acquisition of Management Theories, Inc. at a cash price of $1.5
million. Crimson Services, Inc. has short-term liabilities of $500,000. As a result of acquiring Crimson
Services, Inc., Markepta, Inc. would acquire the copyrights of a national best-seller which would provide
an estimated cash flow of $300,000 for the next five years. The firm has a cost of capital of 20 percent. The
approximate net present value of this acquisition is ________.
A) $500,000
B) $480,800
C) -$102,700.55
D) -$1,102,816.36
13) If the net present value of the target company is ________.
A) lesser than zero, the merger is acceptable
B) greater than zero, the merger is acceptable
C) greater than zero, the merger is rejected
D) equal to zero, the merger is acceptable
14) When making a cash acquisition of a going concern, the acquiring corporation should ________.
A) adjust after-tax cash flows generated from new assets
B) recognize different accounting techniques
C) adjust the discount rate for risk differences
D) consider the problems of assimilating the acquired management
15) Maxi, Inc. is evaluating the acquisition of Mini, Inc., which had a loss carryforward of $2.75 million
which resulted from earlier operations. Maxi can purchase Mini for $3.5 million and liquidate the assets
for $1.25 million. Maxi expects earnings before taxes in the three years following the acquisition to be as
follows:
(These earnings are assumed to fall within the limit legally allowed for application of a tax loss
carryforward resulting from the proposed acquisition.) Maxi has a 40 percent tax rate and a cost of capital
of 10 percent. The total present value of tax advantage of the acquisition in the following three years is
________.
A) $440,374
B) $842,374
C) $1.1 million
D) $2.75 million
16) Tangshan Mining is considering the acquisition of Zhengsen Mining at a cash price of $6,000,000. The
primary motivation for Tangshan’s purchase of Zhengsen is for a special piece of drilling equipment that
it believes will generate after-tax cash flows if $2,000,000 per year during the next 5 years. Zhengsen
Mining has liabilities of $9,000,000 and Tangshan estimates that it can sell the remaining assets $6,500,000.
Tangshan will use a 15 percent cost of capital for evaluating the acquisition. Based on this information,
what is the net value of the special drilling equipment?
A) $1,795,690
B) $1,500,000
C) ($1,795,690)
D) ($1,500,789)
17) Tangshan Mining is considering the acquisition of Zhengsen Mining at a cash price of $6,000,000. The
primary motivation for Tangshan’s purchase of Zhengsen is for a special piece of drilling equipment that
it believes will generate after-tax cash flows of $2,000,000 per year during the next 5 years. Zhengsen
Mining has liabilities of $9,000,000 and Tangshan estimates that it can sell the remaining assets $6,500,000.
Tangshan will use a 15 percent cost of capital for evaluating the acquisition. Based on this information,
what is the net value of the special drilling equipment? Calculate the net value of a second alternative
that would allow Tangshan to purchase a better quality asset for $12,000,000 that would provide a
$2,600,000 in after-tax inflows for the next 5 years. Which alternative would you choose?
A) $1,795,700, $3,284,400, both
B) $1,500,000, $4,500,000, both
C) ($1,795,700), ($3,284,400), neither
D) ($1,795,700), ($4,500,000), neither
18) Hayley Medical, Inc. is evaluating the acquisition of Health-o-Matic, Inc., which had a loss
carryforward of $3.75 million, resulting from earlier operations. Hayley Medical can purchase Health-o-
Matic for $4.5 million and liquidate the assets for $3.25 million. Hayley Medical expects earnings before
taxes in the three years following the acquisition to be as follows:
(These earnings are assumed to fall within the annual limit legally allowed for application of a tax loss
carryforward resulting from the proposed acquisition.) Hayley Medical has a 40 percent tax rate and a
cost of capital of 15 percent. The approximate maximum cash price Hayley Medical would be willing to
pay for Health-o-Matic is ________.
A) $4,757,000
B) $4,253,000
C) $4,409,600
D) $3,750,000
19) The acquiring firm pays a price that is a premium above the market price of the acquired firm. This
means that the ratio of exchange in market price is ________.
A) less than 1
B) greater than 1
C) 0, because the ratio of exchange results in no increase or decrease of shares
D) equal to 1
20) The actual ratio of exchange in a stock-exchange acquisition is the ratio of the ________.
