Student

30
Student: ___________________________________________________________________________
1. In a merger or acquisition, a firm should be acquired if:

A. it generates a positive net present value to the shareholders of an acquiring firm.
B. it is a firm in the same line of business, in which the acquirer has expertise.
C. it is a firm in a totally different line of business which will diversity the firm.
D. it pays a large dividend which will provide cash pass through to the acquirer.

2. One company wishes to acquire another. Which of the following forms of acquisition does not require a
formal vote by the shareholders of the acquired firm?

A. Merger.
B. Acquisition of stock.
C. Acquisition of assets.
D. Consolidation.

3. Firm A and Firm B merge to form firm AB. This is an example of:

A. a tender offer.

B. an acquisition of assets.
C. an acquisition of stock.
D. a consolidation.

4. Dissatisfied shareholders of the acquired firm in a merger can:

A. decide not to tender their shares.

B. exercise their appraisal rights and demand their shares be purchased at fair value.
C. decide not to vote for the current management by proxy.
D. do nothing and are stuck with the outcome.

5. Which of the following is not true of mergers?

A. Mergers are legally simple.

B. Mergers must be approved by a vote of the stockholders of each firm.
C. In a merger, the acquiring firm retains its name and identity.
D. Mergers represent a public offer to buy shares directly from the stockholders of another firm.

6. The complete absorption of one firm by another is called a:

A. merger.
B. consolidation.
C. takeover.
D. spin-off.

7. The positive incremental net gain associated with the combination of two firms through a merger or
acquisition is called:

A. goodwill.
B. the merger cost.
C. the consolidation effect.
D. synergy.

8. Suppose that Verizon and Sprint were to merge. Ignoring potential antitrust problems, this merger would be
classified as a:

A. horizontal merger.
B. vertical merger.
C. conglomerate merger.
D. monopolistic merger.

9. Suppose that General Motors has made an offer to acquire General Mills. Ignoring potential antitrust
problems, this merger would be classified as a:

A. monopolistic merger.
B. horizontal merger.
C. vertical merger.
D. conglomerate merger.

10. Suppose that Exxon-Mobil acquired Schlumberger, an exploration/drilling company. Ignoring potential
antitrust problems, this merger would be classified as a:

B. vertical merger.
D. horizontal merger.

11. If the All-Star Fuel Filling Company, a chain of gasoline stations acquire the Mid-States Refining
Company, a refiner of oil products, this would be an example of a:

A. conglomerate acquisition.
B. white knight.
C. vertical acquisition.
D. going-private transaction.
E. horizontal acquisition.

12. Which of the following is not true of an acquisition of stock or tender offers?

A. No stockholder meetings need to be held.

B. No vote is required.
C. The bidding firm deals directly with the stockholders of the target firm.
D. In most cases, 100% of the stock of the target firm is tendered.

13. If the acquiring firm and acquired firm are not related to each other, then the acquisition is known as

A. consolidation
B. aggregation
C. Takeovers
D. Conglomerate acquisition

14. Following an acquisition, the acquiring firm's balance sheet shows an asset labeled "goodwill." What form
of merger accounting is being used?

A. consolidation
B. aggregation
C. purchase
D. pooling

15. Synergy occurs when the:

A. added value is positive from the combination.

B. sum of the parts is grater than the whole.
C. premium paid to the acquired shareholders equals the NPV
D. standstill agreement is effected.

16. If Microsoft were to acquire Air Canada, the acquisition would be classified as a _____ acquisition.

A. horizontal
B. longitudinal
C. conglomerate
D. vertical

17. The synergy of an acquisition between Firm A and Firm B can be determined by:

A. subtracting the change in cost from the change in revenue.

B. subtracting the change in taxes form the change in revenue.
C. subtracting the change in capital requirements from the change in revenues.
D. discounting the change in the cash flows of the combined firm by the risk adjusted discount rate.
E. discounting the change in the revenues of the combined firm by the risk adjusted discount rate.

18. The value of synergy is estimated by the equation:

A. VA+ VB- ΔRevenue.

B. VAB- VA-
VB.
C. VAB- VB- Taxes.
D. VA- VB- ΔCosts.

19. An important reason for acquisitions is that the combined firm may generate greater revenue that the two
separate firms could. Examples of revenue enhancement would not include:

A. an elimination of a previously ineffective media effort.

B. an elimination of a previously ineffective advertising effort.
C. an elimination of a weak existing distribution effort.
D. economies of scale.

