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Exam 24: Mergers, Acquisitions, and Restructuring

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Question 21

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Currently, mergers in Canada can be accounted for using either the purchase method or the pooling method.

A) True
B) False

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Question 22

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What is NOT a reason for a divestiture?

A) a firm's need for cash
B) the poor performance of a business unit
C) a change in a firm's strategic thinking
D) a reduction in tax burden

E) None of the above
F) All of the above

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Question 23

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

Three procedures used to defend against hostile takeovers are 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. These strategies are known as "poison pills."

The DAB Corp. has unfortunately accumulated net operating losses of $70 million and is likely to go bankrupt. The CLC Corp. has earnings of $200 million and is in the 36% marginal tax bracket. CLC is considering buying DAB and liquidating the company and retaining a few of the assets. What is the minimum value of DAB to CLC?

Dunbar Hardware, a national hardware chain, is considering purchasing a smaller chain, Eastern Hardware. Dunbar'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 Eastern is 16%. Eastern has 4 million shares outstanding and no debt. Eastern's current price is $16.25. What is the maximum price per share that Dunbar should offer?

What is one of the actions that can NOT help managers defend against a hostile takeover?

Firms A and B, both all-equity financed, are merging. Prior to merge, Firm A, having 100 shares outstanding, is worth $15,000, while Firm B has 50 shares outstanding worth $10,000. The combined firm will be worth $30,000. Firm A pays $11,500 in cash for Firm B. What is the net benefit of the merger to Firm A?

Which statement best describes mergers?

Scenario Dustvac 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%. -Refer to Scenario Dustvac. What is the value of Dustvac's equity to Magiclean? (Round your answer to the closest thousand dollars.)

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?

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.

Kelly Tubes is considering a merger with Reilly Tires. Reilly's market-determined value is $3.75 million, and Kelly's market value as a stand-alone company is $4.50 million. Both firms are all equity-financed. Kelly acquires Reilly for $4.25 million because it believes the combined firm value will increase to $9.25 million. What will the synergy from this merger be?

Which of the following is NOT a valid reason for a company to seek external growth through mergers?

The present value of the free cash flows discounted at the unlevered cost of equity is the value of the firm's operations if it had no debt.

Scenario Maritime TV Emporium, a national retailer of flat panel screens, is investigating an opportunity to purchase Maritime TV and Sound Inc. An acquisition is expected to lower overhead costs, improve distribution efficiencies, and improve ordering volumes from the major manufactures. If those improvements (synergies) are implemented, TV Emporium financial staff estimates the following incremental net cash flows to be $5 million, $5.6 million, and $6.9 million for the first three years. Cash flows would grow at 3% thereafter. Maritime TV and Sound's tax rate is 30%. Its cost of equity is 10%. -Refer to Scenario Maritime. What is the horizontal value of Maritime's operation as of year 3?

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.

Firm X is considering acquiring Firm Y by offering one share of its common stock for 0.8728 shares of Firm Y. Currently, the market price of Firm X is $48. What is the cash bidding price proposed for this deal?

A taxable merger offer is one where the acquiring company offers to purchase the target company with cash. However, the same deal is not taxable if the merger is paid by exchanging stocks. Such nontaxable bids should be more popular by far.

Scenario Dustvac 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%. -Refer to Scenario Dustvac. What Dustvac's pre-merger WACC?