Test ID: 7440579
Mergers and Acquisitions
Question #1 of 102
QuestionID:462867ᅞ A) ᅞ B) ᅚ C)
Question #2 of 102
QuestionID:462773ᅞ A) ᅚ B) ᅞ C)
Question #3 of 102
QuestionID:462872ᅞ A) ᅚ B) ᅞ C)
Question #4 of 102
QuestionID:462793A spin-off differs from a sale in that a spin-off involves:
an exchange of the parent's shares for shares of the subsidiary. the divestiture of the subsidiary for cash.
the distribution of shares in the subsidiary to the parent's existing shareholders.
Explanation
Both a spin-off and a sale involve the divestiture of a subsidiary or some coherent subset of the firm's assets. In the case of a spin-off, the divestiture involves the distribution of the new firm's shares to the parent's existing shareholders. In the case of a sale, the divestiture is for cash.
A combination of two firms in the same line of business is called a:
congeneric merger. horizontal merger. vertical merger.
Explanation
A combination of two firms in the same line of business is a horizontal merger.
Insofar as reasons for divestitures are concerned, when a firm divests of assets because of rising costs or a change in consumer tastes, this is mostconsistent with therationale of:
assets no longer fitting the long-term strategy. a lack of profitability.
individual parts are worth more than the whole.
Explanation
ᅞ A) ᅚ B) ᅞ C)
Question #5 of 102
QuestionID:462767ᅚ A) ᅞ B) ᅞ C)
Question #
6
of 102
QuestionID:462829ᅞ A)
ᅚ B) ᅞ C)
Question #7 of 102
QuestionID:462851ᅚ A)
When Firm Aacquires Firm B, and, even though thereareno real economicgains resultingfrom the merger, Firm A's earnings per shareincrease, this is called:
compression. bootstrapping. synergies.
Explanation
Whenafirm acquires anotherfirm andits earnings per shareincrease, even though thereareno economicgains from the merger, this is calledearnings per sharebootstrapping.
Aconglomerateis most likely to participatein which type of merger? Diversifying merger.
Vertical merger. Horizontal merger.
Explanation
Conglomerates by definition invest in unrelated business lines.
Which of the following statements concerning valuation using discounted cash flow analysis of takeover candidates is least accurate?
An advantage is that the estimate is based on forecasts of fundamental conditions in the future rather than on current data.
Adisadvantageis that the model is difficult tocustomize.
Adisadvantageis that the model is difficult to apply whenfreecash flows are negative.
Explanation
An advantageof thediscountedcash flow valuation approach is that the model is relativelyeasy tocustomize.Both remaining statements arecorrect as presented.
ᅞ B)
ᅞ C)
Question #8 of 102
QuestionID:472530ᅞ A) ᅞ B) ᅚ C)
Question #9 of 102
QuestionID:462830ᅞ A)
ᅚ B)
ᅞ C)
Question #10 of 102
QuestionID:462813ᅞ A) ᅚ B)
In a stock offer, gains to the target shareholders aredependent upon the post-merger stock priceof the acquirer.
In a cash offer, the target shareholder's gains arecapped at the amount of the takeover premium.
Explanation
In a stock offer, the target shareholder's gains will generallyexceed thosefrom a comparablecash offer.This, ofcourse, depends upon the acquirer's stock pricefollowing the merger.But, if theexchangeratiois basedupon the acquirer's pre -merger price, andif the post-merger priceexceeds the pre-merger price, the target's gains from the stock offer shouldbe greater than thosefrom a cash offer.
Which of thefollowingis most likely tobeused todescribe a mergerbetweencompetitors? Verticalmerger.
Conglomerate merger. Horizontal merger.
Explanation
Horizontal mergers involvecompanies in the same lineofbusiness; generallycompetitors.
Which of thefollowing statements concerning valuationusingcomparablecompany analysis of takeovercandidates is least accurate?
A disadvantage is that it is difficult to incorporate merger synergies or changing capital structures into the analysis.
An advantageis that the approach implicitly assumes that the market's valuationof thecomparablecompanies is accurate.
An advantageis that data forcomparablecompanies is usuallyeasy to access.
Explanation
Thefact that the approach implicitly assumes that the market's valuationof thecomparablecompanies is accurateis a disadvantageif the assumptionis not correct.Both remaining statements arecorrect as presented.
When the target of anunwanted takeover turns the table and attempts to takeover thefirm attempting to acquireit, this is a: post-offer defense and is called the white squire defense.
ᅞ C)
Question #11 of 102
QuestionID:462772ᅞ A) ᅞ B) ᅚ C)
Question #12 of 102
QuestionID:462868ᅚ A) ᅞ B) ᅞ C)
Question #13 of 102
QuestionID:462835ᅚ A)
ᅞ B)
post-offerdefense andis calledgreenmail.
Explanation
When the target of a takeover turns the table and attempts to takeover thefirm making theoffer, this is called a pac-man defense.This is a post-offerdefense.
If a firm combines with oneofits suppliers orcustomers, it is called a: conglomerate merger.
horizontal merger. vertical merger.
Explanation
When a firm merges with a supplierorcustomer, it is a vertical merger.
When a parent company sells a subsidiaryor a coherent group of assets with a statedreason to provide a near-term infusion ofcash, which methodfor selling the assets is most likely?
Divestiture. Equitycarve-out. Spin-off.