20. An acquisition may take place because of a real or perceived strategic advantage. An example of a strategic
advantage would be:

A. an aircraft manufacturer buying a laser guidance company for possible advanced flight control without
pilots.
B. a manufacturer integrating their supply by acquiring downline.
C. a corporation completing a spin-off.
D. a corporation out-sourcing to achieve cost economies.

21. Which of the following is not true regarding monopoly power as it relates to acquisitions that reduce
competition?

A. The U.S. Justice Department may challenge a merger if it is not determined to benefit society.
B. Empirical evidence suggests that increased monopoly power is a significant reason for firms to consider
merging.
C. If monopoly power is measured through an acquisition, all firms in an industry should benefit as the
industry's price is increased.
D. Empirical evidence finds no consistent tendency for share prices of rival firms to rise.

22. A merger that improves the use of one company's design team and the other company's testing group is
evidence of:

A. replacement of inefficient management.

B. one company exercising monopoly power.
C. complementary resources.
D. minimizing the net operating losses.

23. The market for corporate control is a phrase that would not describe:

A. a shift in management motivated to increase the value of the firm.

B. top management restructuring of the company.
C. an elimination of managerial inefficiency.
D. the system where corporate insiders trade personal stock holdings.
E. alternative management teams competing for the rights to management

24. The Albatross Co. has accumulated net operating losses of $70 million and is likely to enter bankruptcy.
The Zephyr Co. has earnings of $200 million and is in the 36% marginal tax bracket. Zephyr is considering
buying Albatross and liquidating the company and retaining a few of the assets. What is the minimum
value of Albatross to Zephyr?

A. $25.2 million.
B. $72.0 million.
C. $70.0 million.
D. not enough information to calculate.

25. Cowboy Curtiss' Cowboy Hat Company recently completed a merger. When valuing the combined firm
after the merger, which of the following is an example of the type of common mistake that can occur?

A. The use of market values in valuing either the new firm.

B. The inclusion of cash flows that are incremental to the decision.
C. The use of Curtiss' discount rate when valuing the cash flows of the entire company.
D. The inclusion of all relevant transactions cost associated with the acquisition.

26. Firm A is going to acquire Firm B by selling bonds and using the proceeds to purchase (for cash) the stock
of Firm B. What is the appropriate discount rate for use in valuing the benefits of the merger?

A. Firm A's cost of debt.

B. Firm A's weighted average cost of capital.
C. Firm A's cost of equity.
D. Firm B's weighted average cost of capital.
E. none of the above.

27. When two firms merge and there is no synergy gain but the only change is a reduction in risk:

A. there is no effect on the bondholders or stockholders.

B. both the bondholders and stockholders are made better off.
C. the bondholders gain in value while the stockholders lose value.
D. the stockholders gain in value while the bondholders lose value.

28. If two leveraged firms merge, the cost of debt for the new firm will generally be lower than it was for the
two firms as separate entities. One reason for this is:

A. strategic fits.
B. net operating losses.
C. surplus funds.
D. co-insurance.

29. What is the synergy from the merger of V and A. V was worth $450 and A had a market value of $375. V
acquired A for $425 because they thought the combination of VA was worth $925.

A. $50.
B. $100.
C. $500.
D. $475.

30. What is the NPV from the merger of V and A. V was worth $450 and A had a market value of $375. V

A. $0.
B. $50.
C. $450.
D. $425.

31. What is the cost of acquiring A if the V and A merge. V is worth $450 and has 100 shares outstanding. A
has a market value of $375 and has 40 shares outstanding. V to acquire A will swap 80 shares of V for the
40 shares of A. V believes the combination of VA was worth $925.

A. $325.
B. $100.
C. $36.
D. $0.

32. What is the market value exchange ratio of V acquiring A in a merger. V is worth $450 and has 100 shares
outstanding. A has a market value of $375 and has 40 shares outstanding. V to acquire A will swap 80
shares of V for the 40 shares of AC. V believes the combination of VA was worth $925.

