Question 1

(The following data apply to Problems 53 through 55. The problems MUST be kept together.) 
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%.
-What discount rate should you use to discount Dustvac's free cash flows and interest tax savings?

Accepted Answer

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

Question 2

If the capital structure is stable, and free cash flows are expected to be growing at a constant rate at the horizon date, then the horizon value is calculated by discounting the free cash flows plus the expected future tax shields at the weighted average cost of capital.

Accepted Answer

A) True 
 B)False

Question 3

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

Accepted Answer

A) True 
 B)False

Question 4

Which of the following statements is most CORRECT?

Accepted Answer

A)   Leveraged buyouts (LBOs)  occur when a firm issues equity and uses the proceeds to take a firm public.
B)   In a typical LBO, bondholders do well but shareholders see their value decline.
C)   Firms are forbidden by law to sell any assets during the first five years following a leverage buyout.
D)   LBOs are never backed by private equity firms.
E)   LBOs typically use a lot of debt.F) A) and D)
G) C) and D)

Question 5

Which of the following statements is most CORRECT?

Accepted Answer

A)   Firms that are acquired usually have a market price below book value before the merger offer is made. However, once the initial offer is made, the price can rise above book value, but the purchase price, especially in large acquisitions, generally remains within 20% of book value.
B)   When Texaco purchased Getty Oil, many financial analysts felt that the deal made sense because it increased Texaco's market share and expanded its shrinking oil reserves. This merger exemplified the belief among the natural resource companies that buying reserves through acquisitions was less costly than exploring and finding them in the field.
C)   When Mobil Oil Company tried to acquire Conoco, which was another oil company, stockholders were concerned that the U.S. Justice Department would try to block the merger because it would lessen competition. Thus, antitrust considerations affected this proposed horizontal merger.
D)   Answers b and c are correct.
E)   All of the statements above are false.F) A) and E)
G) C) and D)

Question 6

The 3 main advantages of holding companies are (1) control with fractional ownership, (2) taxation benefits, and (3) isolation of operating risks.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following statements is most CORRECT?

Accepted Answer

A)   Tax considerations often play a part in mergers. If one firm has excess cash, purchasing another firm exposes the purchasing firm to additional taxes. Thus, firms with excess cash rarely undertake mergers.
B)   The smaller the synergistic benefits of a particular merger, the greater the scope for striking a bargain in negotiations, and the higher the probability that the merger will be completed.
C)   Since mergers are frequently financed by debt rather than equity, a lower cost of debt or a greater debt capacity are rarely relevant considerations when considering a merger.
D)   Managers who purchase other firms often assert that the new combined firm will enjoy benefits from diversification, including more stable earnings. However, since shareholders are free to diversify their own holdings, and at what's probably a lower cost, diversification benefits is generally not a valid motive for a publicly held firm.
E)   Operating economies are never a motive for mergers.F) B) and E)
G) A) and E)

Question 8

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

Accepted Answer

A) True 
 B)False

Question 9

Which of the following statements is most CORRECT?

Accepted Answer

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)   Cash payments are used in takeovers but never in mergers.
E)   Managers often are fired in takeovers, but never in mergers.F) A) and B)
G) A) and E)

Question 10

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 are 3 procedures used to defend against hostile takeovers. These strategies are known as "poison pills."

Accepted Answer

A) True 
 B)False  True

Question 11

Kelly Tubes is considering a merger with Reilly Tires. Reilly'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 Kelly acquires Reilly, 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 Reilly's required rate of return on equity be after it is acquired?

Accepted Answer

A)   7.4%
B)   8.9%
C)   9.3%
D)   9.6%
E)   9.7%F) A) and B)
G) A) and C)

Question 12

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

Accepted Answer

A) True 
 B)False

Question 13

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.

Accepted Answer

A) True 
 B)False

Question 14

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.

Accepted Answer

A) True 
 B)False

Question 15

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.

Accepted Answer

A) True 
 B)False

Question 16

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?

Accepted Answer

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%; $1,650,000F) A) and C)
G) None of the above

Question 17

Any goodwill created in a merger must be amortized over its expected life, usually 40 years, for shareholder reporting purposes.

Accepted Answer

A) True 
 B)False  False

Question 18

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

Accepted Answer

A) True 
 B)False

Question 19

(The following data apply to Problems 53 through 55. The problems MUST be kept together.) 
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%.
-What Dustvac's pre-merger WACC?

Accepted Answer

A)   9.02%
B)   9.50%
C)   9.83%
D)   10.01%
E)   11.29%F) B) and D)
G) A) and B)

Question 20

(The following data apply to Problems 53 through 55. The problems MUST be kept together.) 
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%.
-What is the value of Dustvac's equity to Magiclean? (Round your answer to the closest thousand dollars.)

Accepted Answer

A)   $16,019,000
B)   $17,111,000
C)   $18,916,000
D)   $22,111,000
E)   $22,916,000F) C) and D)
G) B) and E) B

Exam 21: Mergers, Lbos, Divestitures, and Holding Companies

Correct Answer
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If the capital structure is stable, and free cash flows are expected to be growing at a constant rate at the horizon date, then the horizon value is calculated by discounting the free cash flows plus the expected future tax shields at the weighted average cost of capital.

Correct Answer
verified

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

Correct Answer
verified

Which of the following statements is most CORRECT?

Correct Answer
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Which of the following statements is most CORRECT?

Correct Answer
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The 3 main advantages of holding companies are (1) control with fractional ownership, (2) taxation benefits, and (3) isolation of operating risks.

Correct Answer
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Which of the following statements is most CORRECT?

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

Correct Answer
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Which of the following statements is most CORRECT?

Correct Answer
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Correct Answer
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True

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

Correct Answer
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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.

Correct Answer
verified

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.

Correct Answer
verified

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.

Correct Answer
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Correct Answer
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Any goodwill created in a merger must be amortized over its expected life, usually 40 years, for shareholder reporting purposes.

Correct Answer
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False

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

Correct Answer
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B

Exam 21: Mergers, Lbos, Divestitures, and Holding Companies

Correct AnswerverifiedShow Answer

If the capital structure is stable, and free cash flows are expected to be growing at a constant rate at the horizon date, then the horizon value is calculated by discounting the free cash flows plus the expected future tax shields at the weighted average cost of capital.

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which of the following statements is most CORRECT?

Correct AnswerverifiedShow Answer

Which of the following statements is most CORRECT?

Correct AnswerverifiedShow Answer

The 3 main advantages of holding companies are (1) control with fractional ownership, (2) taxation benefits, and (3) isolation of operating risks.

Correct AnswerverifiedShow Answer

Which of the following statements is most CORRECT?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which of the following statements is most CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedTrue

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Any goodwill created in a merger must be amortized over its expected life, usually 40 years, for shareholder reporting purposes.

Correct AnswerverifiedFalse

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

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedB

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True

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False

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B