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Chapter 21: Mergers True/False Page 679
(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Please see the preface for information on the AACSB letter indicators (F, M, etc.) on the subject
lines.
Multiple Choice: True/False
1
. In a merger with true synergies, the post-merger value exceeds the sum
of the separate companies' pre-merger values.
a. True
b. False
2
. Synergistic benefits can arise from a number of different sources,
including operating economies of scale, financial economies, and
increased managerial efficiency.
a. True
b. False
3
. Most defensive mergers occur as a result of managers' actions to
maximize shareholders' wealth.
a. True
b. False
4
. A conglomerate merger occurs when two firms with either a horizontal or
a vertical business relationship combine.
a. True
b. False
5
. Merger activity is likely to heat up when interest rates are high
because target firms can expect to receive an especially high premium
over the pre-announcement stock price.
a. True
b. False
CHAPTER 21
MERGERS AND ACQUISITIONS
Page 680 True/False Chapter 21: Mergers
6
. A company seeking to fight off a hostile takeover might employ the
services of an investment banking firm to develop a defensive strategy.
a. True
b. False
7
. Post-merger control and the negotiated price paid by the acquirer are
two of the most important issues in the terms to merger agreements.
a. True
b. False
8
. Since the primary rationale for any operating merger is synergy, in
planning such mergers the development of accurate pro forma cash flows
is the single most important task.
a. True
b. False
9
. Borrowing funds on terms that would require immediate repayment of all
loans if the firm is acquired, selling off at bargain prices the assets
that originally made the firm a desirable target, and granting huge
“golden parachutes” that open if the firm is acquired are 3 procedures
used to defend against hostile takeovers. These strategies are known
as “poison pills.”
a. True
b. False
10
. A joint venture is one in which two, or sometimes more, independent
companies agree to combine resources in order to achieve a specific
objective, usually limited in scope.
a. True
b. False
11
. Leveraged buyouts (LBOs) occur when a firm's managers, generally backed
by private equity groups, try to gain control of a publicly owned
company by buying shares in the company using large amounts of borrowed
money.
a. True
b. False
12
. A spin-off is a type of divestiture in which the assets of a division
are sold to another firm.
Chapter 21: Mergers True/False Page 681
a. True
b. False
Page 682 True/False Chapter 21: Mergers
13
. The purchase of assets at below their replacement cost and tax
considerations are two factors that motivate mergers.
a. True
b. False
14
. The primary reason given by managers for most mergers is the
acquisition of more assets so as to increase sales and market share.
a. True
b. False
15
. Since managers' central goal is to maximize stock price, managers'
personal incentives do not interfere with mergers that would benefit
the target firm's stockholders.
a. True
b. False
16
. If a petrochemical firm that used oil as feedstock merged with an oil
producer that had large oil reserves and a drilling subsidiary, this
would be a vertical merger.
a. True
b. False
17
. A congeneric merger is one where the merging firms operate in related
businesses but do not necessarily produce the same products or have a
producer-supplier relationship.
a. True
b. False
18
. One of the main reasons why foreign firms are interested in buying U.S.
companies is to gain entrance to the U.S. market. A decline in the
value of the dollar relative to most foreign currencies makes this
competitive strategy especially attractive.
a. True
b. False
19
. Since a manager's central goal is to maximize the firm's stock price,
any merger offer that provides stockholders with significant gains over
the current stock price will be approved by the current management
team.
a. True
Chapter 21: Mergers True/False Page 683
b. False
Page 684 True/False Chapter 21: Mergers
20
. Only if a target firm's value is greater to the acquiring firm than its
market value as a separate entity will a merger be financially
justified.
a. True
b. False
21
. Discounted cash flow methods are not appropriate for evaluating mergers
because the cash flows are uncertain and the discount rate can only be
determined after the merger is consummated.
a. True
b. False
22
. In a financial merger, the relevant post-merger cash flows are simply
the sum of the expected cash flows of the two companies, measured as if
they were operated independently.
a. True
b. False
23
. The rate used to discount projected merger cash flows should be the
overall cost of capital of the new consolidated firm because it
incorporates the actual capital structure of the new firm.
a. True
b. False
24
. The distribution of synergistic gains between the stockholders of two
merged firms is almost always based strictly on their respective market
values before the announcement of the merger.
a. True
b. False
25
. The value of the target firm is calculated by discounting residual cash
flows that belong to the acquiring firm's shareholders at the target's
cost of equity reflecting any changes to its capital structure as a
result of the merger.
a. True
b. False
Chapter 21: Mergers Conceptual M/C Page 685
Multiple Choice: Conceptual
26
. The text gives a number of valid, acceptable reasons for companies to
merge. Which of the following is NOT acceptable?
a. Synergistic benefits arising from mergers.
b. Reduction in competition resulting from mergers.
c. Acquisition of assets at below replacement value.
d. Attempts to minimize taxes by acquiring a firm with large
accumulated losses that can be used immediately.
e. Using surplus cash to acquire another firm and prevent unfavorable
tax consequences for shareholders.
