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Exam 21: Mergers and Acquisitions

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Question 1

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Merger activity is likely to heat up when interest rates are high because target firms can expect to receive an especially high premium over the pre-announcement stock price.

A) True
B) False

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Question 2

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In a financial merger,the relevant post-merger cash flows are simply the sum of the expected cash flows of the two companies,measured as if they were operated independently.

A) True
B) False

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Question 3

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A conglomerate merger occurs when two firms with either a horizontal or a vertical business relationship combine.

A company seeking to fight off a hostile takeover might employ the services of an investment banking firm to develop a defensive strategy.

At the beginning of the year Giant Inc.'s management is considering making an offer to buy Micro Corporation.Micro's projected operating income (EBIT) for the current year is $30 million,but Giant believes that if the two firms were merged,it could consolidate some operations,reduce Micro's expenses,and raise its EBIT to $35 million.Neither company uses any debt,and they both pay income taxes at a 35% rate.Giant has a better reputation among investors,who regard it as very well managed and not very risky,so its stock has a P/E ratio of 12 versus a P/E of 9 for Micro.Since Giant's management would be running the entire enterprise after a merger,investors would value the resulting corporation based on Giant's P/E.If Micro has 10 million shares outstanding,by how much should the merger increase its share price,assuming all of the synergy will go to its stockholders?

The distribution of synergistic gains between the stockholders of two merged firms is almost always based strictly on their respective market values before the announcement of the merger.

Anacott Steel is acquiring Terafly Incorporated.Terafly is expected to provide Anacott with operating cash flows of $12,$21,$16,and $9 million over the next four years,respectively.In addition,the horizon value of all remaining cash flows at the end of Year 4 is estimated at $18 million.The merger will cost Anacott $45.0 million today.If the value of the merger is estimated at $9.00 per share and Anacott has 1,000,000 shares outstanding,what equity discount rate must the firm be using to value this acquisition?

The rate used to discount projected merger cash flows should be the overall cost of capital of the new consolidated firm because it incorporates the actual capital structure of the new firm.

A joint venture is one in which two,or sometimes more,independent companies agree to combine resources in order to achieve a specific objective,usually limited in scope.

Synergistic benefits can arise from a number of different sources,including operating economies of scale,financial economies,and increased managerial efficiency.

If a petrochemical firm that used oil as feedstock merged with an oil producer that had large oil reserves and a drilling subsidiary,this would be a vertical merger.

The primary reason given by managers for most mergers is the acquisition of more assets so as to increase sales and market share.

Borrowing funds on terms that would require immediate repayment of all loans if the firm is acquired,selling off at bargain prices the assets that originally made the firm a desirable target,and granting huge "golden parachutes" that open if the firm is acquired are 3 procedures used to defend against hostile takeovers.These strategies are known as "poison pills."

Which of the following statements is most CORRECT?

The value of the target firm is calculated by discounting residual cash flows that belong to the acquiring firm's shareholders at the target's cost of equity reflecting any changes to its capital structure as a result of the merger.

Since managers' central goal is to maximize stock price,managers' personal incentives do not interfere with mergers that would benefit the target firm's stockholders.

At the beginning of the year Ham Inc.'s management is considering making an offer to buy Egg Corporation.Egg's projected operating income (EBIT) for the current year is $30 million,but Ham believes that if the two firms were merged,it could consolidate some operations,reduce Egg's expenses,and raise its EBIT to $40 million.Neither company uses any debt,and they both pay income taxes at a 40% rate.Ham has a better reputation among investors,who regard it as better managed and also less risky,so Ham's stock has a P/E ratio of 15 versus a P/E of 12 for Egg.Since Ham's management will be running the entire enterprise after a merger,investors will value the resulting corporation based on Ham's P/E.Based on expected market values,how much synergy should the merger create?

Gekko Properties is considering purchasing Teldar Properties.Gekko's analysts project that the merger will result in incremental after-tax cash flows of $2 million,$4 million,$5 million,and $10 million over the next four years.The horizon value of the firm's operations,as of Year 4,is expected to be $107 million.Assume all cash flows occur at the end of the year.The acquisition would be made immediately,if it is undertaken.Teldar's post-merger beta is estimated to be 2.0,and its post-merger tax rate would be 35%.The risk-free rate is 6%,and the market risk premium is 5.5%.What is the value of Teldar to Gekko Properties?

A congeneric merger is one where the merging firms operate in related businesses but do not necessarily produce the same products or have a producer-supplier relationship.

The text gives a number of valid,acceptable reasons for companies to merge.Which of the following is NOT acceptable?