A. 1:1.
B. 1.20:1.
C. 1.37:1.
D. 1.10:1.

33. In a merger with an exchange of stock, when the premerger prices are used to calculate the exchange ratio
the true cost of the merger:

A. is less than the number of shares received times the original market price.
B. is equal to the number of shares received times the original market price.
C. is greater than the number of shares received times the original market price.
D. Unchanged from the premerger value.

34. Firm A does well in a boom economy. Firm B does well in a bust economy. The probability of a boom is
50%. The end of period values of the two firms depend on the economy as shown below:

Both firms have debt outstanding with a face value of $1,000. In order to diversify, the two firms have
proposed a merger. The NPV of the merger is zero. Which of the following statements is correct?

A. The stockholders are indifferent to merger since the NPV is zero.

B. The bondholders are indifferent to merger since the NPV is zero.
C. The bondholders stand to gain because the risk of the combined firm is less.
D. The stockholders stand to gain because the probability of bankruptcy becomes zero after the merger.

35. A merger should not take place simply for the purpose of:

A. diversification if shareholders can accomplish the same result on there own portfolios.
B. increasing the debt capacity for the tax shield gain.
C. acquiring free cash flow to be put to use by the acquirer.
D. reducing the cost of production.

36. A modification to the corporate charter that requires 80% shareholder approval for a takeover is called
a(n):

A. repurchase standstill provision.

B. exclusionary self-tender.
C. super majority amendment.
D. tender offer.

37. Which of the following is the opposite of a targeted repurchase?

A. Repurchase standstill provision.

B. Exclusionary self-tender.
C. Super majority amendment.
D. Tender offer.

38. When the management and/or a small group of investors takeover a firm and the shares of the firm are
delisted and no longer publicly available, this action is known as:

A. a consolidation.
B. a vertical acquisition.
C. a proxy contest.
D. a going-private transaction.

39. Which of the following defensive tactics completely eliminates the possibility of a takeover via tender
offer?

A. Leveraged buyout (LBO).

C. Targeted repurchase.
D. Super majority amendment.

40. Compensation paid to top management in the event of a takeover is called a:

A. poison pill.
B. golden parachute.
C. self-tender.
D. buyout.

41. As a defensive maneuver, a firm issues deep-discount bonds that are redeemable at par in the event of an
unfriendly takeover. These bonds are an example of:

A. greenmail.
B. a "scorched earth" policy.
C. a poison pill.
D. crown jewels.

42. Firm A does well in a boom economy. Firm B does well in a bust economy. The probability of a boom is
50%. The end of period values of the two firms depend on the economy as shown below:

proposed a merger. The NPV of the merger is zero. Determine the gain or loss under each state of economy
for the stockholders of A and B separately and for the combined firm AB. Should either the stockholders or
bondholders be willing to support the merger (prove and state why)?

43. Chucky Chester Inc. takes over Billy Bob Burgers from Billy himself for $1 million in cold cash. Billy
started the company years ago on an investment of $50,000 in plant and equipment which has long been
paid off. The machinery has no accounting value today. Consider the takeover price as fair market value for
the equipment. Calculate the tax consequences of the merger, assuming that Chucky Chester decides not to
write-up the machinery. Both Billy and Chucky are in the 28% tax bracket.

44. Shuster merges with Leverne. Shuster agrees to exchange 25 of its shares for every 50 of Leverne's old
shares, so that Shuster will have 75 shares available after the merger. There is no synergy. Calculate the
EPS along with other information below for the combined firm in two cases; one where the market is smart,
and another when the market is fooled.

45. Firms A and B, both of which are 100% equity, are going to merge. Before the merger, Firm A (100 shares
outstanding) is worth $15,000. Firm B (50 shares outstanding) is worth $10,000. The combined firm is
worth $30,000. Firm A will pay $11,500 in cash for Firm B. What is the NPV of the merger to Firm A?

46. The Turf-Top Lawn Mower Company has acquired the Quick Clean Power Snow Shovel Company. Turf-
Top has agreed to pay $600 in cash, the money was raised through a new debt issue. All liabilities will be
paid off. The balance sheets of both companies are at market values which are also the book values before
the combination. Construct the new balance sheet for this purchase. How has the position of TTLM
shareholders changed?

47. The Turf-Top Lawn Mower Company has acquired the Quick Clean Power Snow Shovel Company. Turf-
Top has agreed to pay $400 in stock through a tender offer. All liabilities will be assumed. The balance
sheets of both companies are at market values which are also the book values before the combination.
Construct the new balance sheet for this tax-free acquisition. How has the position of TTLM shareholders
changed?

