34) A white knight is a takeover defense in which a firm issues securities that give their holders certain
rights that become effective when a takeover is attempted and that make the target firm less desirable to a
hostile acquirer.
35) A poison pill is a takeover defense in which a target firm finds an acquirer more to its liking than the
initial hostile acquirer and prompts the two to compete to take over the firm.
36) Greenmail is a takeover defense under which a target firm repurchases a large block of stock at a
premium from one or more shareholders in order to end a hostile takeover attempt by those
shareholders.
37) Popular takeover defense methods include white knights, poison pills, greenmail, golden parachutes,
and shark repellents.
38) The owners of a holding company can control significantly larger amounts of assets than they could
acquire through mergers.
39) Before paying dividends, a subsidiary must pay federal and state taxes on its earnings.
40) A major disadvantage of holding companies is the increased risk resulting from the leverage effect.
41) Pyramiding is an arrangement among holding companies wherein one company controls others,
thereby causing an even greater magnification of earnings and losses.
42) The greater the leverage, the smaller the risk involved.
43) The U.S. approaches used in hostile takeovers is an effective method of changing corporate control
and used in many areas of the world including China and Japan.
44) The U.S. approaches used in hostile takeovers is practically nonexistent in most other countries
throughout the world including continental Europe and Asia.
45) A formal proposal to purchase a given number of shares of a firm’s stock at a specified price is a
________.
A) golden parachute
B) call option
C) put option
D) tender offer
46) Most firms seeking merger partners will hire the services of a(n) ________.
A) commercial banker
B) investment broker
C) private contractor
D) investment banker
47) In defending against a hostile takeover, the strategy that involves the target firm finding a more
suitable acquirer and prompting it to compete with the initial hostile acquirer to take over the firm is
called the ________ strategy.
A) poison pill
B) white knight
C) golden parachute
D) greenmail
48) In defending against a hostile takeover, the strategy that involves the target firm creating securities
that give their holders certain rights that become effective when a takeover is attempted is called the
________ strategy.
A) shark repellent
B) greenmail
C) poison pill
D) golden parachute
49) In defending against a hostile takeover, the strategy that involves the firm repurchasing through
negotiation a large block of stock at a premium from one or more shareholders in order to end those
shareholders’ hostile takeover attempt is known as the ________ strategy.
A) poison pill
B) greenmail
C) golden parachute
D) shark repellent
50) In defending against a hostile takeover, the strategy involving the payment of a large, debt–financed,
cash dividend is the ________ strategy.
A) shark repellent
B) golden parachute
C) leveraged recapitalization
D) dividend restructuring
51) In defending against hostile takeover attempts, a company will include provisions in the employment
contracts of key executives that provide them with sizable compensation if the firm is taken over. This is
called the ________ strategy.
A) shark repellent
B) silver parachute
C) greenmail
D) golden parachute
52) In defending against hostile takeover attempts, a company will approve anti–takeover amendments to
the corporate charter that constrain the firm’s ability to transfer managerial control of the firm as a result
of a merger. This is called the ________ strategy.
A) golden parachute
B) greenmail
C) poison pill
D) shark repellent
53) The “stakeholders” in targeted takeover companies include the ________.
A) federal reserve bank
B) media
C) employees
D) state government
54) The primary advantage of a holding company, that permits the firm to control a large amount of
assets with a relatively small dollar investment is known as ________.
A) the leverage effect
B) tax effects
C) administrative effect
D) risk protection
55) Disadvantages of holding companies include ________.
A) high dollar investment
B) acquisition of significantly lesser amount of assets
C) legal responsibility for subsidiaries
D) double taxation
56) Which of the following is true of a tender offer?
A) It is another form of put option.
B) The management of the target company has the exclusive right to accept the offer.
C) The target firm may take defensive tactics to ward off the offer.
D) It facilitates negotiations for an acquisition.
57) A key consideration in the holding company decision is ________.
A) the risk-return tradeoff due to the leverage effect
B) the greater “distance” between top level and operating management
C) the risk of the domino effect if one company in the holding company fails
D) the risk from the separate “companies” in the holding company being classed as one company
58) The advantages of holding companies include ________.
A) reduced federal corporate taxes due to the holding company status
B) decreased risk resulting from the leverage effect
C) possible state tax benefits realized by each subsidiary in its state of incorporation
D) low cost of administration
59) Which of the following represents an advantage for holding companies?
A) They are easy to analyze for investment purposes.
B) They are facilitated with reduced federal corporate taxes due to the holding company status.
C) They are exempted from double taxation.
D) They permit a firm to control a large amount of assets with relatively small dollar investment.
60) Which of the following represents a disadvantage for holding companies?
A) relatively high dollar investment associated with it
B) increased risk resulting from the leverage effect
C) control of lesser amounts of assets than they could acquire through mergers
D) failure of one of the companies results in the failure of the entire holding company
18.4 Business failure fundamentals
1) Technical insolvency occurs when a firm’s liabilities exceed the book value of its assets.
2) Bankruptcy is business failure that occurs when a firm’s liabilities exceed the fair market value of its
assets.
3) The various causes of business failure are mismanagement, poor economic conditions, and corporate
maturity.
4) Which of the following increases the chances of business failures?
A) current ratio of 2:1
B) decreasing days’ sales outstanding
C) solvency ratio of greater than 20%
D) corporate maturity
5) The various causes that increase the chances of business failures are current ratio of 1.33, solvency ratio
of greater than 20%, and rapid decrease in days’ sales outstanding.
6) Which of the following increases the chances of business failures?
