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Ch 22 Mergers and Corporate Control
26. If the capital structure is stable, and free cash flows are expected to be growing at a constant rate at the horizon date,
then the horizon value is calculated by discounting the free cash flows plus the expected future tax shields at the weighted
average cost of capital.
a.
True
b.
False
27. The present value of the free cash flows discounted at the unlevered cost of equity is the value of the firm's operations
if it had no debt.
a.
True
b.
False
Ch 22 Mergers and Corporate Control
28. Which of the following statements is most CORRECT?
a.
Financial theory says that the choice of how to pay for a merger is really irrelevant because, although it may
affect the firm's capital structure, it will not affect its overall required rate of return.
b.
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.
c.
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.
d.
The primary rationale for most operating mergers is synergy.
e.
The acquiring firm's required rate of return in most horizontal mergers will not be affected, because the 2 firms
will have similar betas.
29. Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV)
approach is most CORRECT?
a.
The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings
at the cost of debt.
b.
The horizon value is calculated by discounting the expected earnings at the WACC.
c.
The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings
at the WACC.
d.
The horizon value must always be more than 20 years in the future.
e.
The horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings
at the levered cost of equity.
Ch 22 Mergers and Corporate Control
30. Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV)
approach is most CORRECT?
a.
The value of equity is calculated by discounting the horizon value, the tax shields, and the free cash flows at
the cost of equity.
b.
The value of operations is calculated by discounting the horizon value, the tax shields, and the free cash flows
before the horizon date at the unlevered cost of equity.
c.
The value of equity is calculated by discounting the horizon value and the free cash flows at the cost of equity.
d.
The CAPV approach stands for the accounting pre-valuation approach.
e.
The value of operations is calculated by discounting the horizon value, the tax shields, and the free cash flows
at the cost of equity.
Ch 22 Mergers and Corporate Control
31. Holland Auto Parts is considering a merger with Workman Car Parts. Workman's market-determined beta is 0.9, and
the firm currently is financed with 20% debt, at an interest rate of 8%, and its tax rate is 25%. If Holland acquires
Workman, it will increase the debt to 60%, at an interest rate of 9%, and the tax rate will increase to 35%. The risk-free
rate is 6% and the market risk premium is 4%. What will Workman's required rate of return on equity be after it is
acquired?
a.
7.4%
b.
8.9%
c.
9.3%
d.
9.6%
e.
9.7%
32. Juicers Inc. is thinking of acquiring Fast Fruit Company. Juicers expects Fast Fruit's NOPAT to be $9 million the first
year, with no net new investment in operating capital and no interest expense. For the second year, Fast Fruit is expected
to have NOPAT of $25 million and interest expense of $5 million. Also, in the second year only, Fast Fruit will need $10
million of net new investment in operating capital. Fast Fruit's marginal tax rate is 40%. After the second year, the free
Ch 22 Mergers and Corporate Control
cash flows and the tax shields from Fast Fruit to Juicers will both grow at a constant rate of 4%. Juicers has determined
that Fast Fruit's cost of equity is 17.5%, and Fast Fruit currently has no debt outstanding. Assume that all cash flows occur
at the end of the year, Juicers must pay $45 million to acquire Fast Fruit. What it the NPV of the proposed acquisition?
Note that you must first calculate the value to Juicers of Fast Fruit's equity.
a.
$45.0 million
b.
$68.2 million
c.
$86.5 million
d.
$113.2 million
e.
$133.0 million
33. A two-tier merger offer is one where the acquiring company offers to purchase the target company in a two-part
transaction. Cash is paid to some stockholders, bonds are issued to others, but the total values of each part of the
transaction are equal.
a.
True
b.
False
Ch 22 Mergers and Corporate Control
34. 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
35. The owners of Arthouse Inc., a national artist supplies chain, are contemplating purchasing Craftworks Inc, a smaller
chain. Arthouse's analysts project that the merger will result in incremental free flows and interest tax savings with a
combined present value of $72.52 million, and they have determined that the appropriate discount rate for valuing
Ch 22 Mergers and Corporate Control
Craftworks is 16%. Craftworks has 4 million shares outstanding and no debt. Craftworks' current price is $16.25. What is
the maximum price per share that Arthouse should offer?
a.
$16.25
b.
$16.97
c.
$17.42
d.
$18.13
e.
$19.00
36. The rate used to discount projected merger cash flows should be the cost of capital of the new consolidated firm
because it incorporates the actual capital structure of the new firm.
a.
True
b.
False
Ch 22 Mergers and Corporate Control
37. Raymond Supply, a national hardware chain, is considering purchasing a smaller chain, Strauss & Glazer Parts (SGP).
Raymond's analysts project that the merger will result in the following incremental free cash flows, tax shields, and
horizon values:
Year
1
2
3
4
Free cash flow
$1
$3
$3
$7
Unlevered horizon value
75
Tax shield
1
1
2
3
Horizon value of tax shield
32
Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The
acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue
enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is
2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. Using the
compressed adjusted present value approach, what is the value of SGP to Raymond?
a.
$53.40 million
b.
$61.96 million
c.
$64.64 million
d.
$76.96 million
e.
$79.64 million
HAS VARIABLES:
False
Ch 22 Mergers and Corporate Control
38. Currently (2012), mergers can be accounted for using either the purchase method or the pooling method.
a.
True
b.
False
39. Any goodwill created in a merger must be amortized over its expected life, usually 40 years, for shareholder reporting
purposes.
a.
True
b.
False
Ch 22 Mergers and Corporate Control
40. Although goodwill created in a merger may not be amortized for shareholder reporting purposes, it may be amortized
for Federal tax purposes.
a.
True
b.
False
41. Borrowing funds on terms that would require immediate repayment of all funds if the firm is acquired, selling off
valuable assets, and granting huge "golden parachutes" that open if the firm is acquired are three procedures used to
defend against hostile takeovers. These strategies are known as "poison pills."
a.
True
Ch 22 Mergers and Corporate Control
b.
False
42. Which of the following statements is most CORRECT?
a.
Regulations in the United States prohibit acquiring firms from using common stock to purchase another firm.
b.
Defensive mergers are designed to make a company less vulnerable to a takeover.
c.
Hostile mergers always create value for the acquiring firm.
d.
In a tender offer, the target firm's management always remain after the merger is completed.
e.
A conglomerate merger is one where a firm combines with another firm in the same industry.
Ch 22 Mergers and Corporate Control
43. 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
44. The two principal advantages of holding companies are (1) the holding company can control a great deal of assets with
limited equity and (2) the dividends received by the parent from the subsidiary are not taxed if the parent holds at least
50% of the subsidiary's stock.
a.
True
b.
False
Ch 22 Mergers and Corporate Control
45. The three main advantages of holding companies are (1) control with fractional ownership, (2) taxation benefits, and
(3) isolation of operating risks.
a.
True
b.
False
