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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) 12.0%
B) 13.9%
C) 14.4%
D) 16.0%

E) A) and C)
F) B) and C)

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

A) True
B) False

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

A) True
B) False

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If the constant growth model is used to calculate the value of a target company,the terminal value is an insignificant cash flow analysis.

A) True
B) False

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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.

A) True
B) False

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MaritimeTV 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 manufacturers. If those improvements (synergies) are implemented, TV Emporium financial staff estimate 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?


A) $101.53 million
B) $98.57 million
C) $86.66 million
D) $71.07 million

E) C) and D)
F) B) and C)

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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?


A) $3,500
B) $5,000
C) $11,500
D) $18,500

E) B) and C)
F) A) and C)

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Using the purchase accounting method to report mergers,goodwill is not amortized; rather,it is subject to an annual impairment test.

A) True
B) False

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Which statement best describes mergers?


A) The purchase of Red Lobster Restaurants initiated by Remax Realty is an example of conglomerate mergers.
B) A merger can be blocked either by a firm's customers or its suppliers, not the government.
C) The existence of golden parachutes is one reason that the management of a target company tries to block a takeover.
D) In a hostile takeover, the target company's management makes a tender offer asking its shareholders to sell their shares to the acquiring company.

E) A) and C)
F) C) and D)

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Which of the following best defines a joint venture?


A) a joint venture is one in which two, or sometimes more, independent companies agree to combine resources in order to achieve a specific objective, usually limited in scope.
B) A joint venture is one in which two , or sometimes more, independent companies agree to combine resources in order to achieve a specific objective, usually expansive in scope.
C) A joint venture is one in which two, or sometimes more, independent companies agree to merge into a single firm , usually wider in scope.
D) A joint venture is one in which two, or sometimes more, independent companies agree to combine resources in order to achieve a specific objective, usually limited in scope .

E) B) and C)
F) A) and D)

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

A) True
B) False

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Which of the following is a valid,acceptable reason for a closely held firm proposing a merger activity?


A) synergistic benefits arising from mergers
B) reduction in competition resulting from mergers
C) attempts to stabilize earnings by diversifying
D) minimizing taxes when disposing of excess cash

E) A) and D)
F) A) and C)

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Which statement best describes mergers?


A) The high Canadian dollar relative to foreign currencies makes Canadian companies comparatively inexpensive to foreign buyers, spurring many mergers.
B) The expansion of the junk bond market makes debt more freely available for large acquisitions and LBOs, resulting in an increased level of merger activity.
C) Increased nationalization of business and a desire to scale down and focus on producing in one's home country may virtually halt international mergers.
D) A high Canadian dollar results in a high cost of commodities, which results in mergers being more expensive in Canada.

E) A) and C)
F) All of the above

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Which of the following factors does NOT influence the consideration of a merger and an acquisition of stocks?


A) Shareholders are dealt with directly to bypass the target management and board of directors.
B) In a tender offer, usually some minority shareholders do not tender (offer) their shares. This can result in preventing the target firm from being completely absorbed
C) Target management may be unfriendly and resist an offer, which usually results in a higher stock price.
D) The target company's supplier has developed a new high-quality product.

E) A) and D)
F) All of the above

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Which of the following are synergistic benefits of a merger?


A) operating economies of scale
B) financial economies
C) improved managerial efficiency
D) all of the above

E) All of the above
F) C) and D)

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Which statement best describes leveraged buyouts (LBOs) ?


A) 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 leveraged buyout.
D) The objective is to take the firm public again or to sell to others in a few years after boosting the firm's value through efficient management.

E) All of the above
F) A) and B)

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Which statement best describes accounting for mergers?


A) Goodwill is amortized for shareholder reporting.
B) Goodwill is subject to impairment test for tax purposes.
C) Goodwill is no longer created in a merger.
D) Goodwill is subject to an amortization test and a majority vote of the board of directors.

E) A) and B)
F) A) and D)

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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.

A) True
B) False

Correct Answer

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Which statement best describes mergers?


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) Acquiring firms send a signal that their stock is overvalued if they choose to use cash and bonds to pay for the acquisition.

E) A) and D)
F) C) and D)

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The value of synergy can be estimated by which of the following equations?


A) VAB - VA - VB
B) VAB - VB - taxes
C) VA - VB - costs
D) VA + VB - revenues

E) None of the above
F) A) and C)

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