Ch. 31: Mergers Flashcards
What are the three types of mergers?
Horizontal mergers
Vertical mergers
Conglomerates mergers
A merger taking place between two firms in the same line of business: competing companies is a ____
Horizontal merger
A merger involving companies at different stages of production i.e. the buyer expands back toward the source of raw materials or forward in the direction of the ultimate consumer is a _____
Vertical merger
A merger involving companies in unrelated lines of business, and one that has no effect on the operations or profitability of either firm is a ___
Conglomerate merger
In a merger, the prevalent possible source of added value is termed ____
Synergies
It is often easier to predict synergies than it is to realize them
True/ False
True
One of the sensible motives for mergers is synergies leading to economies of scale. Which of the following is NOT a source of economies of scale?
A) cost savings through e.g., shut-down of less efficient departments and lower labor costs
B) industry consolidation and higher market power
C) larger bargaining power
D) sharing of central services
B) industry consolidation and higher market power
This is another sensible motive for mergers, but not economies of scale
Vertical integration facilitates co-ordination and administration When two parts of an operation are highly dependent on each other, it often makes sense to combine them into a vertically integrated firm.
This “sensible” motive for merger is termed ____
Economies of vertical integration
Firms with a surplus of cash and a shortage of good investment opportunities often turn to mergers financed by cash as a way of redeploying their capital. I.e., this is a case of surplus funds.
Is this a sensible or dubious motive for merger?
Sensible
Which of the following is NOT a sensible motive for merger?
A) Economies of scale
B) Economies of vertical integration
C) Complementary resources
D) Surplus funds
E) Elimination of inefficiencies
F) Diversification
G) industry consolidation
F) Diversification
This is classified as a dubious motive
Why is diversification a dubious reason for merger?
Merging for the sake of diversification is not a good motive, since diversification is easier and cheaper for the stockholder themselves than for the corporation –> stockholders are not willing to pay a premium for diversified firms; in fact, discounts are more common.
Which of the following statements are not true for the bootstrap effect
A) mergers with the goal of achieving the bootstrap effect is categorized as dubious
B) the effect relates to when a merger happens through stock acquisition leading to a higher EPS without any real gain created by the merger
C) the bootstrap game generates earnings growth, not from capital investments or improved profitability, but simply from purchase shares of slowly growing firms with low P/E ratios
D) leads to lower financing costs
D) leads to lower financing costs
Why is lower financing costs obtained from a merger categorized as a dubious motive for merger? One of the following options are wrong
A) lower financing costs is difficult to realize in practice from a merger
B) shareholders gain from a lower interest rate by guaranteeing the other entity’s debt, giving bondholders better protection. Therefore, there is no net gain
C) lower financing costs never leads to a net gain
Wrong: C) lower financing costs never leads to a net gain
Merging decreases the probability of financial distress, which can increase borrowing capacity. The corresponding higher value from interest tax shields CAN lead to a net gain from the merger
The market’s presence or absence of anticipation of the merger can have a significant impact on the price that the acquirer ends up paying for the target
True/ False
True
If the acquirer is optimistic and believes that the share price of the combined entity will be higher than initially anticipated, the preferred payment method is:
A) stock
B) cash
B) cash
if acquirer management is optimistic, and believes that the share price of the merged entity will be higher than initially anticipated – because corresponding gain in a market correction will fall entirely on A’ stockholders
If acquirer is pessimistic and believes that the share price of the merged entity will be lower than initially anticipated, the preferred payment method is:
A) stock
B) cash
A) stock
because corresponding loss in a market correction will fall partly on B’s stockholders, where if payment was with cash, the entire loss would fall on stock A shareholders
The Antitrust law generally states that acquisitions are forbidden whenever the effect “may be substantially to lessen competition, or to tend to create a monopoly.”
True/ False
True
What are the three forms of acquisition?
1) merge two companies into one
2) buy the seller’s stocks in exchange for cash, shares or other securities
3) buys some or all of the seller’s assets
When a company assumes all assets and all liabilities of the target firm, such an acquisition must be approved by a least 50% of the stockholders of each firm.
Which form of acquisition is this?
Merging two companies into one
Ownership of the assets is transferred, and payment is made to the selling firm rather than directly to its stockholders.
