Chapter Seven

Issues for Review and Discussion

8-1. True or False? Acquisition premiums the last few years have averaged 25 to 40 percent, but
sometimes exceed 100 percent; prior research suggests that high premiums generally have
negative impacts on acquisition performance. Explain.

True, acquisition negatively impacts on acquisition performance. Firms are more likely to pay for higher
premiums because This helps companies gain more economies of scale by buying other firms.
Companies acquire other companies more often than people think. This is how companies kill off their
competitions by gaining a monopoly in certain areas of business. However, if the acquisition is failing
firms have a more difficult time getting back on their feet,

8-2. Explain why increasing treasury stock will increase EPS in any corporation.

EPS or earnings per share is total net income / shares outstanding. This means shares who are
outstanding can include treasury stock and repurchase stocks. The overall EPS will go up because the
firm owns the majority of their stocks and while also reducing the outstanding shares.

8-3. Some analysts say that huge New York Stock Exchange IPOs from companies such as
Alibaba, headquartered in China, should be illegal in the United States because under communist
governments there are not sufficient safeguards in place for financial transactions. Do you agree
or disagree? Why?

I disagree because there are many internationally based companies that have IPOs in the New York
Exchange. IPOs developed in the NYSE will then follow the rules and regulations of the United States
law. Prohibiting the IPOs from China will only make other foreign companies to not develop a IPO in
America.

8-4. True or False? In the United States, no federal laws prevent businesses from using GPS
devices to monitor employees, nor does federal law require businesses to disclose to employees
whether they are using such techniques. What are the implications for employees and
companies?

True, most states do not have laws prohibiting the use of GPS devices on their employees. However, if
the employer should disclose in full transparency if they are going to use these devices because it
involves the privacy of their employees.

8-5. To raise capital, what are the pros and cons of selling bonds compared to issuing stock or
borrowing money from a bank?
Corporate bonds are less sensitive to the daily firms’ operations when compared to stocks, it is at a
higher risk of loss. However, can carry a higher rate for smaller firms which can be an expensive
alternative instead of using stocks.
8-6. Many companies are aggressively buying their own stock. What are situations when this
practice is recommended or especially beneficial? What are the pros and cons of increasing
treasury stock on the balance sheet?

When companies buy their own stock is to prevent the undervaluation, because they retain them
instead of running the risk of being sold for a lower price. This can increase the treasury stock while
lowering outstanding stock and can increase their EPS, but while running the risk of lowering the
amount of shareholder equity. Drawback could be not using the money to develop a department or
reinvesting it in the company.

8-7. Hewlett-Packard has more goodwill ($) than the book value ($) of the firm. Explain what
this means, how it could occur, and what can be done about this situation.

Goodwill is a referring to the past life of a company, which for HP, they are known for buying out their
competition. HP has brough out companies that are worth more then their number of outstanding
stocks. However, if HP has never acquired a new company their price would be 0. The book value
reflects the price of the shares. Goodwill is also the extra from the payment of the premiums.

8-8. Give a hypothetical example where Company A buys Company B for a 15 percent premium.
Company A is paying 15 % more than the number of shares out times the price.

8-9. Give a hypothetical example where Company A buys Company B for a 15 percent discount.
Company A is paying 15% less than the number of shares times the price.

8-10. What is treasury stock? When should a company purchase treasury stock?
A treasury stock is back up by the issuing company, which reduces the amount of outstanding stock on
the open market. A company should purchase a treasury stock when they run the risk of ownership
dilution or the stock prices are low.

8-11. What is an IPO? When is an IPO good for a company? Why did Dropbox in 2018 use an
IPO? Was that a wise strategic move? Why?
IPO are might for companies that are going from private to public, which they are starting to sell their
shares to outsiders (or the public). An IPO is great for a company because they increase their cash flows.
Dropbox used an IPO to become more visual to the public, while also making storing files simpler and
connecting all of the workforce. Yes, it was a wise move because they became more commonly used in
the remote work.

8-12. Generally speaking, how large should a firm be to justify having an IPO? Explain the IPO
process.
IPOs starts with the founders, family or angel investors/ venture capitalists. To start the IPO process, you
need to be transparent with where the funds are being acquired. The company need to be mature
enough to follow the SEC regulations and need to advertise their intentions of going public. The
company have to reach unicorn status with the valuation of approximately 1 billion dollars.

