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Chapter 26: Mergers and Corporate Control
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
ANSWER:
True
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
ANSWER:
True
3. A spin-off is a type of divestiture in which the assets of a division are sold to another firm.
a.
True
b.
False
ANSWER:
False
Chapter 26: Mergers and Corporate Control
4. The purchase of assets at below their replacement cost and tax considerations are two factors that motivate mergers.
a.
True
b.
False
ANSWER:
True
5. The primary reason managers give for most mergers is to acquire more assets so as to increase sales and market share.
a.
True
b.
False
ANSWER:
False
Chapter 26: Mergers and Corporate Control
6. Since managers' central goal is to maximize stock price, managerial control issues do not interfere with mergers that
would benefit the target firm's stockholders.
a.
True
b.
False
ANSWER:
False
7. Which of the following are legal and acceptable reasons for the high level of merger activity in the U.S. during the
1980s?
a.
A profitable firm acquires a firm with large accumulated tax losses that may be carried forward.
b.
Attempts to stabilize earnings by diversifying.
c.
Purchase of assets below their replacement costs.
d.
Reduction in competition resulting from mergers.
e.
Synergistic benefits arising from mergers.
ANSWER:
d
Chapter 26: Mergers and Corporate Control
8. Which of the following statements is most CORRECT?
a.
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.
b.
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.
c.
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, diversification benefits is generally not a valid motive for a
publicly held firm.
d.
Operating economies are never a motive for mergers.
e.
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.
ANSWER:
c
9. A conglomerate merger occurs when two firms with either a horizontal or a vertical business relationship combine.
a.
True
b.
False
ANSWER:
False
Chapter 26: Mergers and Corporate Control
10. 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
ANSWER:
True
11. 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
ANSWER:
True
12. 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
ANSWER:
True
Chapter 26: Mergers and Corporate Control
13. A parent holding company sells shares in its subsidiary such that the parent now owns only 65% of the subsidiary and,
thus, the tax returns of the parent and its subsidiary can't be consolidated. The parent receives annual dividends from the
subsidiary of $2,500,000. If the parent's marginal tax rate is 34% and if the exclusion on intercompany dividends is 70%,
what is the effective tax rate on the intercompany dividends, and how much net dividends are received?
a.
10.2%; $2,245,000
b.
10.2%; $2,135,000
c.
23.8%; $1,905,000
d.
10.2%; $1,750,000
e.
34.0%; $1,650,000
ANSWER:
a
Chapter 26: Mergers and Corporate Control
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14. 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
ANSWER:
False
15. Most defensive mergers occur as a result of managers' actions to maximize shareholders' wealth.
a.
True
b.
False
ANSWER:
False
16. Post-merger control and the negotiated price paid by the acquirer are two of the most important issues in agreeing on
the terms of a merger.
a.
True
b.
False
Chapter 26: Mergers and Corporate Control
ANSWER:
True
17. 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
ANSWER:
True
18. 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
b.
False
ANSWER:
False
Chapter 26: Mergers and Corporate Control
19. Firms use defensive tactics to fight off undesired mergers. These tactics do not include
a.
getting a white squire to purchase stock in the firm.
b.
getting white knights to bid for the firm.
c.
repurchasing their own stock.
d.
changing the bylaws to eliminate supermajority voting requirements.
e.
raising antitrust issues.
ANSWER:
d
20. Which of the following statements is most CORRECT?
a.
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.
b.
Acquiring firms send a signal that their stock is undervalued if they choose to use stock to pay for the
acquisition.
c.
Cash payments are used in takeovers but never in mergers.
d.
Managers often are fired in takeovers, but never in mergers.
e.
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.
ANSWER:
a
Chapter 26: Mergers and Corporate Control
21. 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 action.
a.
True
b.
False
ANSWER:
True
22. 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
ANSWER:
True
Chapter 26: Mergers and Corporate Control
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23. 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
ANSWER:
False
24. 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
ANSWER:
True
25. Coca-Cola's acquisition of Columbia Pictures and its announcement that it would operate its new subsidiary separately
Chapter 26: Mergers and Corporate Control
could be described as primarily a financial merger.
a.
True
b.
False
ANSWER:
True
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
ANSWER:
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
ANSWER:
True
Chapter 26: Mergers and Corporate Control
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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.
ANSWER:
d
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.
Chapter 26: Mergers and Corporate Control
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.
ANSWER:
c
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.
ANSWER:
b
Chapter 26: Mergers and Corporate Control
31. 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
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
ANSWER:
c
32. 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
ANSWER:
False
Chapter 26: Mergers and Corporate Control
33. 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
ANSWER:
False
34. 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
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
ANSWER:
d
Chapter 26: Mergers and Corporate Control
35. Currently (2018), mergers can be accounted for using either the purchase method or the pooling method.
a.
True
b.
False
ANSWER:
False
36. Any goodwill created in a merger must be amortized over its expected life, usually 40 years, for shareholder reporting
purposes.
a.
True
b.
False
ANSWER:
False
Chapter 26: Mergers and Corporate Control
37. 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
ANSWER:
True
38. 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
b.
False
ANSWER:
True
Chapter 26: Mergers and Corporate Control
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39. 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.
ANSWER:
b
40. 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
ANSWER:
True
41. 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
Chapter 26: Mergers and Corporate Control
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50% of the subsidiary's stock.
a.
True
b.
False
ANSWER:
False
42. 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
ANSWER:
False