48. Bondholders can be made better off in a merger, this is known as the co-insurance effect. Explain how this
can happen using an example.

49. Dexter Department Stores has a market value of $400 million and 20 million shares outstanding. Walnut
Stores has a market value of $134 million and 13.4 million shares outstanding. Dexter is deciding to
acquire Walnut Stores. The top management of Dexter's have determined that due to the synergies between
the firms the combination will worth $667 million. Dexter expect to pay a $67 million premium for Walnut
Stores. If Dexter offers 10 million shares in exchange for the 13.4 million shares of Walnut, what will the
exchange ratio and the equivalent cash value?

Stores. If Dexter offers 10 million shares in exchange for the 13.4 million shares of Walnut, what will the
after acquisition stock price of Dexter be?

Stores. If Dexter were to make an offer of $201 million in stock for Walnut what would the exchange ratio
be?

52. The empirical evidence strongly indicates that the stockholders of the target firm realize large wealth gains
as a result of a takeover bid but the stockholders in the acquiring firm gain little, if anything. Although
there exists no definitive answer as to why this is the case, several possible explanations have been
proposed. List and explain three of these possible explanations for the minimal returns to the acquiring
firm's stockholders.

53. Describe the three basic legal procedures that one firm can use to acquire another and briefly discuss the
advantages and disadvantages of each.

30 Key

1. In a merger or acquisition, a firm should be acquired if:

A. it generates a positive net present value to the shareholders of an acquiring firm.
B. it is a firm in the same line of business, in which the acquirer has expertise.
C. it is a firm in a totally different line of business which will diversity the firm.
D. it pays a large dividend which will provide cash pass through to the acquirer.

Difficulty: Easy
Learning Objective: 30-01
Ross - Chapter 30 #1

2. One company wishes to acquire another. Which of the following forms of acquisition does not require a
formal vote by the shareholders of the acquired firm?

A. Merger.
B. Acquisition of stock.
C. Acquisition of assets.
D. Consolidation.

Difficulty: Easy

3. Firm A and Firm B merge to form firm AB. This is an example of:

A. a tender offer.

B. an acquisition of assets.
C. an acquisition of stock.
D. a consolidation.

Difficulty: Easy

4. Dissatisfied shareholders of the acquired firm in a merger can:

A. decide not to tender their shares.

B. exercise their appraisal rights and demand their shares be purchased at fair value.
C. decide not to vote for the current management by proxy.
D. do nothing and are stuck with the outcome.

Difficulty: Medium

5. Which of the following is not true of mergers?

A. Mergers are legally simple.

B. Mergers must be approved by a vote of the stockholders of each firm.
C. In a merger, the acquiring firm retains its name and identity.
D. Mergers represent a public offer to buy shares directly from the stockholders of another firm.

Difficulty: Easy

6. The complete absorption of one firm by another is called a:

A. merger.
B. consolidation.
C. takeover.
D. spin-off.

Difficulty: Easy

7. The positive incremental net gain associated with the combination of two firms through a merger or
acquisition is called:

A. goodwill.
B. the merger cost.
C. the consolidation effect.
D. synergy.

Difficulty: Easy

8. Suppose that Verizon and Sprint were to merge. Ignoring potential antitrust problems, this merger
would be classified as a:

A. horizontal merger.
B. vertical merger.
D. monopolistic merger.

Difficulty: Easy

9. Suppose that General Motors has made an offer to acquire General Mills. Ignoring potential antitrust
problems, this merger would be classified as a:

B. horizontal merger.
C. vertical merger.
D. conglomerate merger.

Difficulty: Easy

10. Suppose that Exxon-Mobil acquired Schlumberger, an exploration/drilling company. Ignoring potential
antitrust problems, this merger would be classified as a:

B. vertical merger.
D. horizontal merger.

Difficulty: Easy

11. If the All-Star Fuel Filling Company, a chain of gasoline stations acquire the Mid-States Refining
Company, a refiner of oil products, this would be an example of a:

A. conglomerate acquisition.
B. white knight.
C. vertical acquisition.
D. going-private transaction.
E. horizontal acquisition.