Explanation
Spin-offs involve theissuanceof shares in thenew firm, anddonot generatecash for the parent company. Hence, this canbe ruledout if theintent is aninfusionofcash.Anequitycarve-out will generatecash for the parent when the publicofferingis completed, but this can take time.Adivestitureis typically a sale to anotherfirm forcash, andis likely tobecompleted much morequickly than a carve-out.Therefore, if theintent is to provide a near-term infusionofcash, a divestitureis most likely.
Which of thefollowingorderings is themost accurate with regard to the steps involvedin valuationusingcomparable transaction analysis?
Identify recent takeovers of comparable companies, calculate relative value measures, apply relative value measures to target firm.
Identifyrecent takeovers ofcomparablecompanies, calculaterelative value
ᅞ C)
Question #14 of 102
QuestionID:462781ᅞ A) ᅞ B) ᅚ C)
Question #15 of 102
QuestionID:462865ᅞ A) ᅚ B) ᅞ C)
Question #16 of 102
QuestionID:462779ᅞ A) ᅚ B) ᅞ C)
Identifycomparablecompanies, calculaterelative value measures, applyrelative value measures to target firm, estimate takeover premium, estimate takeover price.
Explanation
Thecorrect orderingis:identifyrecent takeovers ofcomparablecompanies, calculaterelative value measures, applyrelative value measures to target firm.Identifyingcomparablecompanies is not correct byitselfbecause theyneed to havebeen taken over.Thereis noneed toestimate the takeover premium because this will be present in therelative value measures forfirms that havebeen takenover.
Merger synergies areusuallyrealizedfrom: increasing market share.
merger taxbenefits.
decreasingcosts and/orincreasingrevenues.
Explanation
Theexistenceof synergies typicallyresult indecreases incosts for thecombinedfirm (e.g., the samedistributionnetwork can support both firms'retail networks) and/or anincreaseinrevenues (e.g., bycross-selling product lines).Both remaining responses are motivations forM&A activities, but donot result from therealizationof synergies.
Basedupon short-term stock performance around the mergerdate, academic studies concerning thedistributionof the benefits suggest that:
the target usually loses value, but the acquirer usually gains value. the acquirerusually loses value, but the target usuallygains value. both parties usuallygain value.
Explanation
Studies basedupon short-term stock performance around the mergerdate suggest that the acquirer loses a small amount of value, while the target makes significant gains.
Which of thefollowingis least likely a criticism of merging purelyfordiversification purposes? Diversification does not increase the overallvalue of the company.
Questions #17-22 of 102
ExplanationIncreasing the sizeof thefirm does not necessarilybenefit shareholders, but it wouldnot beconsidered a validcriticism. Increasing the sizeof thefirm is a potential benefit for managers becausediversificationreduces the threat of a takeover, and helps management further secure theiremployment.Both remainingreasons stated areeach validcriticisms of a
diversification merger.
GazelleBancorp was formed11years ago to address what its founders deemedunmet consumerneeds.Apparently, they werecorrect in their assessment, and Gazelle has grownrapidly as a niche player.This has attracted the attentionof theother banks inits market, andrumors are swirling that twoofits competitors arecontemplating takeoverbids for Gazelle.Thefirm's management has approached Omega Financial for adviceon strategies it canemploy should thefirm become a takeover target.
Ionnias Padras, CFA, has been assigned as the lead advisor to Gazelle's management.In advanceof theirinitial meeting, he has prepared a list ofquestions anddiscussion points. With this information he hopes tobuilt a coherent strategyeither tofend off the potential suitors or torealize maximum valuefor Gazelle's shareholders, should a takeoverbeconsummated.
During thecourseof his meeting with management, Padras asks thebank managers a series ofquestions, and the answers hereceived are providedbelow each question.
Q1: Wh
at
i
s
your grow
t
h r
at
e,
a
nd how doe
s
i
t
comp
a
re
t
o your po
t
en
t
i
a
l
a
cquirer
s
?
A1:
O
ur
profits
have
been
growing
at
a
rate
of
approximately
10
%
per
year,
while
our
potential
acquirers'
profits
have
been
growing
in
line
with
the
overall
economy,
which
is
about
3
to
4
%
per
year.
Q2:
D
o you h
a
ve
a
ny
ta
keover
d
efen
s
e
s
in pl
a
ce,
a
n
d
, if
s
o, wh
at
a
re
t
hey?
A
2:
We
have
establishe
d
a
set
of
compensation
arrangements
to
enhance
management's
security.
If
a
merger
were
to
occur,
our
top
7
management
personnel
would
each
be
paid
4
years
salary.
This
is
contingent
upon
the
managers
agreeing
to
remain
in
their
jobs
until
the
merger
is
completed.
Q
3
:
How m
a
ny b
a
nk
s
a
re oper
at
ing in
t
he m
a
rke
t
,
a
n
d
wh
at
a
re
t
heir m
a
rke
t
s
h
a
re
s
?
A3:
There
are
11
other
comparable
financial
institutions
in
our
market.
8
of
these
institutions
have
a
market
share
of
6
%
each,
3
of
them
have
a
market
share
of
15
%
each,
and
we
have
a
share
of
7
%
.
Potential
acquirer
1
has
a
share
of
15
%
,
while
potential
acquirer
2
has
a
share
of
6
%
.
Q
4
:
D
o you con
s
i
d
er
a
ny of your curren
t
compe
t
i
t
or
s
s
imil
a
r
t
o G
a
zelle? Were
t
here o
t
her b
a
nk
s
previou
s
ly
pre
s
en
t
in
t
he m
a
rke
t
t
h
at
h
a
ve been
ta
ken over recen
t
ly?
