978-0273713630 Chapter 23 Solution Manual Part 1

234

Mergers and Other Forms of Corporate

Restructuring

In the takeover business, if you want a friend, you buy a

dog.

CARL ICAHN

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ANSWERS TO QUESTIONS

1. Generally, synergy in a merger means that the earnings of the surviving company will be

2. When the P/E multiple of the acquiring firm is greater than the P/E multiple paid for the

acquired company, the shareholders of the acquired company will suffer a dilution in

3. Both methods of analysis should be used. A free-cash-flow analysis emphasizes the long

run with respect to valuation. The future incremental cash flows are discounted to present

4. Mergers are often consummated with stock and there is a marked tendency for more

5. As earnings would no doubt be less than perfectly correlated, a merger would result in less

variability relative to earnings. Therefore, risk could be reduced. If the stocks are both

6. Usually it means growth in earnings per share. Sometimes acquiring companies seek growth

in total earnings or increased growth in sales. More important is the growth in earnings per

7. So many acquisition opportunities look good because the acquirer frequently looks at the

situation with “rose-tinted” glasses. Potential problems in personnel, products, production,

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8. Too often the acquiring company thinks that the merger targets are bargains, but in reality

the situations are priced fairly or overpriced. After all, no one wants to sell out at a bargain

9. Capital expenditures are deducted in a cash-flow analysis because one should be concerned

10. The current purchase treatment method treats the acquired company as an investment. This

The old purchase treatment method (i.e., pre-2001 in the United States) handled the initial

recording of the acquisition in the same way as described above. The two methods differ

11. With a cash acquisition, the selling company’s shareholders must immediately recognize

any capital gain. With a stock acquisition, the acquired company shareholders recognize any

12. There are two schools of thought. The managerial entrenchment hypothesis suggests it will

work to the detriment of stockholders, and that good offers will be thwarted. The

13. This question asks an opinion, so there is no right answer. Many economists believe that the

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14. The two-tier tender offer is designed to get shareholders to tender their shares early in order

15. The sources of possible value creation are many. The most important are sales enhancement

and operating economies, management improvement, frequently through better incentives,

16. With a partial sell-off a business unit is sold to someone else. A spin-off involves the

separation of the business unit from the company as an entirely separate company, owned

17. Liquidation of an entire company makes sense when the individual assets have a higher

18. The motivations for going private are several. The costs of being a publicly held company

19. The leveraged buyout (LBO) is controversial. It is a means for transferring ownership and,

perhaps, getting better incentives for the management. As a result of an LBO, the

20. For the senior lender(s), the incentive to provide financing for the leveraged buyout is a

higher interest rate than on most business loans. Usually this rate is 1.5 to 2.5 percent (or

more) over prime. The incentive for the junior subordinated lender(s) is the warrant(s) to

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SOLUTIONS TO PROBLEMS

1. a. Shares offered of Company A = 1 million

PRE-MERGER

Company A Company B

Present earnings (in millions) $ 20 $ 4

SURVIVING COMPANY A

Shareholders in Company A experience an improvement in earnings per share ($2.18

b. Shares offered of Company A = 2 million

SURVIVING COMPANY A

Total earnings (in millions) $ 24

Company A’s shareholders have the same earnings per share as before.

This represents a substantial (80 percent) premium to pay for Company B. Unless

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c. Shares offered of Company A = 1.5 million

SURVIVING COMPANY A

Company A’s shareholders experience a modest increase in earnings per share.

The merger provides a significant (35 percent) premium in market price to Company B

d. No particular solution recommended.

2. a.

Price per Stevens share $60

SURVIVING (SCHOETTLER) COMPANY

Note: i) old Schoettler EPS = $5M/$1M = $5.00

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b. $75 = X -0.28 (X – $14)

3. a. Exchange ratio = $75/$100 = 0.75 of a share of Schoettler for each share of Stevens

b.

Before After

Schoettler has fared better. This issue is discussed in the answer to Question 2.

c. The original P/E differential could be due to many factors. Typically, good growth

prospects or high quality and moderate growth prospects would cause a high P/E ratio.

e. Such increases in earnings are purely financial and must be accompanied by economies

4. a.

Copper Clapper Surviving Company

Annual earnings $10 million $12 million

b. Because Copper Clapper pays a higher P/E ratio for Brass Bell than its own, ($36/$2.00

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(a) (b) (c) (d) (e) (f)

Years in

Future

Total

Earnings

Copper

Clapper w/o

Merger

(in millions)

Copper

Clapper EPS

Total

Earnings

Brass Bell

w/o Merger

(in millions)

Total

Earnings

Survivor

(b) + (d)

(in millions)

Survivor

EPS

(e)/5.2M

Shares

Now $ 10 $ 2.50 $ 2 $ 12 $ 2.31

1 10.5 2.63 2.2 12.7 2.44

2 11.025 2.76 2.42 13.445 2.59

As seen, earnings per share of the surviving company finally catch up and surpass those

of Copper Clapper without the merger in the 9th year. However, that is a long way out.

Based on this information, the fact that there is no synergy, and the likelihood of the

merger increasing the relative risk of Copper Clapper,∗ the merger opportunity should

probably be declined.

5.

Period

Avg. Annual Cash

Flow (millions)

P.V. Factor

@ 16% P.V.

1– 5 $ 8 3.274 $ 26.192

∗ This would follow if the systematic risk of a stock and growth in earnings are highly

correlated. In turn, we would expect such a relationship in efficient markets.