Chapter 17: Mergers, Lbos, Divestitures, and Business Failure

Chapter17Mergers,LBOs,Divestitures,andBusinessFailure205
Chapter17
Mergers,LBOs,Divestitures,
andBusinessFailure
.1
Learning Goals
1.
Understandmergerfundamentals,includingterminology,motivesformerging,andtypesof
mergers.
2.
Describetheobjectivesandproceduresusedinleveragedbuyouts(LBOs)anddivestitures.
3.
Demonstratetheproceduresusedtovaluethetargetcompany,anddiscusstheeffectofstockswap
transactionsonearningspershare.
4.
Discussthemergernegotiationprocess,holdingcompanies,andinternationalmergers.
5.
Understandthetypesandmajorcausesofbusinessfailureandtheuseofvoluntarysettlementsto
sustainorliquidatethefailedfirm.
6.
Explainbankruptcylegislationandtheproceduresinvolvedinreorganizingorliquidatingabankrupt
firm.
.2
TrueFalse
1.
Amergeroccurswhentwoormorefirmsarecombinedtoformacompletelynewcorporation.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:MergerBasics
2.
Theoverridinggoalformergingisthemaximizationoftheownerswealthasreflectedinthe
acquirersshareprice.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:MergerMotives
3.
Firmsmotivestomergeincludegrowthordiversification,synergy,fundraising,taxconsiderations,
anddefenseagainsttakeover.
Answer: TRUE
LevelofDifficulty:1
206GitmanPrinciplesofFinance,EleventhEdition
LearningGoal:1
Topic:MergerMotives
4.
Aconglomeratemergerisamergercombiningfirmsinunrelatedbusinesses.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:ConglomerateMergers
5.
Acongenericmergerisamergercombiningfirmsinunrelatedbusinesses.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:CongenericMergers
6.
Greatercontrolovertheacquisitionofnewmaterialsorthedistributionoffinishedgoodsisan
economicbenefitofhorizontalmerger.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:HorizontalMergers
7.
Verticalmergermayresultinexpansionofoperationsinanexistingproductlineandeliminationof
acompetitor.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:VerticalMergers
8.
Consolidationinvolvesthecombinationoftwoormorefirms,andtheresultingfirmmaintainsthe
identityofoneofthefirms.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:Consolidations
9.
Thecompaniescontrolledbyaholdingcompanyarenormallyreferredtoasitssubsidiaries.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:HoldingCompanies
10.
Thetakeovertargetsmanagementmaynotsupportaproposedtakeoverduetoaveryhightender
offer.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:TargetFirms
11.
Averticalmergerisamergeroftwofirmsinthesamelineofbusiness.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
12.
Ahorizontalmergerisamergerinwhichonefirmacquiresanotherfirminthesamegeneral
industrybutneitherinthesamelineofbusinessnorasupplierorcustomer.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
13.
Acongenericmergerisamergerinwhichafirmacquiresasupplieroracustomer.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
14.
Tenderofferisaformaloffertopurchaseagivennumberofsharesofafirmsstockataspecified
price.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:TenderOffers
15.
Strategicmergersseektoachievevariouseconomiesofscalebyeliminatingredundantfunctions,
increasingmarketshare,andimprovingrawmaterialsourcingandfinishedproductdistribution.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:StrategicMergers
16.
Anoperatingmergeroccurswhentheoperationsoftheacquiringandtargetfirmsarecombinedin
ordertoachieveeconomiesandtherebycausetheperformanceofthemergedfirmtoexceedthatof
thepremergedfirm.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:OperatingMergers
17.
Aholdingcompanyisacorporationwhichiscontrolledbyoneormoreothercorporations.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
18.
Financialmergersinvolvemergingfirmsinordertoachievevariouseconomiesofscaleby
eliminatingredundantfunctions,increasingmarketshare,andimprovingrawmaterialsourcingand
finishedproductdistribution.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:FinancialMergers
19.
Aconsolidationisacorporationthathasvotingcontrolofoneormoreothercorporations.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
20.
Financialmergerisamergertransactionundertakentoachieveeconomiesofscale.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
21.
Strategicmergerisamergertransactionundertakenwiththegoalofrestructuringtheacquired
companyinordertoimproveitscashflowandunlockitshiddenvalue.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
22.
Thesynergyofmergersistheeconomiesofscaleresultingfromthemergedfirmsloweroverhead.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:SynergyofMergers
23.
Thetaxlosscarryforwardbenefitscanbeusedinmergersbutcannotbeusedintheformationof
holdingcompanies.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:TaxLossCarrybackandCarryforward
24.
LBOsareanexampleofafinancialmergerundertakentocreateahighdebtprivatecorporationwith
improvedcashflowandvalue.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:LeveragedBuyoutBasics
25.
Anattractivecandidateforacquisitionthroughleveragedbuyoutmusthaveagoodpositioninits
industrywithasolidprofithistoryandreasonableexpectationforgrowth.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:LeveragedBuyoutCandidates
26.
Anattractivecandidateforacquisitionthroughleveragedbuyoutusuallyhasarelativelyhighlevel
ofdebtandalowlevelofbankableassets.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:LeveragedBuyoutCandidates
27.
Themotivefordivestitureisoftentogetridofaproductlineinordertogeneratecashforexpansion
ofotherproductlines.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:MotivesforDivestitures
28.
Thesellingofsomeofafirmsassetsforvariousstrategicmotivesiscalleddivestiture.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
29.
Aspinoffisaformofdivestitureinwhichanoperatingunitbecomesanindependentcompanyby
issuingsharesinitonaproratabasistotheparentcompanysshareholders.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:SpinOffs
30.
Thesaleofaunitofafirmtoexistingmanagementisoftenachievedthroughaleveragedbuyout.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:LeveragedBuyouts
31.
Afirmthatwantstoexpandorextenditsoperationsinexistingornewproductareasmayavoid
manyoftherisksassociatedwiththedesign,manufacture,andsaleofadditionalornewproductand
removeapotentialcompetitorbyacquiringasuitablegoingconcern.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:3
Topic:MotivesforAcquisitions
32.
Thebasicdifficultyinapplyingthecapitalbudgetingapproachtotheacquisitionofagoingconcern
istheestimationofinitialcashflowsandcertainriskconsideration.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:3
Topic:AnalyzingAcquisitions
33.
Stockswaptransactionisanacquisitionmethodinwhichtheacquiringfirmexchangesitssharesfor
sharesofthetargetcompanyaccordingtoapredeterminedratio.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:3
Topic:StockSwapTransactions
34.
Ratioofexchangeinmarketpriceindicatesthemarketpricepershareoftheacquiringfirmpaidfor
eachdollarofmarketpricepershareofthetargetfirm.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:RatioofExchangeandAcquisitions
35.
Theactualratioofexchangeinastockexchangeacquisitionistheratiooftheamountpaidpershare
ofthetargetcompanytothepersharemarketpriceoftheacquiringfirm.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
36.
Theearningspershareofthemergedfirmaregenerallyabovethepremergerearningspershareof
onefirmandbelowthepremergerearningspershareoftheother,aftermakingthenecessary
adjustmentfortheratioofexchange.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:3
37.
IfthePEpaidisgreaterthanthePEoftheacquiringcompany,onapostmergerbasisthetarget
firmsEPSincreasesandtheacquiringfirmsEPSdecreases.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:3
Topic:PERatioandMergers
38.
Theownersofaholdingcompanycancontrolsignificantlylargeramountsofassetsthantheycould
acquirethroughmergers.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:4
Topic:HoldingCompanyBasics
39.
Theownersofaholdingcompanycancontrolsignificantlylargeramountsofassetsthantheycould
acquirethroughmergers.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:4
Topic:HoldingCompanyBasics
40.