A) increasing provision for doubtful accounts
B) current ratio of 2:1
C) liabilities that exceed market value of assets
D) book value of assets that exceed liabilities
7) In a voluntary settlement, composition is an arrangement in which the creditor committee replaces the
firm’s operating management and operates the firm until all claims have been settled.
8) ________ is an arrangement initiated by a debtor firm to negotiate with the creditors about a plan for
sustaining or liquidating the firm.
A) Golden parachute
B) Greenmail
C) A filing of Chapter Seven of the Bankruptcy Reform Act of 1978
D) A voluntary settlement
9) A(n) ________ is an arrangement whereby an insolvent firm’s creditors receive full payment, although
not immediately.
A) composition
B) creditor control agreement
C) extension
D) liquidation
10) A(n) ________ is a pro rata cash settlement of creditor claims.
A) composition
B) creditor control agreement
C) extension
D) liquidation
11) A(n) ________ replaces the existing operating management of an insolvent firm with a selected
creditor committee.
A) composition
B) creditor control
C) extension
D) liquidation
12) In a voluntary settlement, each creditor will be paid 20 cents on a dollar in 120 days. The remaining 80
cents on a dollar will be paid within an additional 60 days. This is an example of ________.
A) a composition
B) a combination of a composition and extension
C) an extension
D) a liquidation
13) In a voluntary settlement, each creditor will be paid only 45 cents on a dollar immediately. This is an
example of ________.
A) a composition
B) a combination of a composition and extension
C) an extension
D) a liquidation
14) In a voluntary settlement, one group of creditors having claims of $1,000,000 will be immediately paid
95 cents on a dollar. The remainder of the creditors will postpone payment an additional 60 days. This is
an example of ________.
A) a composition
B) a combination of a composition and extension
C) an extension
D) a liquidation
15) In ________, an assignment may be made by the creditors of an insolvent firm to a third party who
then has the power to liquidate the firm’s assets.
A) a voluntary private liquidation
B) a greenmail
C) an involuntary liquidation under Chapter Seven of the Bankruptcy Reform Act of 1978
D) a voluntary liquidation under Chapter Seven of the Bankruptcy Reform Act of 1978
16) Julie’s Tanning Systems has an estimated liquidation value (after all prior claims have been satisfied)
of $3,000,000, $1,500,000 from fixed assets, and $1,500,000 from current assets. The firm’s value as a going
concern is $4,000,000. The firm’s current capital structure is as follows:
*Secured by fixed assets.
Prepare a table indicating the amount, if any, to be distributed to each claimant, in the event of
liquidation.
18.5 Reorganization and liquidation in bankruptcy
1) Chapter 7 of the Bankruptcy Reform Act of 1978 outlines the procedures for reorganizing a failed (or
failing) firm, whether its petition is filed voluntarily or involuntarily.
2) Under recapitalization, debts are generally exchanged for equity or the maturities of existing debts are
extended.
3) One of the responsibilities of a debtor in possession (DIP) is the liquidation of a bankrupt firm’s assets.
4) A debtor in possession in a Chapter 11 bankruptcy proceeding is responsible for valuing the bankrupt
firm both in terms of its liquidation value and as a going concern.
5) A creditor in possession in a Chapter 12 bankruptcy proceeding is responsible for valuing a firm both
in terms of its liquidation value and as a going concern.
6) In a Chapter 7 liquidation bankruptcy proceeding, the order of priority of satisfying claims is secured
creditors, unsecured creditors, and then equity holders.
7) A reorganization plan ________.
A) seeks to build a high debt-equity ratio
B) generally exchanges equity for debt
C) must increase the fixed charges for a firm
D) must maintain the priorities of the contractual claims of all parties
8) An involuntary petition for reorganization may be filed against a firm if ________.
A) the firm has past-due debts of $5,000 or more
B) the firm’s solvency ratio is greater than 20%
C) the firm’s current ratio is 2:1
D) the book value of the firm’s assets is less than the stated liabilities
9) The responsibilities of a debtor in possession include ________.
A) repurchase of equity from open market
B) change in operational activities
C) change in management
D) recommending a recapitalization plan
10) An important aspect of a firm’s reorganization plan is the recapitalization of the firm’s capital
structure. The goal of restructuring a firm’s debt includes ________.
A) decreasing the times interest earned ratio
B) paying off existing debts
C) exchanging equity for debts
D) reducing the fixed-payment obligations
11) The priority of claims established by Chapter 7 of the Bankruptcy Reform Act of 1978 gives priority to
________.
A) unpaid employee benefit plan contributions over unsecured customer deposits
B) common stockholders over taxes
C) taxes over expenses of administering the bankruptcy
D) preferred stockholders over claims of secured creditors
12) The priority of claims established by Chapter 7 of the Bankruptcy Reform Act of 1978 gives priority to
claims of ________.
A) unsecured creditors over claims of secured creditors
B) preferred stockholders over claims of unsecured creditors
C) wages payable over claims of unsecured creditors
D) farmers in grain storage over expenses of administering the bankruptcy
13) Aiyah, Inc. recently has had financial difficulty and is being liquidated by the Federal Bankruptcy
Court. The firm has a liquidation value of $1,000,000—$400,000 from the fixed assets that served as
collateral for the mortgage bonds and $600,000 from all other assets (all prior claims have been satisfied).
The firm’s current capital structure is as follows:
The common stockholders will receive ________ in the liquidation.
A) $500,000
B) $333,333
C) $198,000
D) $0
14) A firm’s current structure is as follows:
Secured by fixed assets.
Suggest a recapitalized capital structure that would reduce the debt/equity ratio (several solutions are
feasible). Calculate the d/e ratio for the pre-reorganization capital structure and the post-reorganization
capital structure.