Which form of acquisition is this?
Buying the seller’s assets
In the acquisition form: buying the seller’s stocks, which of the following statements is not true?
A) stocks of the target is bought in exchange for cash, shares, or other securities
B) the buyer can deal individually with the shareholders of the selling company
C) the seller’s management must approve the acquisition
Wrong: C
The seller’s management may not be involved at all - even thought the approval and cooperation is sought, the acquisition can be complete without. In this case, the buyer can attempt to acquire an effective majority of the outstanding shares, and if successful, gain control and complete the acquisition
The purchase price in excess of the target’s book value are to be assigned/ reported on the asset side of the balance sheet as _____
Goodwill
Which of the following statements is not true about goodwill?
A) the acquiring firm is obliged to estimate the fair value of goodwill every year
B) if the estimated goodwill value falls below the book value reported goodwill value on the B/S, it is “impaired”
C) goodwill impairment means that the balance sheet value of goodwill must be adjusted upwards
D) the write-off in the case of goodwill impairment must be deducted from the year’s earnings on the P&L statement
Wrong:
C) goodwill impairment means that the balance sheet value of goodwill must be adjusted DOWNWARDS
Impairment means that some goodwill value on B/S is to be written off and deducted from that year’s earnings
Tax considerations in an acquisition:
If an acquisition payment is in the form of cash, it is regarded as:
A) tax deductible
B) taxable
B) taxable
In this case, the selling shareholders are treated as having sold their shares, and must pay tax on any capital gains
In a taxable acquisition, the assets of the selling firm are revalued, with the resulting write-up or write-down being treated as a taxable gain or loss, and tax depreciation is recalculated on the basis of the restated asset values.
True/ False
True
If the acquisition payment is largely in the form of shares, the acquisition is:
A) tax-free
B) taxable
A) tax-free
The shareholders are viewed as exchanging their old shares for similar new ones - no capital gains or losses are recognized
After a tax-free (stock-based) acquisition, the merged firm is taxed as if the two firms had always been together
True/ False
True
If a country does not have a territorial tax system, meaning that profits earned overseas are also taxed at the home country’s rate, which incentive implications doe this have on domestic firms?
A) it creates an incentive for foreign firms to change their domicile to the country, since it streamlines the tax management of the company
B) it creates an incentive for the firm to change its domicile to a country with lower tax rate through merger (being acquired by foreign-established firm)
B) it creates an incentive for the firm to change its domicile to a country with lower tax rate through merger (being acquired by foreign-established firm)
Following statement applies to the market for corporate control (select all correct):
A) it is a mechanism by which firms are matched up with owners and management teams who can make the most of the firm’s resources
B) if it is possible for the value of the firm to be enhanced by changing management or by reorganizing under new owners, there will be incentives for someone to make the change
Both are true
Which are the three ways to change the management of a firm?
A) a leveraged buyout
B) selling crown jewels
C) a takeover through tender offer
D) a successful proxy contest
A) a leveraged buyout
C) a takeover through tender offer
D) a successful proxy contest
Which of the following statements is/ are not true about a proxy contest?
A) a group of shareholders votes in a new board who then pick a new management team
B) a proxy is the right to vote another shareholder’s shares
C) in a proxy contest, the dissident shareholders attempt to obtain enough proxies to elect their own slate o the BoD
D) a proxy fight is a direct contest for control of the firm
E) proxy contests are very often successful
Wrong: E) proxy contests are very often successful
A proxy contest is very expensive and difficult to win. Dissidents who engage in proxy fights must use their own money, but management can use the corporation’s funds and lines of communications with shareholders to defend itself
In a ____, the would-be acquirer offer to buy shares directly to the shareholders of the target. If successful, the new owner is free to make any management changes.
This is one of the 3 ways to change the management of a firm called what?
A) leveraged buyout
B) proxy contest
C) Takeover through tender offer
C) Takeover through tender offer
One of the ways in which the incumbent board/ management can defend hostile takeovers is putting in place a poison pill. What does this entail?
if any single shareholder acquired a holding of more than x% of the firm’s stock, the poison pill will allow the firm to offer its other shareholders additional shares at a substantial discount, thus diluting the ownership of a potential acquirer.