Amajordisadvantageofholdingcompaniesistheincreasedriskresultingfromtheleverageeffect.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:DisadvantagesofHoldingCompanies
41.
Twotierofferisatenderofferinwhichthetermsofferedaremoreattractivetothosewhotender
sharesearly.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:TwoTierOffers
42.
Whiteknightisatakeoverdefenseinwhichafirmissuessecuritiesthatgivetheirholderscertain
rightsthatbecomeeffectivewhenatakeoverisattemptedandthatmakethetargetfirmless
desirabletoahostileacquirer.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
Topic:WhiteKnightTakeoverDefense
43.
Poisonpillisatakeoverdefenseinwhichthetargetfirmfindsanacquirermoretoitslikingthanthe
initialhostileacquirerandpromptsthetwotocompetetotakeoverthefirm.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
Topic:PoisonPillsTakeoverDefense
44.
Greenmailisatakeoverdefenseunderwhichthetargetfirmrepurchasesalargeblockofstockata
premiumfromoneormoreshareholdersinordertoendahostiletakeoverattemptbythose
shareholders.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:GreenmailTakeoverDefense
45.
Pyramidingisanarrangementamongholdingcompanieswhereinonecompanycontrolsothers,
therebycausinganevengreatermagnificationofearningsandlosses.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:PyramidingandHoldingCompanies
46.
Technicalinsolvencyoccurswhenafirmsliabilitiesexceedthefairmarketvalueofitsassets.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:5
Topic:TechnicalInsolvency
47.
Inavoluntarysettlement,compositionisanarrangementinwhichthecreditorcommitteereplaces
thefirmsoperatingmanagementandoperatesthefirmuntilallclaimshavebeensettled.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:VoluntarySettlements
48.
Chapter7oftheBankruptcyReformActof1978outlinestheproceduresforreorganizingafailed
(orfailing)firm,whetheritspetitionisfiledvoluntarilyorinvoluntarily.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
Topic:Chapter7Bankruptcy
49.
Underrecapitalization,debtsaregenerallyexchangedforequityorthematuritiesofexistingdebts
areextended.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:Recapitalization
50.
OneoftheresponsibilitiesoftheDebtorinPossession(DIP)istheliquidationofthefirmsassets.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:6
Topic:DebtorinPossession
51.
Inthebroadestsense,activitiesinvolvingexpansionorcontractionofafirmsoperationsorchanges
initsassetsorownershipstructurearecalledcorporaterestructuring.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateRestructuring
52.
Inthebroadestsense,activitiesinvolvingexpansionorcontractionofafirmsoperationsorchanges
initsassetsorownershipstructurearecalledcorporatemaneuvering.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:CorporateRestructuring
53.
Holdingcompaniessimplyarecorporationsthathavevotingcontrolofoneormoreother
corporationsandthecompaniestheycontrolareoftenreferredtoassubsidiaries.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
54.
Subsidiarycompaniessimplyarecorporationsthathavevotingcontrolofoneormoreother
corporationsandthecompaniestheycontrolareoftenreferredtoasholdingcompanies.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
55.
Primarymotivesformergingincludegrowthordiversification,synergy,fundraising,increased
managerialskillortechnology,taxconsiderations,increasedownershipliquidity,anddefense
againsttakeovers.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:MotivesforMergers
56.
Primarymotivesformergingincludegrowthordiversification,synergy,fundraising,increased
managerialskillortechnology,taxconsiderations,increasedownershipliquidity,andacquiringnew
upperlevelmanagementpersonnel.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
57.
ItisnotunusualforacquirersinLBOstobemembersofthefirmsexistingmanagementteam.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:AcquirersinLBOs
58.
OneofthekeyattributesthatmakesafirmagoodcandidateforanLBOisthatithasstableand
predictablecashflowsthatareadequatetomeetinterestandprincipalpaymentsonthedebtand
provideadequateworkingcapital.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:KeyAttributesofLBOCandidates
59.
OneofthekeyattributesthatmakesafirmagoodcandidateforanLBOisthatithasarelatively
lowlevelofdebtandahighlevelofrelativelyliquidassetsthatcouldbeusedasloancollateral.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
60.
OneofthekeyattributesthatmakesafirmagoodcandidateforanLBOisthatithasarelatively
highlevelofdebtandalowlevelofrelativelyliquidassetsthatcouldbeusedasloancollateral.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
61.
OneofthekeyattributesthatmakesafirmagoodcandidateforanLBOisthatithasasolid
positionintheindustrywithreasonableexpectationsforfuturegrowth.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
62.
Unlikebusinessbankruptcyandbusinessfailure,divestitureisoftenundertakenforpositivemotives
suchastogeneratecashfortheexpansionofproductlines,togetridofpoorlyperforming
operations,tostreamlinethecompany,ortorestructurethebusinessthatisconsistentwiththefirms
strategicgoals.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:Divestitures
63.
Likebusinessbankruptcyandbusinessfailure,divestitureismostoftenundertakentorelieve
pressurebycreditorssuchasbondholdersandbanksduetothefirmsrelativelyhighdebtlevels.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:Divestitures
64.
Methodsofdivestitureincludethesaleofaproductlinetoanotherfirm,thesaleofaunittoexisting
management,spinoffs,andtheliquidationofassets.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:MethodsofDivesting
65.
Methodsofdivestitureincludethesaleofaproductlinetoanotherfirm,thesaleofaunittoexisting
management,thedonationofaunittoacharity,andtheliquidationofassets.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:MethodsofDivesting
66.
Thevalueofafirmmeasuredasthesumofthevaluesofitsoperatingunitsifeachweresold
separatelyisknownasafirmspartandparcelvalue.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:BreakupValueinDivestitures
67.
Thevalueofafirmmeasuredasthesumofthevaluesofitsoperatingunitsifeachweresold
separatelyisknownasafirmsbreakupvalue.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:BreakupValueinDivestitures
68.
Amethodofacquisitioninwhichtheacquiringfirmexchangesitssharesofstockforsharesofthe
targetcompanyaccordingtoapredeterminedratioiscalledastockswaptransaction.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:StockSwapTransactionsinAcquisitions
69.
Amethodofacquisitioninwhichtheacquiringfirmexchangesitssharesofstockforsharesofthe
targetcompanyaccordingtoapredeterminedratioiscalledaleveragedbuyout.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:StockSwapTransactionsinAcquisitions
70.
Acquisitionsareespeciallyattractivewhentheacquiredfirmsstockpriceishigh,becausefewer
sharesmustbeexchangedtoacquirethefirm.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:Acquisitions
71.
Acquisitionsareespeciallyattractivewhentheacquiringfirmsstockpriceishigh,becausefewer
sharesmustbeexchangedtoacquirethefirm.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:Acquisitions
72.
Populartakeoverdefensemethodsincludewhiteknights,poisonpills,greenmail,goldenparachutes,
andsharkrepellents.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:TakeoverDefenses
73.
Populartakeoverdefensemethodsincludewhiteknights,poisonpills,greenmail,financialsabotage,
andsharkrepellents.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:TakeoverDefenses
74.
TheU.S.approachesusedinhostiletakeoversisanaffectivemethodofchangingcorporatecontrol
andusedinmanyareasoftheworldincludingGreatBritain,China,andJapan.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:InternationalMergers
75.
TheU.S.approachesusedinhostiletakeoversispracticallynonexistentinmostothercountries
throughouttheworldincludingcontinentalEuropeandAsia.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
76.
Theprimarycausesofbusinessfailurearemismanagement,pooreconomicconditions,and
corporatematurity.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
77.
Theprimarycausesofbusinessfailureareinventorymismanagement,poormarketingcampaigns,
andcorporatetheft.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
78.
