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Exam 26: Mergers, Lbos, Divestitures, and Holding Companies

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Question 21

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Which of the following statements is most CORRECT?

A) If a company that produces military equipment merges with a company that manages a chain of motels, this is an example of a horizontal merger.
B) A defensive merger is one where the firm's managers decide to merge with another firm to avoid or lessen the possibility of being acquired through a hostile takeover.
C) Acquiring firms send a signal that their stock is undervalued if they choose to use stock to pay for the acquisition.
D) None of the statements above is correct.
E) Answers a and c are correct.

F) A) and B)
G) A) and E)

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Question 22

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The primary reason managers give for most mergers is to acquire more assets so as to increase sales and market share.

A) True
B) False

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Question 23

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Any goodwill created in a merger must be amortized over its expected life, usually 40 years, for shareholder reporting purposes.

Only if a target firm's value is greater to the acquiring firm than its market value as a separate entity will a merger be financially justified.

Which of the following statements about valuing a firm using the APV approach is most CORRECT?

Magiclean Corporation is considering the acquisition of Dustvac Company. Dustvac has a capital structure consisting of $5 million (market value) of 11% bonds and $10 million (market value) of common stock. Dustvac's pre-merger beta is 1.36. Magiclean's beta is 1.02 , and both it and Dustvac face a 40% tax rate. Magiclean's capital structure is 40% debt and 60% equity. The free cash flows from Dustvac are estimated to be $3.0 million for each of the next 4 years and a horizon value of $10.0 million in Year 4. Tax savings are estimated to be $1 million for each of the next 4 years and a horizon value of $5 million in Year 4. New debt would be issued to finance the acquisition and retire the old debt, and this new debt would have an interest rate of 8%. Currently, the risk-free rate is 6.0% and the market risk premium is 4.0%. -What is the value of Dustvac's equity to Magiclean? (Round your answer to the closest thousand dollars.)

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

Great Subs Inc., a regional sandwich chain, is considering purchasing a smaller chain, Eastern Pizza, which is currently financed using 20% debt at a cost of 8%. Great Subs' analysts project that the merger will result in incremental free cash flows and interest tax savings of $2 million in Year 1, $4 million in Year 2, $5 million in Year 3, and $117 million in Year 4. (The Year 4 cash flow includes a horizon value of $107 million.) The acquisition would be made immediately, if it is to be undertaken. Eastern's pre-merger beta is 2.0 , and its post-merger tax rate would be 34%. The risk-free rate is 8%, and the market risk premium is 4%. What is the appropriate rate for use in discounting the free cash flows and the interest tax savings?

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 spin-off is a type of divestiture in which the assets of a division are sold to another firm.

Which of the following statements is most CORRECT?

In a merger with true synergies, the post-merger value exceeds the sum of the separate companies' pre-merger values.

Since a manager's central goal is to maximize the firm's stock price, any merger offer that provides stockholders with significant gains over the current stock price will be approved by the current management team.

Post-merger control and the negotiated price paid by the acquirer are 2 of the most important issues in agreeing on the terms of a merger.

Blazer Inc. is thinking of acquiring Laker Company. Blazer expects Laker's NOPAT to be $9 million the first year, with no net new investment in operating capital and no interest expense. For the second year, Laker is expected to have NOPAT of $25 million and interest expense of $5 million. Also, in the second year only, Laker will need $10 million of net new investment in operating capital. Laker's marginal tax rate is 40%. After the second year, the free cash flows and the tax shields from Laker to Blazer will both grow at a constant rate of 4%. Blazer has determined that Laker's cost of equity is 17.5% , and Laker currently has no debt outstanding. Assume that all cash flows occur at the end of the year, Blazer must pay $45 million to acquire Laker. What it the NPV of the proposed acquisition? Note that you must first calculate the value to Blazer of Laker's equity.

Although goodwill created in a merger may not be amortized for shareholder reporting purposes, it may be amortized for Federal tax purposes.

Currently (2007), mergers can be accounted for using either the purchase method or the pooling method.

Which of the following statements about valuing a firm using the APV approach is most CORRECT?

A joint venture is one in which 2, or sometimes more, independent companies agree to combine resources in order to achieve a specific objective, usually limited in scope.

Borrowing funds on terms that would require immediate repayment of all funds if the firm is acquired, selling off valuable assets, 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."