Difficulty: Medium

12. Which of the following is not true of an acquisition of stock or tender offers?

A. No stockholder meetings need to be held.

B. No vote is required.
C. The bidding firm deals directly with the stockholders of the target firm.
D. In most cases, 100% of the stock of the target firm is tendered.

Difficulty: Easy

13. If the acquiring firm and acquired firm are not related to each other, then the acquisition is known as

A. consolidation
B. aggregation
C. Takeovers
D. Conglomerate acquisition

Difficulty: Easy

14. Following an acquisition, the acquiring firm's balance sheet shows an asset labeled "goodwill." What
form of merger accounting is being used?

A. consolidation
B. aggregation
C. purchase
D. pooling

Difficulty: Easy

15. Synergy occurs when the:

A. added value is positive from the combination.

B. sum of the parts is grater than the whole.
C. premium paid to the acquired shareholders equals the NPV
D. standstill agreement is effected.

Difficulty: Easy

16. If Microsoft were to acquire Air Canada, the acquisition would be classified as a _____ acquisition.

A. horizontal
B. longitudinal
C. conglomerate
D. vertical

Difficulty: Medium

17. The synergy of an acquisition between Firm A and Firm B can be determined by:

A. subtracting the change in cost from the change in revenue.

B. subtracting the change in taxes form the change in revenue.
C. subtracting the change in capital requirements from the change in revenues.
D. discounting the change in the cash flows of the combined firm by the risk adjusted discount rate.
E. discounting the change in the revenues of the combined firm by the risk adjusted discount rate.

Difficulty: Medium

18. The value of synergy is estimated by the equation:

A. VA+ VB- ΔRevenue.

B. VAB- VA-
VB.
C. VAB- VB- Taxes.
D. VA- VB- ΔCosts.

Difficulty: Medium

19. An important reason for acquisitions is that the combined firm may generate greater revenue that the
two separate firms could. Examples of revenue enhancement would not include:

A. an elimination of a previously ineffective media effort.

B. an elimination of a previously ineffective advertising effort.
C. an elimination of a weak existing distribution effort.
D. economies of scale.

Difficulty: Easy

20. An acquisition may take place because of a real or perceived strategic advantage. An example of a
strategic advantage would be:

A. an aircraft manufacturer buying a laser guidance company for possible advanced flight control
without pilots.
B. a manufacturer integrating their supply by acquiring downline.
C. a corporation completing a spin-off.
D. a corporation out-sourcing to achieve cost economies.

Difficulty: Hard

21. Which of the following is not true regarding monopoly power as it relates to acquisitions that reduce
competition?

A. The U.S. Justice Department may challenge a merger if it is not determined to benefit society.
B. Empirical evidence suggests that increased monopoly power is a significant reason for firms to
consider merging.
C. If monopoly power is measured through an acquisition, all firms in an industry should benefit as the
industry's price is increased.
D. Empirical evidence finds no consistent tendency for share prices of rival firms to rise.

Difficulty: Easy

22. A merger that improves the use of one company's design team and the other company's testing group is
evidence of:

A. replacement of inefficient management.

B. one company exercising monopoly power.
C. complementary resources.
D. minimizing the net operating losses.

Difficulty: Easy

23. The market for corporate control is a phrase that would not describe:

A. a shift in management motivated to increase the value of the firm.

B. top management restructuring of the company.
C. an elimination of managerial inefficiency.
D. the system where corporate insiders trade personal stock holdings.
E. alternative management teams competing for the rights to management

Difficulty: Easy

24. The Albatross Co. has accumulated net operating losses of $70 million and is likely to enter bankruptcy.
The Zephyr Co. has earnings of $200 million and is in the 36% marginal tax bracket. Zephyr is
considering buying Albatross and liquidating the company and retaining a few of the assets. What is the
minimum value of Albatross to Zephyr?

A. $25.2 million.
B. $72.0 million.
C. $70.0 million.
D. not enough information to calculate.

Difficulty: Medium

25. Cowboy Curtiss' Cowboy Hat Company recently completed a merger. When valuing the combined firm
after the merger, which of the following is an example of the type of common mistake that can occur?

A. The use of market values in valuing either the new firm.

B. The inclusion of cash flows that are incremental to the decision.
C. The use of Curtiss' discount rate when valuing the cash flows of the entire company.
D. The inclusion of all relevant transactions cost associated with the acquisition.