ThedebtorinpossessioninaChapter11bankruptcyproceedingisresponsibleforvaluingthefirm
bothintermsofitsliquidationvalueandasagoingconcern.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:6
79.
ThecreditorinpossessioninaChapter12bankruptcyproceedingisresponsibleforvaluingthefirm
bothintermsofitsliquidationvalueandasagoingconcern.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
80.
InaChapter7liquidationbankruptcyproceeding,theorderofpriorityofsatisfyingclaimsis
securedcreditors,unsecuredcreditors,andthenequityholders.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:6
.3
Multiple Choice Questions
1.
Businesscombinationsareusedbyfirmstoexternallyexpandinordertoachieveallofthe
followingobjectivesEXCEPT
(a) toincreaseproductivecapacity.
(b) toincreaseliquidity.
(c) toincreasecommonstockoutstanding.
(d) toacquireneededassets.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:MotivesforBusinessCombinations
2.
CommonformsofbusinesscombinationincludeallofthefollowingEXCEPT
(a) congenericformation.
(b) consolidations.
(c) mergers.
(d) holdingcompanies.
Answer: A
LevelofDifficulty:1
LearningGoal:1
Topic:FormsofBusinessCombinations
3.
Thecombinationoftwoormorecompaniestoformacompletelynewcorporationisa
(b) consolidation.
(c) merger.
(d) holdingcompany.
Answer: B
LevelofDifficulty:1
LearningGoal:1
4.
Acombinationofcompanieswheretheformercorporationsceasetoexistis
(a) acongenericformation.
(b) aconsolidation.
(c) amerger.
(d) aholdingcompany.
Answer: B
LevelofDifficulty:1
LearningGoal:1
5.
Thecombinationoftwoormorecompanieswhichresultsinthefirmmaintainingtheidentityofone
ofthefirmsis
(b) consolidation.
(c) merger.
(d) holdingcompany.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:Mergers
6.
Thefirminamergertransactionthatattemptstomergeortakeoveranothercompanyiscalledthe
(a) targetcompany.
(b) holdingcompany.
(c) acquiringcompany.
(d) conglomerate.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:AcquiringCompany
7.
Thefirminamergertransactionthatisbeingpursuedasatakeoverpotentialiscalledthe
(a) acquiringcompany.
(b) targetcompany.
(c) holdingcompany.
(d) conglomerate.
Answer: B
LevelofDifficulty:1
LearningGoal:1
Topic:TargetCompany
8.
Thecombinationoftwoormorecompanieswhichresultsinoneofthecorporationshavingavoting
controlofoneormoreoftheothercompaniesisa
(b) consolidation.
(c) merger.
(d) holdingcompany.
Answer: D
LevelofDifficulty:1
LearningGoal:1
Topic:AcquiringCompany
9.
_________resultsfromthecombinationoffirmsinthesamelineofbusiness.
(a) Congenericgrowth
(b) Conglomeratediversification
(c) Horizontalgrowth
(d) Verticalgrowth
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:HorizontalGrowth
10.
_________resultswhenafirmacquiresasupplieroracustomer.
(a) Congenericmerger
(b) Conglomeratemerger
(c) Horizontalmerger
(d) Verticalmerger
Answer: D
LevelofDifficulty:1
LearningGoal:1
11.
_________involvesthecombinationoffirmsinunrelatedbusinesses.
(d) Verticalmerger
Answer: B
LevelofDifficulty:1
LearningGoal:1
12.
Generally,acombinationoftwofirmsofunequalsizeiscalled
(a) acongenericformation.
(b) aconsolidation.
(c) amerger.
(d) aholdingcompany.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:Mergers
13.
Mostfirmsseekingmergerpartnerswillhiretheservicesof
(a) acommercialbanker.
(b) aninvestmentbroker.
(c) aprivatecontractor.
(d) aninvestmentbanker.
Answer: D
LevelofDifficulty:1
LearningGoal:1
Topic:InvestmentBankersRoleinMergers
14.
Thecombinationofadressmanufacturerandacreditbureauisanexampleof
(a) congenericmerger.
(b) conglomeratemerger.
(c) horizontalmerger.
(d) verticalmerger.
Answer: B
LevelofDifficulty:2
LearningGoal:1
15.
Greatercontrolovertheacquisitionofrawmaterialsorthedistributionoffinishedgoodsisan
economicbenefitof
(d) verticalmerger.
Answer: D
LevelofDifficulty:2
LearningGoal:1
16.
_________mayresultinexpansionofoperationsinanexistingproductlineandeliminationofa
competitor.
(d) Verticalmerger
Answer: C
LevelofDifficulty:2
LearningGoal:1
17.
Typically,reasonsforundertakingmergersare
(a) onlyfinancial.
(b) onlystrategic.
(c) strategicorfinancial.
(d) inconflictwithwealthmaximization.
Answer: C
LevelofDifficulty:2
LearningGoal:1
18.
Whenafirmundertakesamergerinordertoeliminateredundantfunctionsorincreasemarketshare,
thisisanexampleof
(a) financialmerger.
(b) hostiletakeover.
(c) friendlymerger.
(d) strategicmerger.
Answer: D
LevelofDifficulty:2
LearningGoal:1
19.
Whenafirmundertakesamergertoimproveitssourcesandsupplyofrawmaterials,thisisan
exampleofa
(a) financialmerger.
(b) hostiletakeover.
(c) friendlymerger.
(d) strategicmerger.
Answer: D
LevelofDifficulty:2
LearningGoal:1
20.
_________isachievedbyacquiringacompanyinthesamegeneralindustry,butneitherinthesame
lineofbusinessnorasupplieroracustomer.
(d) Verticalmerger
Answer: A
LevelofDifficulty:2
LearningGoal:1
21.
Theabilitytousethesamesalesanddistributionchannelstoreachcustomersofbothbusinessesisa
benefitof
(d) verticalmerger.
Answer: A
LevelofDifficulty:2
LearningGoal:1
22.
Oneofthekeymotivesforcombinationsisthetaxbenefitof
(a) reducingthemarginaltaxrate.
(b) takingadvantageoftheotherfirmstaxlosscarryforward.
(c) usingcapitalgains.
(d) increasingadditionalrecaptureddepreciation.
Answer: B
LevelofDifficulty:2
LearningGoal:1
Topic:MotivesforCombinations
23.
AllofthefollowingarereasonsformergersEXCEPT
(a) increasingmanagerialskills.
(b) taxconsiderations.
(c) synergism.
(d) monopolycontrolofthemarkets.
Answer: D
LevelofDifficulty:2
LearningGoal:1
24.
A_________occurswhentheoperationsoftheacquiringandtargetfirmsarecombinedinorderto
achieveeconomiesandtherebycausetheperformanceofthemergedfirmtoexceedthatofthepre
mergedfirm.
(a) financialmerger
(b) hostiletakeover
(c) operatingmerger
(d) strategicmerger
Answer: D
LevelofDifficulty:3
LearningGoal:1
25.
AfriendlymergertransactionistypicallyconsummatedthroughallofthefollowingEXCEPT
(a) acashpurchase.
(b) anexchangeoftheacquirersstock.
(c) atenderoffer.
(d) anexchangeoftheacquirersstockandbonds.
Answer: C
LevelofDifficulty:3
LearningGoal:1
Topic:FriendlyMergers
26.
Ahostilemergeristypicallyaccomplishedthrough
(a) acashpurchase.
(b) anexchangeoftheacquirersstock.
(c) atenderoffer.
(d) anexchangeoftheacquirersstocksandbonds.
Answer: C
LevelofDifficulty:3
LearningGoal:1
Topic:HostileMergers
27.
