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CHAPTER 26
MERGERS AND ACQUISITIONS
Answers to Concepts Review and Critical Thinking Questions
1. Since both companies are in the liquor industry, this is a horizontal acquisition. A major factor that
may have led Beam to be relatively more attractive to Suntory is that it is based in the U.S. This
means that Suntory would have instant access to Beam’s U.S. based distribution channels.
2. a. Greenmail refers to the practice of paying unwanted suitors who hold an equity stake in the
firm a premium over the market value of their shares to eliminate the potential takeover threat.
b. A white knight refers to an outside bidder that a target firm brings in to acquire it, rescuing the
firm from a takeover by some other unwanted hostile bidder.
subsequent conversion into a privately held company, financed primarily with debt.
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
stock prices) are no longer commingled.
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
assets, while one of the primary disadvantages is the capital gains tax that is payable. The situation is
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7. Economies of scale occur when average cost declines as output levels increase. A merger in this
particular case might make sense because Eastern and Western may need less total capital investment
to handle the peak power needs, thereby reducing average generation costs.
8. Among the defensive tactics often employed by management are seeking white knights, threatening
9. In a cash offer, it almost surely does not make sense to favor the lower offer. In a stock offer,
10. Various reasons include: (a) Anticipated gains may be smaller than thought; (b) Bidding firms are
typically much larger, so any gains are spread thinly across shares; (c) 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:
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The purchase price of Firm Y is the number of shares outstanding times the sum of the current stock
price per share plus the premium per share, so:
The goodwill created will be:
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 Meat’s balance sheet, plus the original long-term debt on
Loaf’s balance sheet, plus the new long-term debt issue, so:
Goodwill will be created since the acquisition price is greater than the book value. The goodwill
Equity will remain the same as the pre-merger balance sheet of the acquiring firm. Current assets and
debt accounts will be the sum of the two firms’ pre-merger balance sheet accounts, and the fixed
assets will be the sum of the book value of the pre-merger fixed assets of the acquirer and the market
value of fixed assets of the target firm. The post-merger balance sheet will be:
Meat Co., Post-Merger
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:
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Equity will remain the same as the pre-merger balance sheet of the acquiring firm. Current assets,
Silver Enterprises, Post-Merger
Current assets $7,300 Current liabilities $ 4,690
5. a. The cash cost is the amount of cash offered, so the cash cost is $51.5 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:
c. Since the NPV is greater with the stock offer, the acquisition should be in stock.
6. 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:
Since the synergy is a perpetuity, we can find the minimum annual synergy using the perpetuity
equation, or:
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7. 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
for three shares of the target firm, new shares in the acquiring firm will be one-third of Bread’s
shares outstanding. So, the new EPS will be:
The market price of Butter will remain unchanged if it is a zero NPV acquisition. Using the PE
ratio, we find the current market price of Butter stock, which is:
If the acquisition has a zero NPV, the stock price should remain unchanged. Therefore, the new
PE will be:
b. The value of Bread to Butter must be the market value of the company since the NPV of the
acquisition is zero. Therefore, the value is:
The cost of the acquisition is the number of shares offered times the share price, so the cost is:
So, the NPV of the acquisition is:
Although there is no economic value to the takeover, it is possible that Butter is motivated to
purchase Bread for non-financial reasons.
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:
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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:
The value of the merged firm will be the market value of the acquirer plus the market value of
the target plus the synergy benefits, so:
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 share offer is better for the target firm shareholders since they receive only $19 per share in the
cash offer. In the share offer, the target firm’s shareholders will receive:
shares in the new firm will be:
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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:
To make the target firm’s shareholders indifferent, they must receive the same wealth, so:
This equation shows that the new offer is the shares outstanding in the target company times the
exchange ratio times the new stock price. The value under the cash offer is the shares outstanding
times the cash offer price. Solving this equation for P, 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:
Since the stock price of the acquiring firm is $43, the firm will have to give up:
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:
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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:
At the proposed bid price, this is a negative NPV acquisition for A since the share price
declines. The firm should revise its bid downward until the NPV is zero.
11. Beginning with the fact that the NPV of a merger is the value of the target minus the cost, we get:
12. a. The synergy will be the present value of the incremental cash flows of the proposed purchase.
Since the cash flows are perpetual, the synergy value is:
b. The value of Flash-in-the-Pan to Fly-by-Night is the synergy plus the current market value of
Flash-in-the-Pan, which is:
c. The cost of the cash option is the amount of cash paid, or $12 million. The cost of the stock
acquisition is the percentage of ownership in the merged company, times the value of the
merged company, so:
d. The NPV is the value of the acquisition minus the cost, so the NPV of each alternative is:
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e. The acquirer should make the cash offer since the NPV of the cash offer is greater than the
NPV of the stock offer.
13. a. The number of shares after the acquisition will be the current number of shares outstanding for
the acquiring firm, plus the number of new shares created for the acquisition, which is:
And the share price will be the value of the combined company divided by the shares
outstanding, which will be:
b. Let equal the fraction of ownership for the target shareholders in the new firm. We can set the
percentage of ownership in the new firm equal to the value of the cash offer, so:
So, the shareholders of the target firm would be equally as well off if they received 24.34
percent of the stock in the new company as if they received the cash offer. The ownership
percentage of the target firm shareholders in the new firm can be expressed as:
To find the exchange ratio, we divide the new shares issued to the shareholders of the target
firm by the existing number of shares in the target firm, so:
Challenge
14. a. To find the value of the target to the acquirer, we need to find the share price with the new
growth rate. We begin by finding the required return for shareholders of the target firm. The
earnings per share of the target are:
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The price per share is:
And the dividends per share are:
The current required return for the target company’s shareholders, which incorporates the risk
of the company, is:
The price per share of the target company with the new growth rate is:
The value of the target firm to the acquiring firm is the number of shares outstanding times the
price per share under the new growth rate assumptions, so:
b. The gain to the acquiring firm will be the value of the target firm to the acquiring firm minus
the market value of the target, so:
c. The NPV of the acquisition is the value of the target firm to the acquiring firm minus the cost of
the acquisition, so:
d. The most the acquiring firm should be willing to pay per share is the offer price per share plus
the NPV per share, so:
Notice, this is the same value we calculated earlier in part a as the value of the target to the
acquirer.
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e. The market value of the acquiring firm is the earnings per share times the price-
earnings ratio times the number of shares outstanding, so:
The price of the stock in the merged firm would be the market value of the acquiring firm plus
the value of the target to the acquirer, divided by the number of shares in the merged firm, so:
The NPV of the stock offer is the value of the target to the acquirer minus the value offered to
the target shareholders. The value offered to the target shareholders is the stock price of the
merged firm times the number of shares offered, so:
g. Using the new growth rate in the dividend growth model, along with the dividend and required
return we calculated earlier, the price of the target under these assumptions is:
And the value of the target firm to the acquiring firm is:
The gain to the acquiring firm will be:
The NPV of the cash offer is now:
And the new price per share of the merged firm with the stock offer will be:
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And the NPV of the stock offer under the new assumption will be:
With the lower projected growth rate, only the cash offer has a positive NPV, although it is
significantly lower. BQ should still purchase iReport with the cash offer.
CHAPTER 26 - 13
