CHAPTER 29
MERGERS, ACQUISITIONS,
AND DIVESTITURES
Answers to Concepts Review and Critical Thinking Questions
1. In the purchase method, assets are recorded at market value, and goodwill is created to account for
the excess of the purchase price over this recorded value. In the pooling of interests method, the
balance sheets of the two firms are combined; no goodwill is created. The choice of accounting
2. a. False. Although the reasoning seems correct, in general, the new firms do not have monopoly
b. True. When managers act in their own interest, acquisitions are an important control device for
c. False. Even if markets are efficient, the presence of synergy will make the value of the
d. False. In an efficient market, traders will value takeovers based on “fundamental factors”
e. False. The tax effect of an acquisition depends on whether the merger is taxable or non-taxable.
f. True. Because of the coinsurance effect, wealth might be transferred from the stockholders to
3. Diversification doesn’t create value in and of itself because diversification reduces unsystematic, not
systematic, risk. As discussed in the chapter on options, there is a more subtle issue as well.
4. A firm might choose to split up because the newer, smaller firms may be better able to focus on their
particular markets. Thus, reverse synergy is a possibility. An added advantage is that performance
5. It depends on how they are used. If they are used to protect management, then they are not good for
6. One of the primary advantages of a taxable merger is the write-up in the basis of the target firm’s
The basic determinant of tax status is whether or not the old stockholders will continue to participate
in the new company, which is usually determined by whether they get any shares in the bidding firm.
7. Economies of scale occur when average cost declines as output levels increase. A merger in this
8. Among the defensive tactics often employed by management are seeking white knights, threatening
to sell the crown jewels, appealing to regulatory agencies and the courts (if possible), and targeted
share repurchases. Frequently, anti-takeover charter amendments are available as well, such as
poison pills, poison puts, golden parachutes, lockup agreements, and supermajority amendments, but
9. In a cash offer, it almost surely does not make sense. In a stock offer, management may feel that one
10. Various reasons include: (1) Anticipated gains may be smaller than thought; (2) Bidding firms are
typically much larger, so any gains are spread thinly across shares; (3) Management may not be
Solutions to Questions and Problems
NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this
solutions manual, rounding may appear to have occurred. However, the final answer for each problem is
found without rounding during any step in the problem.
Basic
1. For the merger to make economic sense, the acquirer must feel the acquisition will increase value by
at least the amount of the premium over the market value, so:
2. With the purchase method, the assets of the combined firm will be the book value of Firm X, the
acquiring company, plus the market value of Firm Y, the target company, so:
The purchase price of Firm Y is the number of shares outstanding times the sum of the current stock
price per share and the premium per share, so:
And the total assets of the combined company will be:
3. Since the acquisition is funded by long-term debt, the post-merger balance sheet will have long-term
debt equal to the original long-term debt of Jurion’s balance sheet plus the new long-term debt issue,
so:
Goodwill will be created since the acquisition price is greater than the market value. The goodwill
amount is equal to the purchase price minus the market value of assets. Generally, the market value
of current assets is equal to the book value, so:
Current liabilities and equity will remain the same as the pre-merger balance sheet of the acquiring
firm. Current assets will be the sum of the two firms’ pre-merger balance sheet accounts, and the
Jurion Co., post-merger
Current assets $32,200 Current liabilities $ 7,700
4. Since the acquisition is funded by long-term debt, the post-merger balance sheet will have long-term
debt equal to the original long-term debt of Silver’s balance sheet plus the new long-term debt issue,
so:
Goodwill will be created since the acquisition price is greater than the market value. The goodwill
amount is equal to the purchase price minus the market value of assets. Since the market value of
Current liabilities and equity will remain the same as the pre-merger balance sheet of the acquiring
firm. Current assets and other assets will be the sum of the two firms’ pre-merger balance sheet
accounts, and the fixed assets will be the sum of the pre-merger fixed assets of the acquirer and the
Silver Enterprises, post-merger
Current assets $ 10,900 Current liabilities $ 5,200
Other assets 2,550 Long-term debt 16,200
5. a. The cash cost is the amount of cash offered, so the cash cost is $37 million.
To calculate the cost of the stock offer, we first need to calculate the value of the target to the
acquirer. The value of the target firm to the acquiring firm will be the market value of the target
The cost of the stock offer is the percentage of the acquiring firm given up times the sum of the
market value of the acquiring firm and the value of the target firm to the acquiring firm. So, the
equity cost will be:
b. The NPV of each offer is the value of the target firm to the acquiring firm minus the cost of
acquisition, so:
NPV cash = $1,818,182
c. Since the NPV is greater with the stock offer, the acquisition should done with stock.
6. a. The EPS of the combined company will be the sum of the earnings of both companies divided
by the shares in the combined company. Since the stock offer is one share of the acquiring firm
The market price of Stultz will remain unchanged if it is a zero NPV acquisition. Using the PE
ratio, we find the current market price of Stultz stock, which is:
b. The value of Flannery to Stultz must be the market value of the company since the NPV of the
acquisition is zero. Therefore, the value is:
So, the NPV of the acquisition is:
7. The decision hinges upon the risk of surviving. That is, consider the wealth transfer from
bondholders to stockholders when risky projects are undertaken. High-risk projects will reduce the
expected value of the bondholders’ claims on the firm. The telecommunications business is riskier
than the utilities business.
8. a. The NPV of the merger is the market value of the target firm, plus the value of the synergy,
minus the acquisition costs, so:
b. Since the NPV goes directly to stockholders, the share price of the merged firm will be the
market value of the acquiring firm plus the NPV of the acquisition, divided by the number of
shares outstanding, so:
c. The merger premium is the premium per share times the number of shares of the target firm
outstanding, so the merger premium is:
d. The number of new shares will be the number of shares of the target times the exchange ratio,
so:
New shares created = 3,400(1/2)
The price per share of the merged firm will be the value of the merged firm divided by the total
shares of the new firm, which is:
e. The NPV of the acquisition using a share exchange is the market value of the target firm plus
synergy benefits, minus the cost. The cost is the value per share of the merged firm times the
number of shares offered to the target firm shareholders, so:
Intermediate
9. The cash offer is better for the target firm shareholders since they receive $24 per share. In the share
offer, the target firm’s shareholders will receive:
From Problem 8, we know the value of the merged firm’s assets will be $465,800. The number of
shares in the new firm will be:
that is, the number of shares outstanding in the bidding firm, plus the number of shares outstanding
in the target firm, times the exchange ratio. This means the post-merger share price will be:
This equation shows that the new offer is the shares outstanding in the target company times the
Combining the two equations, we find:
There is a simpler solution that requires an economic understanding of the merger terms. If the target
firm’s shareholders are indifferent, the bidding firm’s shareholders are indifferent as well. That is, the
offer is a zero sum game. Using the new stock price produced by the cash deal, we find:
10. The cost of the acquisition is:
a. The EPS of the merged firm will be the combined EPS of the existing firms divided by the new
shares outstanding, so:
b. The PE of the acquiring firm is:
Assuming the PE ratio does not change, the new stock price will be:
c. If the market correctly analyzes the earnings, the stock price will remain unchanged since this is
a zero NPV acquisition, so:
d. The new share price will be the combined market value of the two existing companies divided
by the number of shares outstanding in the merged company. So:
And the PE ratio of the merged company will be:
11. Beginning with the fact that the NPV of a merger is the value of the target minus the cost, we get:
NPV =
VB
¿
– Cost
NPV = V + VB – Cost