A(n)_________isundertakenwiththegoalofrestructuringtheacquiredcompanyinorderto
improveitscashflowandunlockitshiddenvalue.
(a) operatingmerger.
(b) strategicmerger.
(c) financialmerger.
(d) hostiletakeover.
Answer: C
LevelofDifficulty:3
LearningGoal:1
28.
Amajorimpetusfuelingfinancialmergersduringthe1980swas
(a) highinterestrates.
(b) hightaxrates.
(c) highcashbalancesthatcouldbeutilizedfortakeovers.
(d) readyavailabilityofjunkbondfinancing.
Answer: D
LevelofDifficulty:3
LearningGoal:1
29.
Amergerofapapermanufacturerandaloggingcompanyisanexampleof
(d) verticalmerger.
Answer: D
LevelofDifficulty:3
LearningGoal:1
30.
Thereductionofriskresultingfromcombiningfirmswithdifferingseasonalorcyclicalpatternsof
salesorearningsisakeybenefitof
(d) verticalmerger.
Answer: B
LevelofDifficulty:3
LearningGoal:1
31.
Afinancialmergerisundertakentoincrease
(a) operatingefficiency,whichisusedtoincreasecashflows.
(b) cashflows,whichareusedtoincreasedividendstoshareholders.
(c) marketshare,whichisusedtomaximizeshareholderwealth.
(d) cashflows,whichareusedtoservicethedebttypicallyincurredtofinancethemerger
transaction.
Answer: D
LevelofDifficulty:4
LearningGoal:1
32.
Anattempttogaincontrolofthefirmbybuyingsufficientsharesofthetargetfirminthe
marketplaceisknownasa_________andistypicallyaccomplishedthrougha_________.
(a) friendlytakeover;tenderoffer
(b) hostiletakeover;merger
(c) friendlytakeover;merger
(d) hostiletakeover;tenderoffer
Answer: D
LevelofDifficulty:4
LearningGoal:1
Topic:TenderOffersandHostileTakeovers
33.
Amergerinvolvingthepurchaseofaspecificproductline,ratherthanthewholecompanyis
(a) anoperatingmerger.
(b) afinancialmerger.
(c) aselectivelinesmerger.
(d) avariationofthestrategicmerger.
Answer: D
LevelofDifficulty:4
LearningGoal:1
34.
Theuseofalargeamountofdebttofinancetheacquisitionofotherfirmsisa
(a) conglomeratemerger.
(b) leveragedbuyout.
(c) hostilemerger.
(d) congenericbuyout.
Answer: B
LevelofDifficulty:1
LearningGoal:2
35.
Theacquisitionofacashrichcompanyallowstheacquiringcompany
(a) toreapgreatertaxbenefits.
(b) toreduceleverageandtoincreaseborrowingpower.
(c) todevelopbettermanagers.
(d) toachieveeconomiesofscaleinsomephaseofthebusiness.
Answer: B
LevelofDifficulty:1
LearningGoal:2
Topic:MotivesforAcquisitions
36.
Thesaleofaunitofafirmtoexistingmanagementisoftenachievedthrough
(a) alimitedpartnership.
(b) aleveragedbuyout.
(c) anemployeestockoption.
(d) acashexchange.
Answer: B
LevelofDifficulty:1
LearningGoal:2
37.
Thesellingofsomeofafirmsassetsiscalled
(a) businessfailure.
(b) verticalsegmentation.
(c) reversemerger.
(d) divestiture.
Answer: D
LevelofDifficulty:1
LearningGoal:2
Topic:Divestitures
38.
Adivestiturewhichresultsinanoperatingunitbecominganindependentcompanyisa
(a) saleofalineofbusiness.
(b) saleofaunittoexistingmanagement.
(c) spinoffofanoperatingunit.
(d) leveragedbuyout.
Answer: C
LevelofDifficulty:2
LearningGoal:2
Topic:SpinOffDivestitures
39.
ThegoalsofdivestitureincludeallofthefollowingEXCEPT
(a) raisingfunds.
(b) focusingoperations.
(c) enhancingprofitability.
(d) expandingoperations.
Answer: D
LevelofDifficulty:2
LearningGoal:2
Topic:GoalsofDivestitures
40.
Aformofdivestitureinwhichanoperatingunitbecomesanindependentcompanybyissuingshares
initonaproratabasistotheparentcompanysshareholdersiscalled
(a) leveragebuyout.
(b) employeestockoption.
(c) spinoff.
(d) merger.
Answer: C
LevelofDifficulty:2
LearningGoal:2
41.
Aspinoffresultsinthedivestedunit
(a) beingsoldtoexistingmanagementresultinginnewowners.
(b) becominganindependentcompanywithnewowners.
(c) becominganindependentcompanywiththesameownersastheparentcompany.
(d) beingmanagedindependently,butstillundertheownershipoftheparentcompany.
Answer: C
LevelofDifficulty:3
LearningGoal:2
42.
Theresultofspinofftotheparentcompanyis
(a) additionalstocktotheparent.
(b) additionalcashfromthesale.
(c) additionaldebtbytheparent.
(d) noadditionalcashorstocktotheparent.
Answer: D
LevelofDifficulty:3
LearningGoal:2
43.
A_________isamethodofstructuringafinancialmerger,whereasa_________involvesthesale
ofthefirmsassets.
(a) leveragedbuyout;bankruptcy
(b) congenericbuyout;divestiture
(c) horizontalmerger;leverageddivestiture
(d) leveragedbuyout;divestiture
Answer: D
LevelofDifficulty:3
LearningGoal:2
44.
Leveragedbuyoutsareclearexamplesof
(a) strategicmergers.
(b) verticalmergers.
(c) financialmergers.
(d) congenericmergers.
Answer: C
LevelofDifficulty:3
LearningGoal:2
45.
Thecreationofahighdebt,privatecorporationwithimprovedcashflowandvalueisthegoalin
(a) issuingjunkbonds.
(b) afinancialmerger.
(c) aconglomeratemerger.
(d) aleveragedbuyout.
Answer: D
LevelofDifficulty:3
LearningGoal:2
46.
Typicallyinaleveragedbuyoutapproximately_________percent(ifnotmore)ofthepurchase
priceisfinancedwithdebt.
(a) 30
(b) 50
(c) 70
(d) 90
Answer: D
LevelofDifficulty:3
LearningGoal:2
47.
Anattractivecandidateforacquisitionthroughaleveragedbuyoutshouldpossessallofthe
followingcharacteristicsEXCEPT
(a) asolidprofithistoryandreasonableexpectationsforgrowth.
(b) lowfixedassets.
(c) alowlevelofdebt.
(d) stableandpredictablecashflows.
Answer: B
LevelofDifficulty:3
LearningGoal:2
48.
Aleveragedbuyoutneedstobecarriedoutthrough
(a) ahostiletakeover.
(b) afriendlymerger.
(c) averticalmerger.
(d) aconglomeratemerger.
Answer: B
LevelofDifficulty:3
LearningGoal:2
49.
ThemotivefordivestitureislikelytobeallofthefollowingEXCEPT
(a) togeneratecashforexpansionofotherproductlines.
(b) togetridofpoorlyperformingoperations.
(c) toheadoffbankruptcy.
(d) tostreamlinethecorporation.
Answer: C
LevelofDifficulty:3
LearningGoal:2
50.
Anattractivecandidateforacquisitionthroughleveragedbuyoutshouldpossesswhichofthe
followingcharacteristics?
(a) Agoodpositioninitsindustrywithasolidprofithistoryandreasonableexpectationsofgrowth.
(b) Arelativelylowlevelofdebt.
(c) Arelativelyhighlevelofbankableassetsthatcanbeusedasloancollateral.
(d) Stableandpredictablecashflowsthatareadequatetomeetinterestandprincipalpaymentson
thedebtandprovideadequateworkingcapital.
