CHAPTER 26—MERGERS AND CORPORATE CONTROL
TYPE: Multiple Choice: Conceptual
34. 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.
Difficulty: Easy
INTE.GENE.16.167 – LO: 26-4
United States – BUSPROG: Analytic
United States – AK – DISC: Mergers and acquisitions a – DISC: Mergers and acquisitions
United States – OH – Default City – TBA
Hostile mergers
TYPE: Multiple Choice: Conceptual
35. 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.
Difficulty: Easy
INTE.GENE.16.170 – LO: 26–14
United States – BUSPROG: Analytic
United States – AK – DISC: Mergers and acquisitions a – DISC: Mergers and acquisitions
United States – OH – Default City – TBA
Miscellaneous merger concepts
TYPE: Multiple Choice: Conceptual
36. 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
CHAPTER 26—MERGERS AND CORPORATE CONTROL
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.
Difficulty: Moderate
INTE.GENE.16.164 – LO: 26-1
United States – BUSPROG: Analytic
United States – AK – DISC: Mergers and acquisitions a – DISC: Mergers and acquisitions
United States – OH – Default City – TBA
Merger motivation
TYPE: Multiple Choice: Conceptual
37. 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.
Difficulty: Moderate
INTE.GENE.16.173 – LO: 26-8
United States – BUSPROG: Analytic
United States – AK – DISC: Mergers and acquisitions a – DISC: Mergers and acquisitions
United States – OH – Default City – TBA
Merger analysis
TYPE: Multiple Choice: Conceptual
38. Which of the following statements about valuing a firm using the APV 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.
Difficulty: Moderate
INTE.GENE.16.173 – LO: 26-8
United States – BUSPROG: Analytic
United States – AK – DISC: Mergers and acquisitions a – DISC: Mergers and acquisitions
analysis
United States – OH – Default City – TBA
Merger analysis
TYPE: Multiple Choice: Conceptual
39. Which of the following statements about valuing a firm using the APV 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 APV 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.
Difficulty: Moderate
INTE.GENE.16.173 – LO: 26-8
United States – BUSPROG: Analytic
United States – AK – DISC: Mergers and acquisitions a – DISC: Mergers and acquisitions
United States – OH – Default City – TBA
Merger analysis
TYPE: Multiple Choice: Conceptual
40. 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.
CHAPTER 26—MERGERS AND CORPORATE CONTROL
Difficulty: Moderate
INTE.GENE.16.167 – LO: 26-4
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
Miscellaneous merger concepts
TYPE: Multiple Choice: Conceptual
41. 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
Difficulty: Easy
INTE.GENE.16.165 – LO: 26-2
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
Intercompany dividends
TYPE: Multiple Choice: Problem
42. A regional restaurant chain, Club Café, is considering purchasing a smaller chain, Sally’s Sandwiches, which is
currently financed using 20% debt at a cost of 8%. Club Café’s analysts project that the merger will result in incremental
free cash flows and interest tax savings of $2 million in Year 1, $4 million in Year 2, $5 million in Year 3, and $117
CHAPTER 26—MERGERS AND CORPORATE CONTROL
million in Year 4. (The Year 4 cash flow includes a horizon value of $107 million.) The acquisition would be made
immediately, if it is to be undertaken. Sally’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%. What is the appropriate rate for use in discounting the free cash flows
and the interest tax savings?
a.
12.0%
b.
13.9%
c.
14.4%
d.
16.0%
e.
16.9%
c
43. 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
CHAPTER 26—MERGERS AND CORPORATE CONTROL
44. 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%
e
Difficulty: Moderate
INTE.GENE.16.173 – LO: 26-8
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
TYPE: Multiple Choice: Problem
45. 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%. 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
CHAPTER 26—MERGERS AND CORPORATE CONTROL
46. 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
Difficulty: Moderate
INTE.GENE.16.175 – LO: 26–10
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
Value of an acquisition
TYPE: Multiple Choice: Problem
CHAPTER 26—MERGERS AND CORPORATE CONTROL
Exhibit 26.1
Best Window & Door Corporation is considering the acquisition of Glassmakers Inc. Glassmakers has a capital structure
consisting of $5 million (market value) of 11% bonds and $10 million (market value) of common stock. Glassmakers’ pre-
merger beta is 1.36. Best’s beta is 1.02, and both it and Glassmakers face a 40% tax rate. Best’s capital structure is 40%
debt and 60% equity. The free cash flows from Glassmakers are estimated to be $3.0 million for each of the next 4 years
and a horizon value of $10.0 million in Year 4. Tax savings are estimated to be $1 million for each of the next 4 years and
a horizon value of $5 million in Year 4. New debt would be issued to finance the acquisition and retire the old debt, and
this new debt would have an interest rate of 8%. Currently, the risk-free rate is 6.0% and the market risk premium is 4.0%.
47. Refer to Exhibit 26.1. What is Glassmakers’ pre-merger WACC?
a.
9.02%
b.
9.50%
c.
9.83%
d.
10.01%
e.
11.29%
c
Difficulty: Moderate
INTE.GENE.16.173 – LO: 26-8
United States – BUSPROG: Analytic
United States – OH – Default City – TBA
Difficulty: Challenging
INTE.GENE.16.173 – LO: 26-8
United States – BUSPROG: Analytic
United States – AK – DISC: Mergers and acquisitions a – DISC: Mergers and acquisitions
United States – OH – Default City – TBA
Merger NPV
TYPE: Multiple Choice: Problem
CHAPTER 26—MERGERS AND CORPORATE CONTROL
48. Refer to Exhibit 26.1. What discount rate should you use to discount Glassmakers’ free cash flows and interest tax
savings?
a.
10.01%
b.
10.06%
c.
11.29%
d.
11.44%
e.
13.49%
c
49. Refer to Exhibit 26.1. What is the value of Glassmakers’ equity to Best? (Round your answer to the closest thousand
dollars.)
a.
$16,019,000
b.
$17,111,000
c.
$18,916,000
d.
$22,111,000
e.
$22,916,000
CHAPTER 26—MERGERS AND CORPORATE CONTROL