27
. Firms use defensive tactics to fight off undesired mergers. These
tactics do NOT include
a. raising antitrust issues.
b. developing poison pills.
c. getting white knights to bid for the firm.
d. repurchasing their own stock.
e. engaging in risk arbitrage.
28
. Which of the following actions does NOT help managers defend against a
hostile takeover?
a. Establishing a poison pill provision.
b. Granting lucrative golden parachutes to senior managers.
c. Establishing a super-majority provision in the company's bylaws to
raise the percentage of the board of directors that must approve an
acquisition from 50% to 75%.
d. Retiring long-term debt early to reduce total debt on the balance
sheet which will increase the firm's financial position.
e. Finding a “white squire” that will buy enough of the target firm's
shares to block the hostile takeover.
29
. Which of the following statements is most CORRECT?
a. A conglomerate merger is one where a firm combines with another firm
in the same industry.
b. Regulations in the United States prohibit acquiring firms from using
common stock to purchase another firm.
c. Defensive mergers are designed to make a company less vulnerable to
a takeover.
d. The equity residual method values a target firm by discounting
residual cash flows at the acquiring firm's overall cost of capital
reflecting the combined firm's post-merger capital structure.
e. A financial merger occurs when the operations of the firms involved
are integrated in the hope of achieving synergistic benefits.
Page 686 Conceptual M/C Chapter 21: Mergers
30
. Which of the following statements is most CORRECT?
a. Tax considerations often play a part in mergers. If one firm has
excess cash, purchasing another firm exposes the purchasing firm to
additional taxes. Thus, firms with excess cash rarely undertake
mergers.
b. The smaller the synergistic benefits of a particular merger, the
greater the scope for striking a bargain in negotiations, and the
higher the probability that the merger will be completed.
c. Since mergers are frequently financed by debt rather than equity, a
lower cost of debt or a greater debt capacity are rarely relevant
considerations when considering a merger.
d. Managers who purchase other firms often assert that the new combined
firm will enjoy benefits from diversification, including more stable
earnings. However, since shareholders are free to diversify their
own holdings, and at what's probably a lower cost, research of U.S.
firms suggests that in most cases, diversification through mergers
does not increase the firm's value.
e. Research of U.S. firms suggests that managers' personal motivations
have had little, if any, impact on firms' decisions to merge.
31
. Which of the following statements is most CORRECT?
a. The high value of the U.S. dollar relative to Japanese and European
currencies in the 1980s, made U.S. companies comparatively
inexpensive to foreign buyers, spurring many mergers.
b. During the 1980s, the Reagan and Bush administrations tried to
foster greater competition and they were adamant about preventing
the loss of competition; thus, most large mergers were disallowed.
c. The expansion of the junk bond market made debt more freely
available for large acquisitions and LBOs in the 1980s, and thus, it
resulted in an increased level of merger activity.
d. Increased nationalization of business and a desire to scale down and
focus on producing in one's home country has virtually halted cross-
border mergers today.
e. Because strategic alliances and joint ventures are easy to form and
enable firms to compete better in the global economy than would
mergers, merger activity has virtually come to a halt in the 21st
century.
32
. Which of the following statements is most CORRECT?
a. The acquiring firm's required rate of return in most horizontal
mergers will not be affected, because the two firms will have
similar betas.
b. The goal of merger valuation is to value the target firm's total
capital at the target firm's weighted average cost of capital
because a firm is acquired from all of its investors--both
shareholders and creditors.
c. The basic rationale for any financial merger is synergy and, thus,
the estimation of pro forma cash flows is the single most important
part of the analysis.
Chapter 21: Mergers Conceptual M/C Page 687
d. In most mergers, the benefits of synergy and the premium the
acquirer pays over the market price are summed and then divided
equally between the shareholders of the acquiring and target firms.
e. The primary rationale for most operating mergers is synergy.
33
. Which of the following statements is most CORRECT?
a. Leveraged buyouts (LBOs) occur when a firm issues equity and uses
the proceeds to take a firm public.
b. In a typical LBO, bondholders do well but shareholders see their
value decline.
c. Firms are forbidden by law to sell any assets during the first five
years following a leverage buyout.
d. Not all target firms are acquired by publicly traded corporations.
In recent years, an increasing number of firms have been acquired by
private equity firms. Private equity firms raise capital from
wealthy individuals and look for opportunities to make profitable
investments.
e. In an LBO sometimes the acquiring group plans to run the acquired
company for a number of years, boost its sales and profits, and then
take it public again as a stronger company. In other instances, the
LBO firm plans to sell off divisions to other firms that can gain
synergies. In either case, the acquiring group expects to make a
substantial profit from the LBO, but the inherent risks are small
due to the heavy use of venture capital and very little debt.