(e) Alloftheabove.
Answer: E
LevelofDifficulty:4
LearningGoal:2
51.
Cashacquisitionsofgoingconcernsarebestanalyzedusing
(a) aninvestmentopportunityschedule.
(b) ratioanalysis.
(c) capitalbudgetingtechniques.
(d) theweightedmarginalcostofcapitaltheory.
Answer: C
LevelofDifficulty:1
LearningGoal:3
Topic:AcquisitionAnalysis
52.
Normally,theacquiringfirmpaysapricethatisapremiumabovethemarketpriceoftheacquired
firm.Thismeansthattheratioofexchangeinmarketpriceis
(a) alwayslessthan1.
(b) alwaysgreaterthan1.
(c) usuallynegative.
(d) equalto1.
Answer: B
LevelofDifficulty:2
LearningGoal:3
Topic:AcquisitionAnalysisandtheRatioofExchange
53.
MarketingConcepts,Inc.isconsideringtheacquisitionofManagementTheories,Inc.atacashprice
of$1.5million.ManagementTheories,Inc.hasshorttermliabilitiesof$500,000.Asaresultof
acquiringManagementTheories,Inc.,MarketingConcepts,Inc.wouldacquirethecopyrightstoa
nationalbestsellerwhichwouldprovideanestimatedcashflowof$300,000forthenextfiveyears.
Thefirmhasacostofcapitalof20percent.Theapproximatenetpresentvalueofthisacquisitionis
(a) $500,000.
(b) $480,800.
(c) $102,700.
(d) $1,102,700.
Answer: D
LevelofDifficulty:3
LearningGoal:3
54.
Theactualratioofexchangeinastockexchangeacquisitionistheratioofthe
(a) amountpaidpershareofthetargetcompanytothepersharebookvalueoftheacquiringfirm.
(b) bookvaluepershareofthetargetcompanytothepersharemarketpriceoftheacquiringfirm.
(c) marketvaluepershareofthetargetcompanytothepersharemarketpriceoftheacquiringfirm.
(d) amountpaidpershareofthetargetcompanytothepersharemarketpriceoftheacquiringfirm.
Answer: D
LevelofDifficulty:3
LearningGoal:3
55.
Whentheratioofexchangeinamergerisequaltooneandboththeacquiringandthetarget
companieshavethesamepremergerearningspershare,themergedfirmsearningspersharewill
initially
(a) decline.
(b) remainconstant.
(c) increase.
(d) droptozero.
Answer: B
LevelofDifficulty:3
LearningGoal:3
56.
Whentheratioofexchangeinamergerisequaltooneandboththeacquiringandthetarget
companieshavethesamepremergerearningspershare,boththeacquiringandthetargetcompanies
havethesame
(a) debtratio.
(b) bookvaluepershare.
(c) returnonequity.
(d) PEratio.
Answer: D
LevelofDifficulty:3
LearningGoal:3
57.
IfthePEpaidisgreaterthanthePEoftheacquiringcompany,theeffectontheearningspershare
oftheacquiredcompanywillbe
(a) positive.
(b) neutral.
(c) negative.
(d) uncorrelated.
Answer: A
LevelofDifficulty:3
LearningGoal:3
Topic:AcquisitionAnalysisandthePERatio
58.
IfthePEpaidisequaltothePEoftheacquiringcompany,theeffectontheearningspershareof
theacquiredcompanywillbe
(a) positive.
(b) neutral.
(c) negative.
(d) uncorrelated.
Answer: B
LevelofDifficulty:3
LearningGoal:3
59.
IfthePEpaidislessthanthePEoftheacquiringcompany,theeffectontheearningspershareof
theacquiredcompanywillbe
(a) positive.
(b) neutral.
(c) negative.
(d) uncorrelated.
Answer: C
LevelofDifficulty:3
LearningGoal:3
60.
Theoverridinggoalformergingisto
(a) increasecashflows.
(b) maximizeshareholderwealthasreflectedintheacquirersshareprice.
(c) maximizeshareholderwealthasreflectedinthesharepriceofthetargetfirm.
(d) maximizeoperatingefficiency.
Answer: B
LevelofDifficulty:3
LearningGoal:3
Topic:MotivesforMerging
61.
Whenmakingacashacquisitionofagoingconcern,theacquiringcorporationmustbecertain
(a) toadjustaftertaxcashflows.
(b) torecognizedifferentaccountingtechniques.
(c) toadjustthediscountrateforriskdifferences.
(d) toconsidertheproblemsofassimilatingtheacquiredmanagement.
Answer: C
LevelofDifficulty:3
LearningGoal:3
62.
Thelongruneffectontheearningspershareofthemergedfirmdependslargelyon
(a)
(b)
(c)
(d)
thepremergerPEratio.
theratioofexchange.
thesynergyofthemergedfirm.
thetaxconsiderations.
Answer: C
LevelofDifficulty:3
LearningGoal:3
Topic:MotivationforMerging
63.
Firmatron,Inc.isevaluatingtheacquisitionofHealthoMatic,Inc.,whichhadalosscarryforward
of$3.75million,resultingfromearlieroperations.FirmatroncanpurchaseHealthoMaticfor$4.5
millionandliquidatetheassetsfor$3.25million.Firmatronexpectsearningsbeforetaxesinthe
threeyearsfollowingtheacquisitiontobeasfollows:
Year
1
2
3
EarningsbeforeTaxes
$1,270,000
1,662,400
1,275,000
(Theseearningsareassumedtofallwithintheannuallimitlegallyallowedforapplicationofatax
losscarryforwardresultingfromtheproposedacquisition.)Firmatronhasa40percenttaxrateanda
costofcapitalof15percent.TheapproximatemaximumcashpriceFirmatronwouldbewillingto
payforHealthoMaticis
(a) $4,750,000.
(b) $4,500,000.
(c) $4,410,000.
(d) $3,750,000.
Answer: C
LevelofDifficulty:4
LearningGoal:3
Topic:AcquisitionAnalysisandTaxLossCarryforward
64.
Maxi,Inc.isevaluatingtheacquisitionofMini,Inc.,whichhadalosscarryforwardof$2.75million
whichresultedfromearlieroperations.MaxicanpurchaseMinifor$3.5millionandliquidatethe
assetsfor$1.25million.Maxiexpectsearningsbeforetaxesinthethreeyearsfollowingthe
acquisitiontobeasfollows:
Year
1
2
3
EarningsbeforeTaxes
$800,000
850,000
900,000
(Theseearningsareassumedtofallwithinthelimitlegallyallowedforapplicationofataxloss
carryforwardresultingfromtheproposedacquisition.)Maxihasa40percenttaxrateandacostof
capitalof10percent.Thetotalpresentvalueoftaxadvantageoftheacquisitioninthefollowing
threeyearsis
(a) $440,000.
(b) $842,000.
(c) $1.1million.
(d) $2.75million.
Answer: B
LevelofDifficulty:4
LearningGoal:3
65.
Aformalproposaltopurchaseagivennumberofsharesofafirmsstockataspecifiedpriceisa
(a) warrant.
(b) stockpurchaseoption.
(c) right.
(d) tenderoffer.
Answer: D
LevelofDifficulty:1
LearningGoal:4
Topic:TenderOffers
66.
Thestakeholdersintargetedtakeovercompaniesincludethe
(a) customers.
(b) creditors.
(c) employees.
(d) stockholders.
(e) alloftheabove.
Answer: E
LevelofDifficulty:1
LearningGoal:4
Topic:Stakeholders
67.
Theprimaryadvantageofaholdingcompany,thatpermit(s)thefirmtocontrolalargeamountof
assetswitharelativelysmalldollarinvestmentisknownas
(a) theleverageeffect.