A4:
N
one
of
the
current
competitors
have
business
models
or
growth
rates
that
are
comparable
to
Gazelle.
There
are
three
previously
independent
institutions
that
have
business
models
and
growth
rates
similar
to
ours,
and
are
our
direct
competitors.
These
banks
were
taken
over
by
other
banks
within
the
past
3
years.
Question #17 of 102
QuestionID:462822ᅞ A) ᅞ B) ᅚ C)
Question #1
8
of 102
QuestionID:462823ᅞ A) ᅚ B) ᅞ C)
your bo
a
r
d
woul
d
a
gree
t
o
a
ta
keover if
t
he price were righ
t
?
A5:
Our
current
share
price
is
$
43,
and
there
are
50
million
shares
outstanding.
We
estimate
that
the
present
value
of
potential
cost
reductions
and
revenue
enhancements
for
an
acquirer
would
be
approximately
$
500m.
The
board
can
probably
be
convinced
to
accept
an
offer
it
believes
to
be
adequate.
Q
6
:
D
e
s
cribe
t
he
st
ruc
t
ure of your b
a
nking oper
at
ion
s
.
I
s
t
here
a
ny o
t
her cour
s
e of
a
c
t
ion
t
h
at
you woul
d
con
s
i
d
er
t
h
at
migh
t
m
a
ke
t
he b
a
nk le
ss
att
r
a
c
t
ive
as
a
ta
keover
ta
rge
t
?
A6:
Gazelle
is
a
combination
of
a
traditional,
full
service
bank,
and
a
24/7
provider
of
personal
financial
services.
For
example,
we
have
been
able
to
obtain
exclusive
agreements
with
the
2
largest
grocery
chains
in
our
market
to
open
branch
offices
in
their
stores.
We
have
similar
agreements
with
other
24/7
retail
establishments,
and
consumers
have
found
the
ability
to
bank
at
any
time
of
the
day
extremely
attractive.
We
believe
that
this
is
the
part
of
Gazelle
that
our
prospective
suitors
are
seeking.
Based upon theinformation provided to Padras, does it appear that the potential suitors are seeking tobootstrap their earnings? What stageof theindustry lifecycleis Gazellemost likelyin?
Bootstrap Earnings Industry Life Cycle
Yes Rapid growth
No Rapid growth
No Maturegrowth
Explanation
Inorderforbootstrapping tooccur, a high price-to-earnings (P/E)firm needs to acquire a low P/E firm. In this case, based upon therelativegrowth rates, theoppositeis likely tobe true. Gazelleis most likelyin the maturegrowth stage. In this stage, competitionis present, but thereis still opportunityfor above averagegrowth.During therapid growth stage, competitionis more limited than appears tobe thecasefor Gazelle. (Study Session9, LOS 29.d)
What typeof take-over defense does Gazelle havein place, and is this likely tobe sufficient tofend off a potential suitor? Take-OverDefenseDefense Sufficient?
Greenmail No Golden parachute No Golden parachute Yes
Question #19 of 102
QuestionID:462824ᅞ A)
ᅚ B)
ᅞ C)
Question #20 of 102
QuestionID:462825ᅞ A) ᅞ B) ᅚ C)
Question #21 of 102
QuestionID:462826ᅞ A) ᅚ B) ᅞ C)
Thecompany has a golden parachute packagein place. If thecompensationfor the top 7 managers averaged $500,000, the total cost of thegolden parachuteis $14m. This is probablynot sufficient to deter a bidder.Conversely, to theextent that it helps keep management in place during the acquisition, it may make Gazelle more attractive as an acquisitioncandidate. (Study Session9, LOS 29.f)
Ifboth of the prospective acquirers were to makebids, what are the probable antitrust ramifications for potential acquirer1 and potential acquirer 2, respectively?
Antitrust action virtually certain because change in HHI is greater than 100; small chance of antitrust action because change in HHI is less than 50. Good chanceof antitrust actionbecausechangein HHI is greater than100; small chanceof antitrust actionbecausechangein HHI is less than100.
Nochanceof antitrust actionbecausechangein HHI is less than100; nochanceof antitrust actionbecausechangein HHI is less than 50.
Explanation
Based upon the market share data provided, theinitial HHI valueis:
If acquirer1 were successful, thenew HHI = 1222 (anincreaseof 210). This indicates a good chanceof an antitrust challenge. If acquirer 2 were successful, thenew HHI = 1096 (anincreaseof 84). This indicates a small chanceof an antitrust challenge. (Study Session9, LOS 29.g)
Based upon theinformation provided, what typeof valuation methodologyis most likely tobeused by the potential acquirers? Discounted cash flow.
Comparablefirm.
Comparable transaction.
Explanation
Since there arenocomparable direct competitors in the market, comparablefirmanalysisis unlikely. Discountedcashflow analysisis a viable possibility. However, given that there havebeen 3 comparable transactions over the past 3 years, this argues stronglyinfavorof a comparabletransaction valuation methodology. (Study Session9, LOS 29.h)
What is the probable pricerangefor anofferfor Gazelle? Ifoneof the acquirers makes anofferof$55, should theboard accept it?
Question #22 of 102
QuestionID:462827ᅞ A)
ᅚ B) ᅞ C)
Question #23 of 102
QuestionID:462811ᅞ A) ᅚ B) ᅞ C)
Question #24 of 102
QuestionID:462837Explanation
The probable pricerangeis thecurrent market price to thecurrent price + the valueof the synergies. That is, $43 to$43 + 500m / 50m = $53. If theyreceive anoffergreater than$53, theboard should accept. (Study Session9, LOS 29.k)
If Gazelle were to separateitselfinto two parts, the traditional bank and the 24/7 bank, and to sell off the 24/7 bank in a public offering, what would the actionbecalled from the standpoint of the sale and from the standpoint of a takeover defense?