8-13. How could or would dividends affect an EPS/EBIT analysis? Would it be correct to refer
to “earnings after taxes, interest, and dividends” as retained earnings for a given year?
When using the equity to raise capital, but will often have additional expense from paying off the
dividends. For dividend-paying firms, this could make equity a bit less attractive vs. having debt.
Considering dividends in the EPS/EBIT analysis would make the analysis more difficult. To consider
dividends in an EPS/EBIT analysis, a row should be inserted for "Dividends" below the "EAT" row, and
then an "Earnings after taxes and dividends" row should be inserted below the “EAT” row.

8-14. In performing an EPS/EBIT analysis, where do the first-row (EBIT) numbers come from?
The numbers from (EBIT) are from the year before and with a few what they recommended. The
analysis will want a range of high and low so the EBIT will fall in-between.

8-15. In performing an EPS/EBIT analysis, where does the tax rate percentage come from?
The company will use their prior tax rate. Which will be divided by the income before the taxes of the
year prior. The paid taxes will be shown in the income statement.

8-16. Show algebraically that the price-earnings ratio formula is identical to the number of shares
outstanding multiplied by the stock price formula. Why are the values obtained from these two
methods sometimes different?
Price-earnings ratio method = [stock price / EPS X N.I.] = [#shrs X stock price.]

The number won’t be identical because the prices will be different every day.

8-17. In accounting terms, distinguish between intangibles and goodwill on a balance sheet. Why
do these two items generally stay the same on projected financial statements?
Intangibles are copyright, trademarks, and patents. Goodwill are the premiums that companies have to
pay to acquire other companies. They will be recorded as noncurrent assets because they are long-term
investments that can’t be realized within the current financial year.

8-18. Explain four methods often used to calculate the total worth of a business.
The four common valuations methods are: asset-based valuation, market-based, ROI-based, and future
earnings-based valuation.

8-19. Explain how and why top executives can and do, on occasion, legally manipulate financial
statements to inflate or deflate expected results.
It is common that business legally manipulate financial to make the business more profitable. This will
avoid shareholders to freak out if the business is in financial difficulties. Directors may “cook the book”
to make the monetary goals they were assigned.

8-20. Explain why EPS/EBIT analysis is a central strategy-implementation technique.

Extra capital is needed to implement strategies. The EPS/EBIT analysis provides information on if a stock
should be issued, funds should be borrowed, or a combination if the stock or debt is the best method to
raise the company capital.

8-21. Identify and discuss the limitations of EPS/EBIT analysis.

A limitation of the EPS/EBIT analysis is the assumption that the firm is attempting to maximize their
earnings per share.

8-22. True or False? Retained earnings on the balance sheet are not monies available to finance
strategy implementation. Explain.
True, the number for RE is money spent of the firm, not the available funds for the firm.

NI-DIVE= RE, which can be in the negative.

8-23. Explain why projected financial statement analysis is considered both a strategy-
formulation and a strategy-implementation tool.
Projected financial statements need to reflect the recommendations. Strategy formulation can be used
to assess the impact before making a choice. Implementation tool is maintaining the progress of the
project, while also monitoring it.

8-24. Complete the following EPS/EBIT analysis for a company whose stock price is $20,
interest rate on funds is 5 percent, tax rate is 20 percent, number of shares outstanding is 500
million, and EBIT range is $100 million to $300 million. The firm needs to raise $200 million in
capital. Use the following table to complete the work.

100,000 100,000 100,000

5% 5% 5%

20 20 20

20% 20% 20%

30 30 30

500 500 500

200 500 500

8-25. Under what conditions would retained earnings on the balance sheet decrease from one
year to the next?
The condition is having a cumulative of net losses, but also a decrease in net income will make the
balance sheet have a deficit.

8-26. In your own words, list all the steps in developing projected financial statements.
Step 1: convert the firms most recent Form 10K

Step 2: Income statement

Step 3: Retained earning row

Step 4: Balance sheet

Step 5: How much cash flow

Step 6: Financial ratios

8-27. Based on the financial statements provided for Coca-Cola (here), how much dividends in
dollars did Coca-Cola pay in 2016? In 2017?
Coca-Cola paid 0.35 cents in dividends in 2016. In 2017, they paid 0.37 cents.

8-28. Why should you be careful not to use historical percentages blindly in developing
projected financial statements?
You do not want to blindly use historical information when developing projected financial statements
because every year the market will change. The recommendations from last year can be every different
from the current year. It could have shown the numbers from buying another firm.