(b) taxeffects.
(c) administrativecosts.
(d) riskprotection.
Answer: A
LevelofDifficulty:1
LearningGoal:4
Topic:AdvantagesofHoldingCompanies
68.
AllofthefollowingaredisadvantagesofholdingcompaniesEXCEPT
(a) increasedrisk.
(b) doubletaxation.
(c) highcostofadministration.
(d) legalresponsibilityforsubsidiaries.
Answer: D
LevelofDifficulty:1
LearningGoal:4
69.
Mostfirmsseekingmergerpartnerswillhiretheservicesof
(a) acommercialbanker.
(b) aninvestmentbroker.
(c) aprivatecontractor.
(d) aninvestmentbanker.
Answer: D
LevelofDifficulty:1
LearningGoal:4
Topic:InvestmentBankersRoleinMergers
70.
AllofthefollowingmaybetrueabouttenderoffersEXCEPT
(a) theymayaddpressuretoexistingmergernegotiations.
(b) managementhastheexclusiverighttoaccepttheoffer.
(c) defensivetacticsmaybetakentowardofftheoffer.
(d) theymaybemadewithoutwarningasanabruptattemptatacorporatetakeover.
Answer: B
LevelofDifficulty:3
LearningGoal:4
Topic:TenderOffers
71.
Indefendingagainstahostiletakeover,thestrategythatinvolvesthetargetfirmfindingamore
suitableacquirerandpromptingittocompetewiththeinitialhostileacquirertotakeoverthefirmis
calledthe_________strategy.
(a) poisonpill
(b) whiteknight
(c) goldenparachute
(d) greenmail
Answer: B
LevelofDifficulty:3
LearningGoal:4
Topic:HostileTakeoverDefenseStrategies
72.
Indefendingagainstahostiletakeover,thestrategythatinvolvesthetargetfirmcreatingsecurities
thatgivetheirholderscertainrightsthatbecomeeffectivewhenatakeoverisattemptediscalledthe
_________strategy.
(a) sharkrepellent
(b) greenmail
(c) poisonpill
(d) goldenparachute
Answer: C
LevelofDifficulty:3
LearningGoal:4
73.
Indefendingagainstahostiletakeover,thestrategythatinvolvesthefirmrepurchasingthrough
negotiationalargeblockofstockatapremiumfromoneormoreshareholdersinordertoendthose
shareholdershostiletakeoverattemptisknownasthe_________strategy.
(a) poisonpill
(b) greenmail
(c) goldenparachute
(d) sharkrepellent
Answer: B
LevelofDifficulty:3
LearningGoal:4
74.
Indefendingagainstahostiletakeover,thestrategyinvolvingthepaymentofalarge,debtfinanced,
cashdividendisthe_________strategy.
(a) sharkrepellent
(b) goldenparachute
(c) leveragedrecapitalization
(d) whiteknight
Answer: C
LevelofDifficulty:3
LearningGoal:4
75.
Indefendingagainsthostiletakeoverattempts,acompanywillincludeprovisionsinthe
employmentcontractsofkeyexecutivesthatprovidethemwithsizablecompensationifthefirmis
takenover.Thisiscalledthe_________strategy.
(a) sharkrepellent
(b) whiteknight
(c) greenmail
(d) goldenparachute
Answer: D
LevelofDifficulty:3
LearningGoal:4
76.
Indefendingagainsthostiletakeoverattempts,acompanywillapproveantitakeoveramendments
tothecorporatecharterthatconstrainthefirmsabilitytotransfermanagerialcontrolofthefirmasa
resultofamerger.Thisiscalledthe_________strategy.
(a) goldenparachute
(b) greenmail
(c) poisonpill
(d) sharkrepellent
Answer: D
LevelofDifficulty:3
LearningGoal:4
77.
Akeyconsiderationintheholdingcompanydecisionis
(a) theriskreturntradeoffduetotheleverageeffect.
(b) thegreaterdistancebetweentoplevelandoperatingmanagement.
(c) theriskofthedominoeffectifonecompanyintheholdingcompanyfails.
(d) theriskfromtheseparatecompaniesintheholdingcompanybeingclassedasonecompany.
Answer: A
LevelofDifficulty:3
LearningGoal:4
78.
AllofthefollowingareadvantagesofholdingcompaniesEXCEPT
(a) possiblestatetaxbenefitsrealizedbyeachsubsidiaryinitsstateofincorporation.
(b) sinceeachsubsidiaryisaseparatecorporation,thefailureofonecompanyshouldcostthe
holdingcompanynomorethanitsinvestmentinthatsubsidiary.
(c) reducedfederalcorporatetaxesduetotheholdingcompanystatus.
(d) lawsuitsorlegalactionsagainstasubsidiarywillnotthreatentheremainingcompanies.
Answer: C
LevelofDifficulty:3
LearningGoal:4
79.
BusinessfailuremaybecausedbyallofthefollowingEXCEPT
(a) lowornegativereturns.
(b) technicalinsolvency.
(c) bookvalueofassetsthatexceedliabilities.
(d) liabilitiesthatexceedmarketvalueofassets.
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:CausesofBusinessFailure
80.
BusinessfailuremaybecausedbyallofthefollowingEXCEPT
(a) corporatematurity.
(b) mismanagement.
(c) economicdownturns.
(d) increasingliquidity.
Answer: D
LevelofDifficulty:1
LearningGoal:5
Topic:CausesofBusinessFailure
81.
_________isanarrangementinitiatedbythedebtorfirmtonegotiatewiththecreditorsaboutaplan
forsustainingorliquidatingthefirm.
(a) Aninvoluntaryreorganization
(b) Aninvoluntaryliquidation
(c) AfilingofChapterSevenoftheBankruptcyReformActof1978
(d) Avoluntarysettlement
Answer: D
LevelofDifficulty:1
LearningGoal:5
Topic:VoluntarySettlements
82.
_________isanarrangementwherebythefirmscreditorsreceivefullpayment,althoughnot
immediately.
(a) Acomposition
(b) Acreditorcontrolagreement
(c) Anextension
(d) Aliquidation
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:ExtensionsinVoluntarySettlements
83.
_________isaproratacashsettlementofcreditorclaims.
(a) Acomposition
(c) Anextension
(d) Aliquidation
Answer: A
LevelofDifficulty:1
LearningGoal:5
Topic:CompositionsinVoluntarySettlements
84.
_________mayreplacetheoperatingmanagementwithaselectedcreditor.
(a) Acomposition
(c) Anextension
(d) Aliquidation
Answer: B
LevelofDifficulty:1
LearningGoal:5
Topic:CreditorControlAgreementsinVoluntarySettlements
85.
Inavoluntarysettlement,eachcreditorwillbepaid20centsonthedollarin120days.The
remaining80centsonthedollarwillbepaidwithinanadditional60days.Thisisanexampleof
(a) acomposition.
(b) acombinationofacompositionandextension.
(c) anextension.
(d) aliquidation.
Answer: C
LevelofDifficulty:3
LearningGoal:5
Topic:ExtensionsinVoluntarySettlements
86.
Inavoluntarysettlement,eachcreditorwillbepaidonly45centsonthedollarimmediately.Thisis
anexampleof
(a) acomposition.
(c) anextension.
(d) aliquidation.
Answer: A
LevelofDifficulty:1
LearningGoal:5
Topic:CompositionsinVoluntarySettlements
87.
Inavoluntarysettlement,onegroupofcreditorshavingclaimsof$1,000,000willbeimmediately
paid95centsonthedollar.Theremainderofthecreditorswillpostponepaymentanadditional
60days.Thisisanexampleof
(a) acomposition.
(c) anextension.
(d) aliquidation.