Sale TakeoverDefense
Equity carve-out Leveraged recapitalization defense
Equitycarve-out Crown jewel defense Split-off Crown jewel defense
Explanation
A publicofferingof a subsidiary as a stand-aloneenterpriseis called anequitycarve-out. Using this technique tofend off a mergeris known as a crown jewel defense. (Study Session9, LOS 29.n)
Duringnegotiations over the method of payment tobe madeby the acquirer, which of thefollowingissues would leastlikelybe considered?
The distribution of the risk and reward from the transaction. Therelative tax-effect on the acquiringfirm's shareholders. Therelative valuations of thefirms involved.
Explanation
The method of payment is not likely to have any direct tax-effect on the acquiringfirm's shareholders, but mayon the target's shareholders.Both remaining answers areissues that should beconsidered during the determinationof payment method.
An analyst has identified threecompanies that theybelieve arecomparable to a firm underevaluation as a takeover candidate. Therelative value measures they have selected are price-to-earnings (P/E) and price-to-cash flow (P/CF). The market price, earnings per share, and cash flow per share, foreach company, respectively, are:
Market Price EPS CF per Share Company
A 55 4.80 6.26
Company
ᅚ A) ᅞ B) ᅞ C)
Question #25 of 102
QuestionID:462831ᅞ A) ᅞ B) ᅚ C)
Question #2
6
of 102
QuestionID:462777ᅚ A) ᅞ B) ᅞ C)
Question #27 of 102
QuestionID:462780B
Company
C 19 1.80 2.10
What values for theseratios should be applied to the target firm?
P/E= 11.5x, P/CF = 9.1x. P/E = 11.9x, P/CF = 9.0x. P/E = 12.5x, P/CF = 8.9x.
Explanation
Gambit Enterprises is beingevaluated as an acquisition target.An analyst believes that thefirm will havefreecash flow (FCF)
of$500m duringyear 5, after which thegrowth ratein FCF is expected tobe4%indefinitely. The weighted averagecost of capital (WACC)for Gambit is 10%. What is theestimated valueof thefirm at theend ofyear 5?
$8333m. $9167m.
$8667m.
Explanation
Value at end ofyear 5 = (FCF year 5 × (1 + g)) / (WACC - g) Value at end ofyear 5 = (500 × 1.04) / (0.10 - 0.04) = $8667m
Which of thefollowingis NOT a commonlyused mergerclassification describingforms ofintegration? Regulatory merger.
Subsidiary merger.
Consolidation.
Explanation
ᅚ A) ᅞ B) ᅞ C)
Question #2
8
of 102
QuestionID:462794ᅞ A) ᅞ B) ᅚ C)
Question #29 of 102
QuestionID:462818ᅞ A) ᅚ B) ᅞ C)
Achievinginternational business objectives is sometimes used as therationalefor a merger. Which of thefollowing areleast likely tobe valid objectives that canberealized from a cross-border merger? The merger:
achieves a reduction in exchange rate exposure.
gives the acquiringfirm the ability touse technologyinnew markets. provides the ability to work around tradebarriers.
Explanation
Ingeneral, a cross-border mergeris likely toincrease the acquiringfirm's exchangerateexposure.Both remaining statements are valid arguments in support of a cross-border merger.
Use thefollowing data tocalculate the EPS of thecombined firm following the merger. Topeka Industries has EPS of$4.00, a market priceof$90 per share, and 500,000 shares outstanding. Omaha Company has EPS of$2.00, a market priceof$25, and 500,000 shares outstanding. If Topeka acquires Omaha in an all-stock transaction, what is the EPS of thecombined company?
$3.00. $3.57.
$4.70.
Explanation
The total valueof Omaha is $25 × 500,000 = $12,500,000. Topeka will need toissue12,500,000 / 90 = 138,889new shares to acquire Omaha. Thecombined firm will have total earnings of ($4 × 500,000) + ($2 × 500,000) = $3,000,000. Thecombined firm will have EPS = $3,000,000 / (138,889 + 500,000) = $4.70.Note that the pre-merger P/E ratiofor Topeka was 90 / 4 = 22.5, vs. 25 / 2 = 12.5 for Omaha.
In the advanced widget industry, there are10firms, each with the same market share. Twoof thefirms arecontemplating a merger. What is the likely antitrust action, and which U.S.federal regulatory agencyis responsiblefor taking any action deemed necessary?
Certain challenge; Federal Trade Commission. Possiblechallenge; Federal TradeCommission. Possiblechallenge; CommerceDepartment.
Explanation
Question #33 of 102
QuestionID:462873ᅞ A) ᅚ B) ᅞ C)
Question #34 of 102
QuestionID:462768ᅞ A) ᅞ B) ᅚ C)
Question #35 of 102
QuestionID:462809ᅞ A)
ᅚ B)
ᅞ C) Explanation
The merger price should fall within therangeof the pre-merger valueof the target ($1,600m) and the pre-merger value plus theestimated synergies ($2,300m). Since the acquireris confident that the synergies will be$700m orgreater, they will most likely seek to payincash so that theycapture anyupsidefor themselves.
Regarding divestitures as corporaterestructuring, when a firm divests of assets becauseof a desire tofocus onits core business, this is mostconsistent with therationaleof:
individualparts being worthmore than the whole. assets no longerfitting the long-term strategy. lack of profitability.
