Chapter 21: Mergers and Acquisitions
Learning Objectives
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Chapter 21
Mergers and Acquisitions
Learning Objectives
After reading this chapter, students should be able to:
◆ Identity the different types of mergers and the various rationales for mergers.
◆ Conduct a simple analysis to evaluate the potential value of a target firm and discuss the various
considerations that influence the bid price.
◆ Explain whether the typical merger creates value for the participating shareholders.
◆ Discuss the value of other transactions such as leveraged buyouts (LBOs), corporate alliances, and
divestitures.
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Lecture Suggestions
Chapter 21: Mergers and Acquisitions
Lecture Suggestions
In this chapter we discuss mergers, LBOs, merger rationales, classifications, merger regulation, and merger
analysis. In addition, we discuss corporate alliances and private equity investments. Finally, we talk about
divestitures and the rationale behind them.
DAYS ON CHAPTER: 2 OF 56 DAYS (50-minute periods)
Chapter 21: Mergers and Acquisitions
Answers and Solutions
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Answers to End-of-Chapter Questions
21-1 Horizontal and vertical mergers are most likely to result in governmental intervention, but mergers
21-2 A tender offer might be used. Although many tender offers are made by surprise and over the
21-3 An operating merger involves integrating the company’s operations in hopes of obtaining
21-4 Disney’s management could (and did) argue that its stock was worth more than $4.22 per share,
21-5 Academicians have long argued that conglomerate mergers that produce no synergy are not
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Answers and Solutions
Chapter 21: Mergers and Acquisitions
Solutions to End-of-Chapter Problems
21-1 D1 = $2.00; g = 5%; b = 0.9; rRF = 5%; RPM = 6%; P0 = ?
21-2 D1 = $2.00; g = 7%; b = 1.1; rRF = 5%; RPM = 6%; P0 = ?
b. The value of Vaccaro is $14.93 million:
Chapter 21: Mergers and Acquisitions
Answers and Solutions
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Value at t4 of CF5 and all subsequent cash flows is:
21-5 0 1 2 3 10
| | | | • • • |
21-6 a. Since the cash flows are equity returns, the appropriate discount rate is that cost of equity
c. Annual cash flows are calculated as follows:
2015
2016
2017
2018
Cost of goods sold (65%)
(390.0)
Gross profit
Selling/Admin. expenses
EBIT
Interest
Taxes (35%)
Net income/Cash flow
$ 74.8
10%
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Comprehensive/Spreadsheet Problem
Chapter 21: Mergers and Acquisitions
Comprehensive/Spreadsheet Problem
Note to Instructors:
The solutions for parts a, b, and c are provided at the back of the text; however, the solution to
part d is not. Instructors can access the
Excel
file on the textbook’s website.
21-7 See parts a, b, and c on the preceding page.
Chapter 21: Mergers and Acquisitions
Integrated Case
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Integrated Case
21-8
Smitty’s Home Repair Company
Merger Analysis
Smitty’s Home Repair Company, a regional hardware chain that specializes in do-
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Integrated Case
Chapter 21: Mergers and Acquisitions
A. Several reasons have been proposed to justify mergers. Among the
more prominent are (1) tax considerations, (2) risk reduction,
(3) control, (4) purchase of assets at below–replacement cost, and
(5) synergy. In general, which of the reasons are economically
justifiable? Which are not? Which fit the situation at hand? Explain.
Answer: [Show S21–1 through S21–3 here.] The economically justifiable
rationales for mergers are synergy and tax consequences. Synergy
Chapter 21: Mergers and Acquisitions
Integrated Case
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Integrated Case
Chapter 21: Mergers and Acquisitions
B. Briefly describe the differences between a hostile merger and a
friendly merger.
Answer: [Show S21–4 here.] In a friendly merger, the management of one
firm (the acquirer) agrees to buy another firm (the target). In most
Chapter 21: Mergers and Acquisitions
Integrated Case
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C. Use the data developed in Table IC 21.1 to construct the H division’s
cash flow statements for 2015 through 2018. Why is interest expense
deducted in merger cash flow statements, whereas it is not normally
deducted in a capital budgeting cash flow analysis? Why are earnings
retentions deducted in the cash flow statement?
Table IC 21.1 Estimates of Hill’s Hardware Data for Merger Analysis
2015 2016 2017 2018
Net sales $60.0 $90.0 $112.5 $127.5
Cost of goods sold (60%) 36.0 54.0 67.5 76.5
Selling/administrative expense 4.5 6.0 7.5 9.0
Interest expense 3.0 4.5 4.5 6.0
Necessary retained earnings 0.0 7.5 6.0 4.5
Answer: [Show S21–5 through S21-7 here.] The easiest approach here is to
create cash flow statements for the H division, assuming that the
acquisition is made (in millions of dollars).
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Integrated Case
Chapter 21: Mergers and Acquisitions
D. Conceptually, what is the appropriate discount rate to apply to the
cash flows developed in Part C? What is your actual estimate of this
discount rate?
Answer: [Show S21–8 and S21–9 here.] As discussed above, the cash flows are
residuals, and they belong to the acquiring firm’s shareholders. Since
Chapter 21: Mergers and Acquisitions
Integrated Case
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E. What is the estimated continuing value of the acquisition; that is,
what is the estimated value of the H division’s cash flows beyond
2018? What is Hill’s value to Smitty’s? Suppose another firm were
evaluating Hill’s as an acquisition candidate. Would it obtain the same
value? Explain.
Answer: [Show S21–10 through S21-12 here.] The 2018 cash flow is $17.1
million, and it is expected to grow at a 6% constant growth rate in
2019 and beyond. With a constant growth rate, the Gordon model
= $221.0 million.
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Chapter 21: Mergers and Acquisitions
F. Assume that Hill’s has 10 million shares outstanding. These shares are
traded relatively infrequently; but the last trade, made several weeks
ago, was at a price of $9 per share. Should Smitty’s make an offer for
Hill’s? If so, how much should it offer per share?
Answer: [Show S21–13 through S21–18 here.] With a current price of $9 per
Chapter 21: Mergers and Acquisitions
Integrated Case
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G. What merger-related activities are undertaken by investment
bankers?
Answer: [Show S21–19 here.] The investment banking community is involved