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:CompositionsandExtensionsinVoluntarySettlements
88.
In_________,anassignmentmaybemadebythecreditorstoathirdpartywhothenhasthepower
toliquidatethefirmsassets.
(a) avoluntaryprivateliquidation
(b) aninvoluntaryprivateliquidation
(c) aninvoluntaryliquidationunderChapterSevenoftheBankruptcyReformActof1978
(d) avoluntaryliquidationunderChapterSevenoftheBankruptcyReformActof1978
Answer: A
LevelofDifficulty:3
LearningGoal:5
Topic:VoluntaryPrivateLiquidations
89.
AreorganizationplanmustmeetallofthefollowingcriteriaEXCEPT
(a) itmustbefairandequitable.
(b) itmustbefeasible.
(c) itmaintainstheprioritiesofthecontractualclaimsofallparties.
(d) themarketvalueofthefirmsassetsmustexceedthestatedliabilities.
Answer: D
LevelofDifficulty:2
LearningGoal:6
Topic:ReorganizationPlans
90.
Aninvoluntarypetitionforreorganizationmaybefiledagainstafirmifanyoneofthefollowing
conditionsaremetEXCEPT
(a) thebookvalueofthefirmsassetsislessthanthestatedliabilities.
(b) pastduedebtsof$5,000ormore.
(c) threeormorecreditorswhocanproveaggregateclaimsof$5,000againstthefirm.
(d) insolvency.
Answer: A
LevelofDifficulty:3
LearningGoal:6
Topic:InvoluntaryReorganizationinChapter11Bankruptcy
91.
TheresponsibilitiesofthedebtorinpossessionincludeallofthefollowingEXCEPT
(a) thevaluationofthefirmasagoingconcern.
(b) drawingupaplanofreorganization.
(c) recommendingarecapitalizationplan.
(d) liquidatingtheassetsofthefirm.
Answer: D
LevelofDifficulty:3
LearningGoal:6
Topic:DebtorinPossessioninChapter11Bankruptcy
92.
Animportantaspectofthefirmsreorganizationplanistherecapitalizationofthefirmscapital
structure.ThegoalofrestructuringthefirmsdebtincludesallofthefollowingEXCEPT
(a) providingareasonablelevelofearningsfortheowners.
(b) exchangingdebtforequity.
(c) reducingthefixedpaymentobligations.
(d) decreasingthetimesinterestearnedratio.
Answer: D
LevelofDifficulty:3
LearningGoal:6
Topic:RecapitalizationinChapter11Bankruptcy
93.
ThepriorityofclaimsestablishedbyChapterSevenoftheBankruptcyReformActof1978gives
priorityto
(a) unpaidemployeebenefitplancontributionsoverunsecuredcustomerdeposits.
(b) commonstockholdersovertaxes.
(c) taxesoverexpensesofadministeringthebankruptcy.
(d) preferredstockholdersoverclaimsofsecuredcreditors.
Answer: A
LevelofDifficulty:3
LearningGoal:6
Topic:PriorityofClaimsinChapter7Bankruptcy
94.
ThepriorityofclaimsestablishedbyChapterSevenoftheBankruptcyReformActof1978gives
prioritytoclaimsof
(a) unsecuredcreditorsoverclaimsofsecuredcreditors.
(b) preferredstockholdersoverclaimsofunsecuredcreditors.
(c) wagespayableoverclaimsofunsecuredcreditors.
(d) farmersingrainstorageoverexpensesofadministeringthebankruptcy.
Answer: C
LevelofDifficulty:3
LearningGoal:6
Topic:PriorityofClaimsinChapter7Bankruptcy
95.
WhiteandWong,Inc.recentlyhashadfinancialdifficultyandisbeingliquidatedbytheFederal
BankruptcyCourt.Thefirmhasaliquidationvalueof$1,000,000$400,000fromthefixedassets
thatservedascollateralforthemortgagebondsand$600,000fromallotherassets(allpriorclaims
havebeensatisfied).Thefirmscurrentcapitalstructureisasfollows:
SourceofCapital
Unsecuredbonds
Mortgagebonds
Preferredstock
Commonstock
Amount
$500,000
400,000
100,000
500,000
Thecommonstockholderswillreceive_________intheliquidation.
(a) $500,000
(b) $333,333
(c) $198,000
(d) $0
Answer: D
LevelofDifficulty:4
LearningGoal:6
Topic:Chapter7BankruptcyAnalysis
96.
TangshanMiningisconsideringtheacquisitionofZhengsenMiningatacashpriceof$6,000,000.
TheprimarymotivationforTangshanspurchaseofZhengsenisforaspecialpieceofdrilling
equipmentthatitbelieveswillgenerateaftertaxcashflowsif$2,000,000peryearduringthenext
5years.ZhengsenMininghasliabilitiesof$9,000,000andTangshanestimatesthatitcansellthe
remainingassets$6,500,000.Tangshanwillusea15percentcostofcapitalforevaluatingthe
acquisition.Basedonthisinformation,whatisthenetvalueofthespecialdrillingequipment?
(a) $1,795,690
(b) $1,500,000
(c) ($1,795,690)
(d) ($1,500,000)
Answer: C
LevelofDifficulty:3
LearningGoal:3
97.
TangshanMiningisconsideringtheacquisitionofZhengsenMiningatacashpriceof$6,000,000.
TheprimarymotivationforTangshanspurchaseofZhengsenisforaspecialpieceofdrilling
equipmentthatitbelieveswillgenerateaftertaxcashflowsof$2,000,000peryearduringthenext
5years.ZhengsenMininghasliabilitiesof$9,000,000andTangshanestimatesthatitcansellthe
remainingassets$6,500,000.Tangshanwillusea15percentcostofcapitalforevaluatingthe
acquisition.Basedonthisinformation,whatisthenetvalueofthespecialdrillingequipment?
CalculatethenetvalueofasecondalternativethatwouldallowTangshantopurchaseabetter
qualityassetfor$12,000,000thatwouldprovidea$2,600,000inaftertaxinflowsforthenext5
years.Whichalternativewouldyouchoose?
(a) $1,795,690,$3,284,396,both
(b) $1,500,000,$4,500,000,both
(c) ($1,795,690),($3,284,396),neither
(d) ($1,795,690),($4,500,000),neither
Answer: C
LevelofDifficulty:4
LearningGoal:3
98.
TangshanMiningisattemptingtoacquireZhengsenMining.Selectedfinancialdataispresentedfor
bothcompaniesinthetablebelow:
Item
Earningsavailableforcommonstock
Numberofsharesofstockoutstanding
Marketpricepershare
TangshanMining
$100,000
100,000
$60
ZhengsenMining
$40,000
20,000
$120
TangshanMininghassufficientauthorizedbutunissuedsharestocarryouttheproposedmerger.If
theratioofexchangeis1.8,whatwillbetheEPSofthemergedfirm?
(a) $1.00
(b) $1.029
(c) $1.078
(d) $2.00
Answer: B
LevelofDifficulty:4
LearningGoal:3
Topic:RatioofExchangeandEPS
99.
KeyadvantagesofholdingcompaniesincludeallofthefollowingEXCEPT
(a) theypermitafirmtocontrolalargeamountofassetswithrelativelysmalldollarinvestment.
(b) theyhelpintermsofriskprotectionbecausethefailureofoneofthecompaniesdoesnotresult
inthefailureoftheentirefirm.
(c) lawsuitsorlegalactionsagainstasubsidiarydonotthreatentheremainingcompanies.
(d) Alloftheaboveareadvantages.
Answer: D
LevelofDifficulty:2
LearningGoal:4
100. KeydisadvantagesofholdingcompaniesincludeallofthefollowingEXCEPT
(a) theyresultinincreasedriskbecauseoftheleverageeffect.