Difficulty: Medium

26. Firm A is going to acquire Firm B by selling bonds and using the proceeds to purchase (for cash) the
stock of Firm B. What is the appropriate discount rate for use in valuing the benefits of the merger?

A. Firm A's cost of debt.

B. Firm A's weighted average cost of capital.
C. Firm A's cost of equity.
D. Firm B's weighted average cost of capital.
E. none of the above.

Difficulty: Medium

27. When two firms merge and there is no synergy gain but the only change is a reduction in risk:

A. there is no effect on the bondholders or stockholders.

B. both the bondholders and stockholders are made better off.
C. the bondholders gain in value while the stockholders lose value.
D. the stockholders gain in value while the bondholders lose value.

Difficulty: Easy

28. If two leveraged firms merge, the cost of debt for the new firm will generally be lower than it was for
the two firms as separate entities. One reason for this is:

A. strategic fits.
B. net operating losses.
C. surplus funds.
D. co-insurance.

Difficulty: Easy

29. What is the synergy from the merger of V and A. V was worth $450 and A had a market value of $375.
V acquired A for $425 because they thought the combination of VA was worth $925.

A. $50.
B. $100.
C. $500.
D. $475.

Difficulty: Medium

30. What is the NPV from the merger of V and A. V was worth $450 and A had a market value of $375. V

A. $0.
B. $50.
C. $450.
D. $425.

Difficulty: Medium

31. What is the cost of acquiring A if the V and A merge. V is worth $450 and has 100 shares outstanding.
A has a market value of $375 and has 40 shares outstanding. V to acquire A will swap 80 shares of V
for the 40 shares of A. V believes the combination of VA was worth $925.

A. $325.
B. $100.
C. $36.
D. $0.

Difficulty: Hard

32. What is the market value exchange ratio of V acquiring A in a merger. V is worth $450 and has 100
shares outstanding. A has a market value of $375 and has 40 shares outstanding. V to acquire A will
swap 80 shares of V for the 40 shares of AC. V believes the combination of VA was worth $925.

A. 1:1.
B. 1.20:1.
C. 1.37:1.
D. 1.10:1.

Difficulty: Medium

33. In a merger with an exchange of stock, when the premerger prices are used to calculate the exchange
ratio the true cost of the merger:

A. is less than the number of shares received times the original market price.
B. is equal to the number of shares received times the original market price.
C. is greater than the number of shares received times the original market price.
D. Unchanged from the premerger value.

Difficulty: Medium

34. Firm A does well in a boom economy. Firm B does well in a bust economy. The probability of a boom
is 50%. The end of period values of the two firms depend on the economy as shown below:

proposed a merger. The NPV of the merger is zero. Which of the following statements is correct?

A. The stockholders are indifferent to merger since the NPV is zero.

B. The bondholders are indifferent to merger since the NPV is zero.
C. The bondholders stand to gain because the risk of the combined firm is less.
D. The stockholders stand to gain because the probability of bankruptcy becomes zero after the merger.

Difficulty: Medium

35. A merger should not take place simply for the purpose of:

A. diversification if shareholders can accomplish the same result on there own portfolios.
B. increasing the debt capacity for the tax shield gain.
C. acquiring free cash flow to be put to use by the acquirer.
D. reducing the cost of production.

Difficulty: Easy

36. A modification to the corporate charter that requires 80% shareholder approval for a takeover is called
a(n):

A. repurchase standstill provision.

B. exclusionary self-tender.
C. super majority amendment.
D. tender offer.

Difficulty: Easy

37. Which of the following is the opposite of a targeted repurchase?

A. Repurchase standstill provision.

C. Super majority amendment.
D. Tender offer.

Difficulty: Easy

38. When the management and/or a small group of investors takeover a firm and the shares of the firm are
delisted and no longer publicly available, this action is known as:

A. a consolidation.
B. a vertical acquisition.
C. a proxy contest.
D. a going-private transaction.

Difficulty: Easy

39. Which of the following defensive tactics completely eliminates the possibility of a takeover via tender
offer?

A. Leveraged buyout (LBO).

C. Targeted repurchase.
D. Super majority amendment.

Difficulty: Easy

40. Compensation paid to top management in the event of a takeover is called a:

A. poison pill.
B. golden parachute.
C. self-tender.
D. buyout.

Difficulty: Easy

41. As a defensive maneuver, a firm issues deep-discount bonds that are redeemable at par in the event of
an unfriendly takeover. These bonds are an example of:

A. greenmail.
B. a "scorched earth" policy.
C. a poison pill.
D. crown jewels.

Difficulty: Easy

42. Firm A does well in a boom economy. Firm B does well in a bust economy. The probability of a boom
is 50%. The end of period values of the two firms depend on the economy as shown below:

proposed a merger. The NPV of the merger is zero. Determine the gain or loss under each state of
economy for the stockholders of A and B separately and for the combined firm AB. Should either the
stockholders or bondholders be willing to support the merger (prove and state why)?

Neither shareholders will want to support the merger but bondholders would as their risk is lower and
potential gain under a bust is $200.00.

Difficulty: Medium

43. Chucky Chester Inc. takes over Billy Bob Burgers from Billy himself for $1 million in cold cash. Billy
started the company years ago on an investment of $50,000 in plant and equipment which has long been
paid off. The machinery has no accounting value today. Consider the takeover price as fair market value
for the equipment. Calculate the tax consequences of the merger, assuming that Chucky Chester decides
not to write-up the machinery. Both Billy and Chucky are in the 28% tax bracket.

Difficulty: Hard

44. Shuster merges with Leverne. Shuster agrees to exchange 25 of its shares for every 50 of Leverne's old
shares, so that Shuster will have 75 shares available after the merger. There is no synergy. Calculate the
EPS along with other information below for the combined firm in two cases; one where the market is
smart, and another when the market is fooled.

Difficulty: Hard

45. Firms A and B, both of which are 100% equity, are going to merge. Before the merger, Firm A (100
shares outstanding) is worth $15,000. Firm B (50 shares outstanding) is worth $10,000. The combined
firm is worth $30,000. Firm A will pay $11,500 in cash for Firm B. What is the NPV of the merger to
Firm A?

Synergy = $30,000 - 15,000 - 10,000 = 5,000

NPV = Synergy - Premium = $5,000 - 1,500 = $3,500.
Value of Firm A After the Acquisition: $30,000 - 11,500 = $18,500
NPV to Firm A = $18,500 - 15,000 = $3,500

Difficulty: Medium

46. The Turf-Top Lawn Mower Company has acquired the Quick Clean Power Snow Shovel Company.
Turf-Top has agreed to pay $600 in cash, the money was raised through a new debt issue. All liabilities
will be paid off. The balance sheets of both companies are at market values which are also the book
values before the combination. Construct the new balance sheet for this purchase. How has the position
of TTLM shareholders changed?

Repay CL & LTD = 240; leaves $360 for equity implies $60 in goodwill.

Turf-Top Lawn Mower shareholders are in a much riskier position now due to the added leverage; was
D/E = .524; D/V = .344 which increased to D/E = 1.095; D/V = .523.

Difficulty: Medium

47. The Turf-Top Lawn Mower Company has acquired the Quick Clean Power Snow Shovel Company.
Turf-Top has agreed to pay $400 in stock through a tender offer. All liabilities will be assumed. The
balance sheets of both companies are at market values which are also the book values before the
combination. Construct the new balance sheet for this tax-free acquisition. How has the position of
TTLM shareholders changed?

The $100 difference in market value of stock paid to Quick Clean shareholders does not appear on the
balance sheet as goodwill in pooling. They also become Turf-Top shareholders. Change in shareholder
position based on book value.
Before: D/E = .524; D/V = .344
After: D/E = 790/1350 = .585; D/V = 790/2140 = .369
Total Debt relative to equity and total value has increased slightly indicating a small increase in risk
based on book values. Actually risk may not have increased if based on market values.

Difficulty: Medium

48. Bondholders can be made better off in a merger, this is known as the co-insurance effect. Explain how
this can happen using an example.

For an example see page 860

Co-insurance effect--transfer of wealth to bondholders from stockholders.
In a combination that reduces risk to debtholders due to diversification with no net gains to shareholders
bondholders are better off.
Lower risk because of better chance of payment under all economic outcomes.
Lower risk implies lower discount and higher value.