A) amount paid per share of the target company to the per share book value of the acquiring firm
B) book value per share of the target company to the per share market price of the acquiring firm
C) market value per share of the target company to the earnings per share of the acquiring firm
D) amount paid per share of the target company to the per share market price of the acquiring firm
21) When the ratio of exchange in a merger is equal to one and both the acquiring and the target
companies have the same premerger earnings per share, the merged firm‘s earnings per share will
initially ________.
A) decline
B) remain constant
C) increase
D) drop to zero
22) When the ratio of exchange in a merger is equal to one and both the acquiring and the target
companies have the same premerger earnings per share, both the acquiring and the target companies
have the same ________.
A) debt ratio
B) book value per share
C) return on equity
D) P/E ratio
23) If the P/E paid is greater than the P/E of the acquiring company, the effect on the earnings per share of
the acquired company will be ________.
A) positive
B) neutral
C) negative
D) unrelated
24) If the P/E paid for a target company is greater than the P/E of the acquiring company, the effect on the
earnings per share of the acquiring company will be ________.
A) positive
B) neutral
C) negative
D) uncorrelated
25) If the P/E paid for a target company is equal to the P/E of the acquiring company, the effect on the
earnings per share of the acquired company will be ________.
A) positive
B) neutral
C) negative
D) uncorrelated
26) If the P/E paid for a target company is less than the P/E of the acquiring company, the effect on the
earnings per share of the acquired company will be ________.
A) positive
B) neutral
C) negative
D) uncorrelated
27) If the P/E paid for a target company is less than the P/E of the acquiring company, the effect on the
earnings per share of the acquiring company will be ________.
A) positive
B) neutral
C) negative
D) uncorrelated
28) The long-run effect on the earnings per share of the merged firm depends largely on ________.
A) the pre-merger P/E ratio
B) the ratio of exchange
C) the synergy of the merged firm
D) the tax considerations
29) Tangshan Mining is attempting to acquire Zhengsen Mining. Selected financial data is presented for
both companies in the table below:
Tangshan Mining has sufficient authorized but unissued shares to carry out the proposed merger. If the
ratio of exchange is 1.8, what will be the EPS of the merged firm?
A) $1.00
B) $1.03
C) $1.08
D) $2.00
30) Jia’s Oven Manufacturing is evaluating the acquisition of Cuisinaire Kitchen Appliance Co. Cuisinaire
has a loss carryforward of $1.5 million which resulted from earlier operations. Jia’s Oven can purchase
Cuisinaire for $1.8 million and liquidate the assets for $1.3 million. Jia’s Oven expects earnings before
taxes in the five years following the acquisition to be as follows:
(These earnings are assumed to fall within the annual limit legally allowed for application of the tax loss
carryforward resulting from the proposed acquisition.) Jia’s Oven is in the 40 percent tax bracket and has
a cost of capital of 17 percent.
(a) What is the tax advantage of the acquisition each year for Jia’s Oven?
(b) What is the maximum cash price Jia’s Oven would be willing to pay for Cuisinaire?
(c) Do you recommend the acquisition? Why or why not?
31) ZhenYee Electronics, Inc. is considering the acquisition of Datamatic, Inc. at a cash price of $5,000,000.
Datamatic, Inc. has short-term liabilities of $1,500,000. As a result of acquiring Datamatic, Inc., ZhenYee
Electronics would also acquire rights to one major patent which would provide an estimated cash inflow
of $1,800,000 per year for the next eight years. The firm has a cost of capital of 12 percent. Would you
recommend the cash acquisition?
32) Tangshan Mining is attempting to acquire Zhengsen Mining. Selected financial data is presented for
both companies in the table below:
Tangshan Mining has sufficient authorized but unissued shares to carry out the proposed merger.
(a) Calculate the EPS of Tangshan Mining and Zhengsen Mining before the merger.
(b) If the ratio of exchange is 1.8, what will be the earnings per share of the merged company?
(c) Repeat part (a) if the ratio of exchange is 2.0.
(d) Repeat part (a) if the ratio of exchange is 2.2
(e) discuss the principal illustrated by your answers to parts (a) through (d)
33) A two-tier offer is a tender offer in which the terms offered are more attractive to those who tender
shares early.