(b) theyresultintripletaxation.
(c) theyaredifficulttoanalyze.
(d) theyarecostlytoadminister.
Answer: B
LevelofDifficulty:2
LearningGoal:4
.4
Essay Questions
1.
BakersOvenManufacturingisevaluatingtheacquisitionofCuisinaireKitchenApplianceCo.
Cuisinairehasalosscarryforwardof$1.5millionwhichresultedfromearlieroperations.Bakers
OvencanpurchaseCuisinairefor$1.8millionandliquidatetheassetsfor$1.3million.Bakers
Ovenexpectsearningsbeforetaxesinthefiveyearsfollowingtheacquisitiontobeasfollows:
Year
1
2
3
4
5
EarningsbeforeTaxes
$108,000
288,000
324,000
425,000
425,000
(Theseearningsareassumedtofallwithintheannuallimitlegallyallowedforapplicationofthetax
losscarryforwardresultingfromtheproposedacquisition.)BakersOvenisinthe40percenttax
bracketandhasacostofcapitalof17percent.
(a) WhatisthetaxadvantageoftheacquisitioneachyearforBakersOven?
(b) WhatisthemaximumcashpriceBakersOvenwouldbewillingtopayforCuisinaire?
(c) Doyourecommendtheacquisition?Whyorwhynot?
Answers:
Year EarningsbeforeTaxes
1
$0
2
0
3
0
4
0
5
70,000
Taxes
0
0
0
0
28,000
TaxRelief
$43,200
115,200
129,600
170,000
142,000
Totaltaxrelief$1,500,0000.40$600,000
(b)
Year
1
2
3
4
5
TotalPVoftaxbenefits
TaxBenefit
$43,200
115,200
129,600
170,000
142,000
Liquidationvalueofassets
PVoftaxbenefits
MaximumPrice
PVIF,17%,n
0.855
0.731
0.624
0.534
0.456
$36,936
84,211
80,870
90,780
64,752
$357,549
$1,300,000
357,549
$1,657,549
(c) No,thePVofthebenefitsislessthanthepurchasepriceoftheacquisition
($1.8million).
LevelofDifficulty:3
LearningGoal:3
2.
GeneralElectronics,Inc.isconsideringtheacquisitionofDatamatic,Inc.atacashpriceof
$5,000,000.Datamatic,Inc.hasshorttermliabilitiesof$1,500,000.Asaresultofacquiring
Datamatic,Inc.,GeneralElectronicswouldalsoacquirerightstoonemajorpatentwhichwould
provideanestimatedcashinflowof$1,800,000peryearforthenexteightyears.Thefirmhasacost
ofcapitalof12percent.Wouldyourecommendthecashacquisition?
Answer:
PVIF,12%,n
CFO($5,000,000)
CF1($1,500,000)*$1,800,000
CF28$1,800,000
0.893
(4.9680.893)
PVofCF
($5,000,000)
267,900
7,335,000
NPV$2,602,900
*AssumedshorttermliabilitieswerepaidoffinfirstyearsincetheNPV>0,theGeneral
ElectronicsshouldacquireDatamatic,Inc.
LevelofDifficulty:3
LearningGoal:3
3.
HolidayTanningSystemshasanestimatedliquidationvalue(afterallpriorclaimshavebeen
satisfied)of$3,000,000;$1,500,000fromfixedassetsand$1,500,000fromcurrentassets.The
firmsvalueasagoingconcernis$4,000,000.Thefirmscurrentcapitalstructureisasfollows:
Debentures
$5,000,000
Mortgagebonds*
2,000,000
Preferredstock
1,000,000
Commonstock
4,000,000
Total
$12,000,000
*Securedbyfixedassets.
Prepareatableindicatingtheamount,ifany,tobedistributedtoeachclaimant,intheeventof
liquidation.
Answer:
SourceofCapital
Debentures55.5($1,500,000)
Mortgagebonds0.55.5($1,500,000)$1,500,000**
Preferredstock
Commonstock
Claim
$1,363,636
1,636,364
0
0
Afterpaymenttothemortgagebondholdersfromthe$1,500,000proceedsfromthesaleof
thefixedassets,theremainingdebtis($7,000,0001,500,000)$5,500,000.
**Mortgagebondreceives$1,500,000fromfixedassetsliquidationandthenjoins
liquidationasageneralcreditor.
LevelofDifficulty:4
LearningGoal:5
Topic:Chapter7BankruptcyAnalysis
4.
Afirmscurrentstructureisasfollows:
Debentures
$5,000,000
Mortgagebonds*
2,000,000
Preferredstock
1,000,000
Commonstock
4,000,000
Total
$12,000,000
*Securedbyfixedassets.
Suggestarecapitalizedcapitalstructurethatwouldreducethedebtequityratio(severalsolutionsare
feasible).Calculatethederatiofortheprereorganizationcapitalstructureandthepost
reorganizationcapitalstructure.
Answer: Asuggestedrecapitalizationplan:
Debentures
Mortgagebonds
Preferredstock
Commonstock
5,000,000
2,000,000
1,000,000
4,000,000
Debentures
Mortgagebonds
Incomebonds
Preferredstock
Commonstock
12,000,000
DE1.40
1,500,000
500,000
500,000
500,000
1,000,000
4,000,000
DE1.00*
*Incomebonds,preferredstockandcommonstockareincludedinstockholdersequity.
LevelofDifficulty:4
LearningGoal:6
Topic:Chapter11BankruptcyAnalysisandRecapitalization
5.
TangshanMiningisattemptingtoacquireZhengsenMining.Selectedfinancialdataispresentedfor
bothcompaniesinthetablebelow:
Item
Earningsavailableforcommonstock
Numberofsharesofstockoutstanding
Marketpricepershare
TangshanMining
$10,000,000
1,000,000
$100
ZhengsenMining
$1,000,000
50,000
$120
TangshanMininghassufficientauthorizedbutunissuedsharestocarryouttheproposedmerger.
(a) CalculatetheEPSofTangshanMiningandZhengsenMiningbeforethemerger.
(b) Iftheratioofexchangeis1.8,whatwillbetheearningspershareofthemergedcompany?
(c) Repeatpart(a)iftheratioofexchangeis2.0.
(d) Repeatpart(a)iftheratioofexchangeis2.2
(e) discusstheprincipalillustratedbyyouranswerstoparts(a)through(d)
Answers:
(a) Priortothemerger,theEPSofTangshanis$10.00andtheEPSofZhengsenis$20.
(b) Iftheratioofexchangeis1.8,thenTangshanwillgiveZhengsen1.8ofitssharesfor
Zhengsens50,000sharesor90,000shares.Thecombinedearningsofthetwo
companiesare$11,000,000.ThetotalnumberofsharesofTangshanwillnowbe
1,090,000.Therefore,EPSforthecombinedcompanywillbe$11,000,000
1,090,000$10.09.
(c) Iftheratioofexchangeis2.0,thenTangshanwillgiveZhengsen2.0ofitssharesfor
Zhengsens50,000sharesor1,090,000shares.Thecombinedearningsofthetwo
1,100,000$10.00.ThisisthesamevalueforTangshanasbeforethemerger.
(d) Iftheratioofexchangeis2.2,thenTangshanwillgiveZhengsen2.2ofitssharesfor
Zhengsens50,000sharesor110,000shares.Thecombinedearningsofthetwo
1,110,000$9.91.
(e) Thisshowsthatthegreatertheratioofexchange,thelowerwillbetheEPSofthe
combinedfirmafterthemerger.
LevelofDifficulty:4
LearningGoal:3
Topic:RatioofExchangeandEPS

Chapter 17: Mergers, Lbos, Divestitures, and Business Failure

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