Explanation
A stated desire tofocus on thefirm's corebusiness indicates that the assets being sold arenot a part of thecorebusiness. Thus, the assets no longerfit the long-term strategy.
Acombinationof twofirms inentirely different industries is called a:
verticalmerger. horizontal merger. conglomerate merger.
Explanation
When twofirms inentirely different industries merge, it is called a conglomerate merger.
When the attitudeof the target firm's management is unfriendly with regard to the proposed merger, which of thefollowing statements is most accurate? Theofferis said tobe:
antagonistic, and the acquirer can resort to a proxy battle to persuade the target firm's shareholders, or a tender offer to replace members of the target's board of directors.
hostile, and the acquirercanresort to a tenderoffer to the target firm's shareholders, or a proxybattle toreplace members of the target's board of directors.
Question #3
6
of 102
QuestionID:462814ᅚ A) ᅞ B) ᅞ C)
Question #37 of 102
QuestionID:462782ᅞ A)
ᅚ B)
ᅞ C)
Question #3
8
of 102
QuestionID:462783ᅞ A) ᅚ B) Explanation
If the acquirer persists in pursuing a merger when the target's management is unfriendly to theconcept, theofferis said tobe hostile. In such a case, the acquirergenerally attempts togo around management and negotiate with the shareholders of the target directly. This usually takes theform of a tenderoffer to purchase the target's stock from existing shareholders, or a proxycontest in which the acquirer seeks toconvince the target's shareholders toreplace theboard of directors with a slate morefriendly to theconcept of merging with the acquirer.
A takeover defense that allows thefirm's existing shareholders to purchase additional shares of thecompany's stock at attractive prices is a:
pre-offer defense and is called a poison pill. pre-offer defense and is called a poison put. post-offer defense and is called greenmail.
Explanation
When thefirm's existing shareholders are allowed to purchase additional shares of stock at a significant discount to thecurrent market pricein an attempt to thwart a takeover, this is called a poison pill defense. This is a pre-offer defense.
Which of thefollowing statements concerningM&A activityis most accurate? Mergers based upon a desire to diversifyusually do:
not make sense from the shareholders' standpoint, and do not make sense from the management's standpoint.
not make sensefrom the shareholders' standpoint, but may make sensefrom the management's standpoint.
make sensefrom the shareholders' standpoint, and alsousually make sensefrom the management's standpoint.
Explanation
Mergers predicated upon theneed to diversify areusuallynot sensiblefrom the shareholders' perspective, because theycan easily diversify theirinvestments by holding shares in multiplefirms. Such mergers may make sensefor management, becausecompensationis often positivelycorrelated with firm size.
Which of thefollowing motives for mergers leastlikely makes economic sense? Surplus funds and vertical integration.
ᅞ C)
Question #39 of 102
QuestionID:462850ᅚ A) ᅞ B) ᅞ C)
Question #40 of 102
QuestionID:462838ᅞ A)
Complementaryresources and eliminatinginefficiencies.
Explanation
Diversification does not makeeconomic senseforcompany shareholders. It is much easier and cheaperfor the shareholders to diversify simplybyinvestingin the shares ofunrelated companies themselves rather thanexpend the time and resources necessary togo through a merger. Similarly, merging to simplyreducefinancingcosts is a misplaced argument since the lowercost of debt financing arises becauseof thegreater security afforded bondholders.
Big Steel is considering making a bid for Small Steel. Thefollowing data applies to the analysis:
Big Steel Small Steel Pre-merger stock price $75 $100
Number of shares outstanding 500m 40m
Pre-merger market value $37,500m $4,000m Estimated synergies $600m
IfBig Steel buys Small Steel byexchanging1.45 shares ofits stock foreach shareof Small Steel, what are thegains toBig Steel and Small Steel, respectively?
Big Steel Small Steel
$223.9m $376.1m
$100.8m $491.3m $246.2m $353.8m
Explanation
Value after takeover = $37,500 + $4,000 + $600 = $42,100m. Shares exchanged for Small Steel = 1.45 × 40m = 58m.
Post-takeover share price = value after takeover / shares outstanding = 42,100m / 558m = $75.45.
Takeover price = numberof shares to small steel × post-takeover share price = 58m × $75.45 = $4,376.1m. Gains to Small Steel = takeover premium = $4,376.1 - $4,000 = $376.1m.
Gains toBig Steel = synergies - takeover premium = $600 - $376.1 = $223.9m.
Which of thefollowingorderings is most accurate with regard to the steps involved in valuationusingcomparablecompany analysis?
Identify comparable companies, apply value measures to target firm, calculate relative value measures, estimate takeover premium, and calculate the
ᅞ B)
ᅚ C)
Question #41 of 102
QuestionID:462828ᅞ A)
ᅚ B)
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Question #42 of 102
QuestionID:462841ᅞ A)
Calculaterelative value measures, identifycomparablecompanies, apply value measures to target firm, estimate takeover premium, and calculate theestimated takeover price.
Identifycomparablecompanies, calculaterelative value measures, apply value measures to target firm, estimate takeover premium, and calculate theestimated takeover price.
Explanation
Thecorrect orderingis identifycomparablecompanies, calculaterelative value measures, apply value measures to target firm, estimate takeover premium, and calculate theestimated takeover price.Note that theestimationof the takeover premium could be done at any point prior to thefinal step, but theotherfour steps are sequential.
Which of thefollowing statements concerning valuationusingcomparable transaction analysis of takeovercandidates is least accurate?
