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Exam 26: Mergers and Corporate Control

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Question 21

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Exhibit 26.1 Best Window & Door Corporation is considering the acquisition of Glassmakers Inc. Glassmakers has a capital structure consisting of $5 million (market value) of 11% bonds and $10 million (market value) of common stock. Glassmakers' pre-merger beta is 1.36. Best's beta is 1.02, and both it and Glassmakers face a 40% tax rate. Best's capital structure is 40% debt and 60% equity. The free cash flows from Glassmakers 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%. -Refer to Exhibit 26.1.What discount rate should you use to discount Glassmakers' free cash flows and interest tax savings?

A) 10.01%
B) 10.06%
C) 11.29%
D) 11.44%
E) 13.49%

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

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Question 22

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A parent holding company sells shares in its subsidiary such that the parent now owns only 65% of the subsidiary and,thus,the tax returns of the parent and its subsidiary can't be consolidated.The parent receives annual dividends from the subsidiary of $2,500,000.If the parent's marginal tax rate is 34% and if the exclusion on intercompany dividends is 70%,what is the effective tax rate on the intercompany dividends,and how much net dividends are received?

A) 10.2%; $2,245,000
B) 10.2%; $2,135,000
C) 23.8%; $1,905,000
D) 10.2%; $1,750,000
E) 34.0%; $1,650,000

F) B) and C)
G) None of the above

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Question 23

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

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

Currently (2012),mergers can be accounted for using either the purchase method or the pooling method.

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

The purchase of assets at below their replacement cost and tax considerations are two factors that motivate mergers.

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

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

Holland Auto Parts is considering a merger with Workman Car Parts.Workman's market-determined beta is 0.9,and the firm currently is financed with 20% debt,at an interest rate of 8%,and its tax rate is 25%.If Holland acquires Workman,it will increase the debt to 60%,at an interest rate of 9%,and the tax rate will increase to 35%.The risk-free rate is 6% and the market risk premium is 4%.What will Workman's required rate of return on equity be after it is acquired?

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.

Which of the following statements is most CORRECT?

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.

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

A regional restaurant chain,Club Café,is considering purchasing a smaller chain,Sally's Sandwiches,which is currently financed using 20% debt at a cost of 8%.Club Café's 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.Sally'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?

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

Which of the following statements is most CORRECT?

The owners of Arthouse Inc.,a national artist supplies chain,are contemplating purchasing Craftworks Inc,a smaller chain.Arthouse's analysts project that the merger will result in incremental free flows and interest tax savings with a combined present value of $72.52 million,and they have determined that the appropriate discount rate for valuing Craftworks is 16%.Craftworks has 4 million shares outstanding and no debt.Craftworks' current price is $16.25.What is the maximum price per share that Arthouse should offer?

Coca-Cola's acquisition of Columbia Pictures and its announcement that it would operate its new subsidiary separately could be described as primarily a financial merger.

A two-tier merger offer is one where the acquiring company offers to purchase the target company in a two-part transaction.Cash is paid to some stockholders,bonds are issued to others,but the total values of each part of the transaction are equal.