Difficulty: Hard

acquire Walnut Stores. The top management of Dexter's have determined that due to the synergies
between the firms the combination will worth $667 million. Dexter expect to pay a $67 million
premium for Walnut Stores. If Dexter offers 10 million shares in exchange for the 13.4 million shares of
Walnut, what will the exchange ratio and the equivalent cash value?

Market Value exchange ratio = (.746(20))/10 = 1.49:1 or (10(20))/13.4 = 1.49:1

Share exchange ratio = 10/13.4 = .746

Difficulty: Hard

premium for Walnut Stores. If Dexter offers 10 million shares in exchange for the 13.4 million shares of
Walnut, what will the after acquisition stock price of Dexter be?

Price = Total Value/Total # of shares = 667/(20 + 10) = 667/30 = 22.23.

Difficulty: Hard

premium for Walnut Stores. If Dexter were to make an offer of $201 million in stock for Walnut what
would the exchange ratio be?

Exchange Fraction of Total Value = 201/667

Total Shares for Ownership fraction = .301 = X/(X + 20)
X = 6.02/.699 = 8.6123
Value per Share = 667/(20 + 8.6123) = 23.3117
Proof: 8.6123(23.3117) = 200.77 = 201 QED.

Difficulty: Hard

52. The empirical evidence strongly indicates that the stockholders of the target firm realize large wealth
gains as a result of a takeover bid but the stockholders in the acquiring firm gain little, if anything.
Although there exists no definitive answer as to why this is the case, several possible explanations have
been proposed. List and explain three of these possible explanations for the minimal returns to the
acquiring firm's stockholders.

Size differentials, competition in the takeover market, lack of achieving merger gains, management
goals other than the best interests of the shareholders, and early announcements of corporate acquisition
intent are all presented as possible explanations in the textbook.

Difficulty: Medium

53. Describe the three basic legal procedures that one firm can use to acquire another and briefly discuss the
advantages and disadvantages of each.

The three forms are merger, acquisition of stock, and acquisition of assets. A merger has the advantage
that it is legally simple and therefore low cost but it has the disadvantage that it must be approved by the
shareholders of both firms. Acquisition by stock requires no shareholder meetings and management of
the target firm can be bypassed. However, it can be a costly form of acquisition and minority
shareholders may hold out, thereby raising the cost of the purchase. An acquisition of assets requires the
vote of the target firm's shareholders. However, it can become quite costly to transfer title to all of the
assets.

Difficulty: Medium

30 Summary

Category # of Questions
Difficulty: Easy 26
Difficulty: Hard 8
Difficulty: Medium 19
Learning Objective: 30-01 14
Ross - Chapter 30 53

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30

1. In a merger or acquisition, a firm should be acquired if:

A. a tender offer.

A. decide not to tender their shares.

A. Mergers are legally simple.

A. No stockholder meetings need to be held.

A. added value is positive from the combination.

A. subtracting the change in cost from the change in revenue.

A. VA+ VB- ΔRevenue.

A. an elimination of a previously ineffective media effort.

A. replacement of inefficient management.

A. a shift in management motivated to increase the value of the firm.

A. The use of market values in valuing either the new firm.

A. Firm A's cost of debt.

A. there is no effect on the bondholders or stockholders.

A. The stockholders are indifferent to merger since the NPV is zero.

A. repurchase standstill provision.

A. Repurchase standstill provision.

A. Leveraged buyout (LBO).

A. a tender offer.

A. decide not to tender their shares.

A. Mergers are legally simple.

A. No stockholder meetings need to be held.

A. added value is positive from the combination.

A. subtracting the change in cost from the change in revenue.

A. VA+ VB- ΔRevenue.

A. an elimination of a previously ineffective media effort.

A. replacement of inefficient management.

A. a shift in management motivated to increase the value of the firm.

A. The use of market values in valuing either the new firm.

A. Firm A's cost of debt.

A. there is no effect on the bondholders or stockholders.

A. The stockholders are indifferent to merger since the NPV is zero.

A. repurchase standstill provision.

A. Repurchase standstill provision.

A. Leveraged buyout (LBO).

Synergy = $30,000 - 15,000 - 10,000 = 5,000

For an example see page 860

Market Value exchange ratio = (.746(20))/10 = 1.49:1 or (10(20))/13.4 = 1.49:1

Price = Total Value/Total # of shares = 667/(20 + 10) = 667/30 = 22.23.

Exchange Fraction of Total Value = 201/667

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