An advantage is that estimates of value are derived directly from actual transactions, rather than from assumptions and estimates about the future. A disadvantageis that since the approach uses data from actual transactions, it can be difficult toestimate the takeover premium.
An advantageis that byusingreal transactions data as thebasis ofevaluation, the risk offuture litigationconcerning the proposed takeover priceis reduced.
Explanation
Thefact that the approach uses data from actual transactions is an advantage, sinceit is not necessary toestimate the takeover premium.Both remaining statements arecorrect as presented.
Thequick changeoil industry has beenin a consolidation phasefor about a decade, during which time thenumberoffirms has shrunk from more than 50 to15.An analyst is evaluatingoneof theremaining15 firms as an acquisition target, and has comeup with thefollowingestimated acquisition prices:
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t
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d
s
of An
a
ly
s
i
s
Price per Sh
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re
D
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s
coun
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d
C
F
$
5
0
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a
ble
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$
48
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ion
$
57
Under thecircumstances, which of theseestimates is mostlikely torepresent theultimate acquisitioncost, and why? Discounted cash flow(CF), because this considers expectations for the future
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Question #43 of 102
QuestionID:462819ᅞ A) ᅚ B) ᅞ C)
Question #44 of 102
QuestionID:462817ᅚ A)
ᅞ B) ᅞ C)
Comparablecompany, because thereis a largeenough sample toensure that valuationis correct, on average.
Comparable transaction, because a sufficient numberof transactions haveoccurred forintrinsic value toberelatively well-understood by market participants.
Explanation
Given the largenumberof acquisitions that haveoccurred in theindustry, comparable transactionis likely to provide the most reliableestimateof theultimate acquisition price.Comparablecompany analysis is certainly a viable method toestimate value, but still requires the analyst toestimate the takeover premium. This step is unnecessary whenusing thecomparable
transaction approach.Discounted CF valuationis also a viable method, but, in the presenceofnumerous comparablefirms and transactions, logic suggests that the market-based valuation provided by thecomparable transaction approach is more likely to produce superiorresults.
The threebroad index valuecategories for the post-mergercompetitiveness of anindustry, based upon the Herfin dahl-Hirschman Index, are:
Less than 1000, between 1000 and 2000, and greater than 2000. Less than1000, between1000 and 1800, and greater than1800. Less than900, between900 and 1800, and greater than1800.
Explanation
The threebroad valuecategories for the post-mergercompetitiveness of anindustry, based upon the HHI index are less than 1000 (competitive), between1000 and 1800 (moderatelyconcentrated), and greater than1800 (highlyconcentrated).
Froogal Inc.operates in anindustry where thecurrent Herfindahl-Hirschman Index (HHI)is at 1,500. Thecompanyis considering merging with a competitor that would increase the HHI by 75. Is the merger likely to attract anti-trust action?
No, because the industry pre-merger is considered moderately concentrated and the change in the HHI is less than 100.
Not enough information about thenumberofcompetitors.
Yes, because theindustry pre-mergeris considered highlyconcentrated and the changein HHI is greater than 50.
Explanation
If the post-merger HHI is less than1,000, theindustryis considered competitive and an antitrust challengeis unlikely.A po st-merger HHI valuebetween1,000 and 1,800 will place theindustryin themoderatelyconcentratedcategory. In this case, regulators will compare the pre-merger and post-merger HHI. If thechangeis greater than100 points, the mergeris likely to bechallenged on antitrust grounds.A post-merger HHI calculationgreater than1,800implies a highlyconcentrated industry.
Question #45 of 102
QuestionID:462806ᅞ A) ᅞ B) ᅚ C)
Question #4
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QuestionID:462842ᅚ A) ᅞ B) ᅞ C)
Question #47 of 102
QuestionID:462804ᅞ A) ᅞ B) ᅚ C)
When anindustry has reached the stabilization stage, themostcommon typeof mergeris:
vertical. conglomerate. horizontal.
Explanation
In the stabilization stage, companies typically seek mergers toimproveeconomies of scale. Horizontal mergers are the most common as strongercompanies acquire weakercompanies toexpand market share and reducecosts.
An analyst has identified threecompanies that haverecentlybeen takenover which theybelieve arecomparable to a firm underevaluation as a takeovercandidate. Therelative value measures that they have selected are the price-to-earnings (P/E) and price-to-cash flow (P/CF), and the average values of theseratios are11.2 and 8.6. The target firm has earnings per share of$2.45, and cash flow per shareof$3.05. What is theestimated takeover price per share?
$26.84.
$27.44.
$26.23.
Explanation
Theestimated valuebased upon P/E is $27.44 = (2.45 × 11.2). Theestimated valuebased upon P/CF is $26.23 = (3.05 × 8.6).
Theestimated takeover priceis the averageof these two values:$26.84.
The Larson Trust holds a broad portfoliooffirms. Oneof the Trust's holdings, Music World, is growing at roughly the same, or slightly slowerrate as theoverall economy. The Trust is considering selling thefirm. What stageof theindustry lifecycleis Music World most likelyin, and which method of selling thefirm is most probable?
Stabilization phase, equity carve-out. Decline phase, divestiture.
Stabilization phase, divestiture.
Explanation
Question #4
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QuestionID:462778ᅞ A) ᅞ B) ᅚ C)
Question #49 of 102
QuestionID:462869ᅚ A)
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GroganMedical Devices (GMD)is a leading manufacturerofcardiac treatment devices including defibrillators and pacemakers. Over the last three months, problems havebeen discovered with a GMD defibrillator model, resultingin a massive product recall.As a result of therecall, and the potential impact onfuture sales, the priceof GMD's stock dropped to its current level of$18 per share.