Shark-repellent is a mechanism for takeover defense. Which of the following is/are not shark-repellents?
A) staggered (classified) board
B) supermajority
C) fair price
D) poison pill
E) restricted voting rights
F) waiting period
D) poison pill
When the board is classified into three equal groups, where only one group is elected each year, resulting in the hostile acquirer not being able to gain control immediately.
Which type of shark-repellent is a mechanism for takeover defense is this?
A) staggered (classified) board
B) supermajority
C) fair price
D) restricted voting rights
E) waiting period
A) staggered (classified) board
When a high percentage of shares, typically 80%, is needed to approve a merger, which type of shark-repellent mechanism for takeover defense is this?
A) staggered (classified) board
B) supermajority
C) fair price
D) restricted voting rights
E) waiting period
B) supermajority
When mergers are restricted unless a fair price (determined by formula or appraisal) is paid, which type of shark-repellent mechanism for takeover defense is this?
A) staggered (classified) board
B) supermajority
C) fair price
D) restricted voting rights
E) waiting period
C) fair price
When shareholders who acquire more than a specified proportion of the target have no voting rights unless approved by the target’s board, which type of shark-repellent mechanism for takeover defense is this?
A) staggered (classified) board
B) supermajority
C) fair price
D) restricted voting rights
E) waiting period
D) restricted voting rights
When unwelcome acquires must wait for a specified number of years before they can complete a merger, which type of shark-repellent mechanism for takeover defense is this?
A) staggered (classified) board
B) supermajority
C) fair price
D) restricted voting rights
E) waiting period
E) waiting period
When existing shareholders are issued rights that, if there is a significant purchase of shares by a bidder, can be used to purchase additional stock in the company at bargain price, this is:
A) poison put
B) poison pill
B) Poison pill
When existing bondholders can demand repayment if there is a change of control as a result of a hostile takeover, what type of pre-offer defense is this?
Poison put
Which of the following is NOT a post-offer defense mechanism?
A) Litigation
B) Liability restructuring
C) Asset restructuring
D) Poison put
D) Poison put
When target files a suit against bidder for violating antitrust or securities laws, which type of post-offer defense mechanism is this?
Litigation
When a target buys assets that the bidder does not want, or that will create antitrust problems, this is a post-offer defense mechanism termed _____
Asset restructuring
When a target issues shares to a friendly third party, increasing the number of shareholders, or repurchases shares from existing shareholders at a premium - this dilutes the shares of the hostile acquirer.
Which type of post-offer defense mechanism is this?
Liability restructuring
In an attempt to overcome target managers’ opposition to takeovers, the acquirer can offer golden parachutes. What does this mean?
Golden parachute: a generous payoff if the managers lose their jobs as a result of a takeover
A merger adds value only if the two companies are worth more together than apart
True/ False
True
Buyer Firms Typically gain more from a Merger than Seller (Target) Firms
True/ False
False: targets tend to gain and buyers tend to roughly break-even
Why do sellers generally gain more from mergers than buyers? (Select all correct)
A) buyer is typically larger, and sometimes, even substantial net benefits do not show up clearly in the buyer’s share price
B) competition among potential bidders can force up the takeover premium, and more of the merger gain slides toward the target
C) behavioral explanations: the managers of acquirer may be driven overconfidence in their ability to run target better than existing management - and therefore pays too much because gains are overestimated
E) the threat of takeover may spur managers of the targe to work harder, leading to better performance
All are true
There are occasions when the merger does achieve gains but the buyer nevertheless loses because it pays too much
True/ False
True
Example: target inventory value may be overestimated; cost of renovation and integration may be underestimated; target may have environmental liabilities such as pollution giving rise to unexpected clean-up costs
This is why due diligence is particularly important
Corporate diversification does not increase value in perfect markets as long as investors’ diversification opportunities are unrestricted. This is the explanation of which principle?
Value-additivity principle
In a conglomerate merger, there is no possibility of excess demand of the merged stock, but a definite possibility of excess supply. This means that the stock price of the combined entity will be less or equal to the price of the two entities separate:
PV_AB ≤ PV_A + PV_B
True/ False
True
Conglomerate mergers are not in coherence with the value additivity principle
