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Exam 21: Mergers and Acquisitions

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Question 1

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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) In a liquidation, the firm's existing stockholders are given new stock representing separate ownership rights in the division that was divested. The division establishes its own board of directors and officers, and it becomes a separate company.
E) If there are no synergistic benefits to be gained from a merger, the acquiring company will stop its plans for the merger. However, if synergistic gains are large, plans for the merger will continue. In fact, the greater the synergistic gains, the smaller the gap between the target's current price and the maximum the acquiring company could pay because of the acquiring company's upper hand in the merger.

F) A) and C)
G) A) and E)

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Question 2

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One of the main reasons why foreign firms are interested in buying U.S. companies is to gain entrance to the U.S. market. A decline in the value of the dollar relative to most foreign currencies makes this competitive strategy especially attractive.

A) True
B) False

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Question 3

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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.

Discounted cash flow methods are not appropriate for evaluating mergers because the cash flows are uncertain and the discount rate can only be determined after the merger is consummated.

In early 2009 Giant Inc.'s management was considering making an offer to buy Micro Corporation. Micro's projected operating income (EBIT) for 2009 was $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 well managed and not 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?

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.

In early 2009 Ham Inc.'s management was considering making an offer to buy Egg Corporation. Egg's projected operating income (EBIT) for 2009 was $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?

In a financial merger, the relevant post-merger cash flows are simply the sum of the expected cash flows of the 2 companies, measured as if they were operated independently.

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?

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.

Firms use defensive tactics to fight off undesired mergers. These tactics do NOT include

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

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

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.

Which of the following actions does NOT help managers defend against a hostile takeover?

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."

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.

Since the primary rationale for any operating merger is synergy, in planning such mergers the development of accurate pro forma cash flows is the single most important action.

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