As a result of the drop in the priceof the stock, twofirms haveexpressed interest in acquiring GMD. PaulsgroveCorporation (Paulsgrove)is a large health careconglomerate with businesses inconsumer products, pharmaceuticals, and cardiac treatment devices. The management team at Paulsgrove sees a merger with GMD as a means tocombineits current defibrillator and pacemakeroperations with thoseof GMD, creating the worldwide leaderin those two product lines.
Bailey Scientific (Bailey)is a specialty manufacturerof stents used toopenclogged arteries during heart surgery.Bailey sees a merger with GMD as a natural extensionofits existing heart treatment product line, and believes usingits existing stent product specialists to also market defibrillators and pacemakers could result in significant cost savings. They alsobelieve that there would bebenefits from expanding the sizeofBailey's operations.
What would be thebest descriptionof the typeof mergerif GMD were to merge Paulsgroveorif GMD were to merge with Baileyrespectively?
Merger with PaulsgroveMerger with Bailey
Horizontalmerger Verticalmerger Conglomerate merger Horizontal merger Horizontal merger Horizontal merger
Explanation
Either a merger with Paulsgroveor a merger with Bailey would be described as a horizontal merger. In a horizontal merger, the twobusinesses operatein the sameor similarindustries. Even though Paulsgroveis already a conglomeratefirm, the purposeof the merger would be tocombine Paulsgrove's existing defibrillator and pacemakerbusiness with that of GMD.A merger with Bailey would alsobeconsidered a horizontal merger as the twofirms operatein similarindustries.Note that the primarybenefit foreither PaulsgroveorBaileyis economies of scale, which is typically the strategybehind a pure horizontal merger. With a vertical merger, a firm moves up or down the supplychain (i.e., acquiring a firm that makes theequipment to make pacemakers, orbuying a hospital to distribute the products). With a conglomerate merger, thebusinesses operatein separateindustries.
The differencebetween a spin-off and a split-offis that in a spin-off:
the parent's existing shareholders receive shares in the new firm on a pro-rata basis,whereas they must surrender their shares in the parent to obtain shares of the new firm in a split-off.
ᅞ C)
Question #50 of 102
QuestionID:462796ᅞ A) ᅚ B)
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Questions #51-5
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the parent's existing shareholders must surrender their shares in the parent toobtain shares of thenew firm, whereas theyreceive shares in thenew firm on a pro-rata basis in a split-off.
Explanation
In a spin-off, shares of thenew firm are distributed to the parent's existing shareholders on a pro-rata basis. In a split-off, the parent's existing shareholders must surrender their shares in the parent toobtain shares in thenew firm.
Ingeneral, inorderforearnings per sharebootstrapping tooccur, which of thefollowingis most accurate? The P/E ratio of the target must be greater than that for the acquirer.
The price-to-earnings (P/E)ratioof the acquirer must begreater than that for the target.
Thenet incomeof the target must begreater than that for the acquirer.
Explanation
Inorderforearnings per sharebootstrapping tooccur, the P/E ratioof the acquirer must begreater than that for the target.
Clothing Treeis a Milan-based holdingcompany. The holdingcompanycomprises individual firms with uniquebrands that produce and sell products rangingfrom infant and children's clothing, tofashion wear, to work uniforms, toundergarments. Thefirm's founder and chairman, RomanoNocci, says that "since we assume that people will continue to wearclothes, we continue tobelieve that this is a good business for the long haul."
However, in spiteof his overall beliefin the soundness of theclothing market, herealizes that tastes and fashions change, and believes that thefirm should constantlybeon the lookout for suitablecandidates to add to theClothing Treeempire. He also believes that it may make sense torestructure thefirm bycreating a new holdingcompany, Family Tree, toown theClothing Tree plus twonew divisions-Food Tree and Drug Tree.
The Food Tree would be a holdingcompanyformed to acquirecompanies in all phases of thefood business. TheDrug Tree would be a holdingcompanyformed to acquirecompanies in all phases of thenon-prescription pharmaceuticals market.Both of these product lines arenecessarygoods, soNoccibelieves that they would fit well with thefirm's existingclothing
businesses.
To help implement this acquisition strategy, Nocci has hired Zurich Investment Advisers.Armando Palocci, CFA has been assigned tobe the lead advisorin this effort. When Palocci and his team met with Nocci and other key Tree managers, they discussed a wide-ranging set of subjects relating to thenascent acquisition plans. These discussions are summarized in the paragraphs below.
Question #51 of 102
QuestionID:462844ᅞ A) ᅚ B) ᅞ C)
Question #52 of 102
QuestionID:462845ᅞ A)
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Question #53 of 102
QuestionID:462846Does the Tree want to avoid firms that have takeover defenses in place? If so, which types of defenses? Nocciresponds that he "would prefer to avoid firms that have pre-offer defenses, such as poison pills and pac-man defenses in placebecause these make thecost of an acquisition prohibitive. However, if a firm has shown a willingness to paygreenmail in the past, he would not be averse to testing the management againon this count."
Someof the acquisition targets will likely havebusiness interests in the U.S. and Canada, as well as Europe. Palocci describes toNocci how industryconcentrationis measured in the U.S., and what might cause an acquisition tobechallenged on antitrust grounds.Nocciindicates that whetherornot it makes sense torun therisk of an antitrust challenge will depend, in part, on the potential gains from the merger. Thus, they must beevaluated on a casebycasebasis.