34
. Which of the following statements is most CORRECT?
a. If a company that produces military equipment merges with a company
that manages a chain of motels, this is an example of a horizontal
merger.
b. A defensive merger is one where the firm's managers decide to merge
with another firm to avoid or lessen the possibility of being
acquired through a hostile takeover.
c. Acquiring firms send a signal that their stock is undervalued if
they choose to use stock to pay for the acquisition.
d. In a liquidation, the firm's existing stockholders are given new
stock representing separate ownership rights in the division that
was divested. The division establishes its own board of directors
and officers, and it becomes a separate company.
e. If there are no synergistic benefits to be gained from a merger, the
acquiring company will stop its plans for the merger. However, if
synergistic gains are large, plans for the merger will continue. In
fact, the greater the synergistic gains, the smaller the gap between
the target's current price and the maximum the acquiring company
could pay because of the acquiring company's upper hand in the
merger.
Page 688 M/C Problems Chapter 21: Mergers
Multiple Choice: Problems
35
. Simpson Inc. is considering a vertical merger with The Lachey Company.
Simpson currently has a required return of 11%, while Lachey's required
return is 15%. The market risk premium is 5% and the risk-free rate is
5%. Assume the market is in equilibrium. If Simpson is going to make
up 67% of the new firm (and Lachey will comprise the remaining 33%),
what will be the beta of the new merged firm? There will be no
additional infusion of debt in the merger.
a. 1.46
b. 1.54
c. 1.61
d. 1.69
e. 1.78
36
. In early 2011 Ham Inc.'s management was considering making an offer to
buy Egg Corporation. Egg's projected operating income (EBIT) for 2011
was $30 million, but Ham believes that if the two firms were merged, it
could consolidate some operations, reduce Egg's expenses, and raise its
EBIT to $40 million. Neither company uses any debt, and they both pay
income taxes at a 40% rate. Ham has a better reputation among
investors, who regard it as better managed and also less risky, so
Ham's stock has a P/E ratio of 15 versus a P/E of 12 for Egg. Since
Ham's management will be running the entire enterprise after a merger,
investors will value the resulting corporation based on Ham's P/E.
Based on expected market values, how much synergy should the merger
create?
a. $129.96
b. $136.80
c. $144.00
d. $151.20
e. $158.76
37
. Gekko Properties is considering purchasing Teldar Properties. Gekko's
analysts project that the merger will result in incremental after-tax
cash flows of $2 million, $4 million, $5 million, and $10 million over
the next four years. The horizon value of the firm's operations, as of
Year 4, is expected to be $107 million. Assume all cash flows occur at
the end of the year. The acquisition would be made immediately, if it
is undertaken. Teldar's post-merger beta is estimated to be 2.0, and
its post-merger tax rate would be 35%. The risk-free rate is 6%, and
the market risk premium is 5.5%. What is the value of Teldar to Gekko
Properties?
a. $66,680,846
b. $70,190,364
c. $73,699,883
d. $77,384,877
e. $81,254,121
Chapter 21: Mergers M/C Problems Page 689
38
. In early 2011 Giant Inc.'s management was considering making an offer
to buy Micro Corporation. Micro's projected operating income (EBIT)
for 2011 was $30 million, but Giant believes that if the two firms were
merged, it could consolidate some operations, reduce Micro's expenses,
and raise its EBIT to $35 million. Neither company uses any debt, and
they both pay income taxes at a 35% rate. Giant has a better
reputation among investors, who regard it as very well managed and not
very risky, so its stock has a P/E ratio of 12 versus a P/E of 9 for
Micro. Since Giant's management would be running the entire enterprise
after a merger, investors would value the resulting corporation based
on Giant's P/E. If Micro has 10 million shares outstanding, by how
much should the merger increase its share price, assuming all of the
synergy will go to its stockholders?
a. $7.94
b. $8.36
c. $8.80
d. $9.26
e. $9.75
39
. Anacott Steel is acquiring Terafly Incorporated. Terafly is expected
to provide Anacott with operating cash flows of $12, $21, $16, and $9
million over the next four years, respectively. In addition, the
horizon value of all remaining cash flows at the end of Year 4 is
estimated at $18 million. The merger will cost Anacott $45.0 million
today. If the value of the merger is estimated at $9.00 per share and
Anacott has 1,000,000 shares outstanding, what equity discount rate
must the firm be using to value this acquisition?
a. 11.63%
b. 12.25%
c. 12.89%
d. 13.57%
e. 14.25%
Page 690 Answers Chapter 21: Mergers
CHAPTER 21
ANSWERS AND SOLUTIONS