Palocci and Nocciconclude their discussions with a review of acquisition target valuation methods, theevidenceconcerning the distributionof mergerbenefits, and strategies that thefirm might employifit were to purchase a firm with several divisions, someof which it does not wish to keep.
If Food Treeis successful in purchasing a food companyfor which it maintains thefirm's existingidentity and brands, thefirst such purchase would beclassified as a:
subsidiary,horizontalmerger. subsidiary, conglomerate merger. statutory, conglomerate merger.
Explanation
Thefirst food company, beingin anentirely different business from clothing, would have tobeconsidered a conglomerate merger. Thefact that thefirm intends to maintain the target's identity afterit is acquired indicates that it would beconsidered a subsidiary merger. (Study Session9, LOS 29.a)
With regard toNocci's descriptionof the types of takeover defenses he would prefer to avoid, heis: incorrect with respect to the poison pill defense, and incorrect with respect to the pac-man defense.
correct with respect to the poison pill defense, and correct with respect to the pac-man defense.
correct with respect to the poison pill defense, but incorrect with respect to the pac -man defense.
Explanation
Nocciis correct with respect to the poison pill defense. It is a pre-offer defense that can make an acquisition prohibitively expensive. The pac-man defenseis a post-offer defense. It involves the acquisition target turning the table and attempting to acquire thefirm that is making theoffer. (Study Session9, LOS 29.f)
ᅚ A)
ᅞ B) ᅞ C)
Question #54 of 102
QuestionID:462847ᅚ A) ᅞ B) ᅞ C)
Question #55 of 102
QuestionID:462848ᅞ A) ᅚ B) ᅞ C)
Question #5
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QuestionID:462849quantitative measure of industry concentration, but that the issue is not clear -cut.
qualitative measureofindustryconcentration, but that theissueis not clear-cut. quantitative measureofindustryconcentration, and that theissueis clear-cut once the changein the measureis known.
Explanation
Palocci should have told him that the decision tochallengeis based upon a quantitative measureofindustryconcentration, but that theissueis not necessarilyclear-cut. (Study Session9, LOS 29.g)
Food Treeis likely to have toevaluate potential acquisition targets that are temporarilyexperiencingfinancial distress or earnings problems that canbe solved with an applicationof the Tree's financial strength and management expertise. That said, thefood industry, by and large, consists offirms that haverelatively predictablerevenue and cost patterns, and the level ofinvestment risk is well-understood.All elsebeingequal this set ofcircumstances would seem to arguefor which of the following valuation approaches?
Discounted cash flow. Comparablecompany.
Comparable transaction.
Explanation
If a firm is infinancial distress orexperiencingearnings problems, this will makeit difficult to apply thecomparablecompanyor comparable transaction approaches. However, if thefirm canberestored to health and futurecash flows and risks arefairly predictable, this implies that discounted cash flow valuation may provide thebest results. (Study Session9, LOS 29.i)
Suppose that Drug Tree has identified threecomparablecompanies relative to a target underevaluation. The valuation metric is price to sales (P/S). The threecomparablecompanies have P/S ratios of 2.17, 1.98, and 2.09. The target has sales of 600m. What valueof the P/S should be applied to the target, and what is theestimated value?
P/S Estimated Value
2.17 1302m 2.08 1248m 1.98 1188m
Explanation
ᅞ A)
ᅞ B)
ᅚ C)
Question #57 of 102
QuestionID:462866ᅞ A) ᅞ B) ᅚ C)
Question #5
8
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QuestionID:462834ᅞ A) ᅚ B)
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Palocci advises that if the Food Tree purchases a firm that includes a division that does not fit the Tree's strategic plan, the firm can sell the division via divestiture, equitycarve-out, spin-off, or split-off. However, he tells Nocci that only the divestiture will provide Food Tree with cash aftercompletion, because theothers all involve the distributionof stock in the division. Palocci's adviceis:
incorrect with respect to the alternatives, and incorrect with respect to the provision of cash.
correct with respect to the alternatives, and correct with respect to the provisionof cash.
correct with respect to the alternatives, but incorrect with respect to the provisionof cash.
Explanation
Palocci's list of methods is correct for a goingconcern (liquidationis also anoptionif thefirm is infinancial distress, which is assumed not tobe thecase here). However, heis incorrect with respect to the provisionofcash.Anequitycarve-out will also generatecash, via the publicofferingof shares in the division.A spin-offor split-off will not generatecash for Food Tree. (Study Session9, LOS 29.n)
Which of thefollowingcharacteristics is leastlikely tobeindicativeof a merger and acquisition transaction that creates value for the acquirer?
The initialmarket reaction is favorable. Thebuyeris strong.
Thenumberofbidders is high.
Explanation
AnM&A transaction where thenumberofbidders is low (not high) points to anM&A transaction that creates value. Past empirical results suggest that M&A deals create value when1) thebuyeris strong, 2) transaction premiums are low, 3) the numberofbidders is low, and 4) theinitial market reactionis favorable.
Felix Hernandez is evaluating a prospective mergerbetween twofirms ofrelativelyequal size. The acquireris planning to borrow theentire purchase price and payfor the mergerincash. Which method ofestimating the target's intrinsic value and potential merger synergies is likely tobemostuseful?
Comparable company analysis because the values are market-based.
Discounted cash flow analysis becauseit will allow him toincorporatechanges in the capital structure and cost ofcapital that are likely toresult from the way the acquirer intends toraise thefunds to payfor the target.
