Corporate Finance, 3Ce (Berk, DeMarzo, Strangeland)

Chapter 28 Mergers and Acquisitions

28.1 Background and Historical Trends

1) This period is known as the conglomerate wave because firms typically acquired firms in
unrelated businesses:
A) 1960s
B) 1970s
C) 1980s
D) 1990s
Answer: A
Diff: 1 Type: MC
Topic: 28.1 Background and Historical Trends

2) This period is known for hostile, "bust-up" takeovers, in which the acquirer purchased a
poorly performing conglomerate and sold off its individual business units for more than the
purchase price:
A) 1960s
B) 1970s
C) 1980s
D) 1990s
Answer: C
Diff: 1 Type: MC
Topic: 28.1 Background and Historical Trends

3) This period is known for known for "strategic" or "global" deals that were more likely to
be friendly and to involve companies in related businesses; these mergers often were
designed to create strong firms on a scale that would allow them to compete globally:
A) 1960s
B) 1970s
C) 1980s
D) 1990s
Answer: D
Diff: 1 Type: MC
Topic: 28.1 Background and Historical Trends

4) The 1990s were known for "strategic" deals that were more likely to be ________ in
related businesses; these mergers often were designed to create strong firms on a scale
that would allow them to compete ________.
A) friendly and to involve companies; globally
B) hostile but to involve companies; globally
C) friendly but not to involve companies; globally
D) friendly and to involve companies; domestically
Answer: A
Diff: 2 Type: MC
Topic: 28.1 Background and Historical Trends
5) Which of the following statements is false?
A) Merger activity is greater during economic expansions than during contractions and
correlates with bull markets.
B) Merger activity is greater during economic contractions than during expansions and
correlates with bear markets.
C) According to Thomson Reuters, 2007 saw the value of merger and acquisition activity hit
an all-time high, with over $4.5 trillion worth of deals announced globally.
D) The latest merger wave came to a crashing end as the credit crisis of late 2007 and
2008 curtailed the ability to finance mergers.
Answer: B
Diff: 3 Type: MC
Topic: 28.1 Background and Historical Trends

6) Which of the following statements is false?

A) There are two primary mechanisms by which ownership and control of a public
corporation can change: either another corporation or group of individuals can acquire the
target firm, or the target firm can merge with another firm.
B) Merger activity is greater during economic contractions than during expansions.
C) Mergers and acquisitions are part of what is often referred to as "the market for
corporate control."
D) The takeover market is also characterized by merger waves — peaks of heavy activity
followed by quiet troughs of few transactions.
Answer: B
Explanation: B) Merger activity is greater during economic expansions than during
contractions.
Diff: 3 Type: MC
Topic: 28.1 Background and Historical Trends

28.2 Market Reaction to a Takeover

1) In Canada, the law requires that when existing shareholders of a target firm are forced
to sell their shares, they receive ________ for their shares.
A) a fair market value
B) a discounted value
C) a risk-free stock value
D) the current market value
Answer: A
Diff: 1 Type: MC
Topic: 28.2 Market Reaction to a Takeover
2) Which of the following statements is false?
A) In practice, most acquirers pay a substantial acquisition premium, which is the
percentage difference between the acquisition price and the premerger price of the target
firm.
B) When a bid is announced, the target shareholders enjoy a gain of 16% on average in
their stock price.
C) In Canadian provinces, the law requires that when existing shareholders of a target firm
are forced to sell their shares, they receive the market price for their shares. In most cases,
this concept is interpreted as the value inclusive of any value that arises because of the
merger itself.
D) A bidder is unlikely to acquire a target company for less than its current market value.
Answer: C
Explanation: C) In Canadian provinces, the law requires that when existing shareholders of
a target firm are forced to sell their shares, they receive a fair value for their shares. In
most cases, this concept is interpreted as the value exclusive of any value that arises
because of the merger itself.
Diff: 3 Type: MC
Topic: 28.2 Market Reaction to a Takeover

28.3 Reasons to Acquire

1) The fact that a large company can enjoy savings from producing goods in high volumes
that are not available to a small company is called
A) economies of scale.
B) horizontal integration.
C) vertical integration.
D) economies of scope.
Answer: A
Diff: 1 Type: MC
Topic: 28.3 Reasons to Acquire

2) For most investors an investment in the stock market is a ________ investment.

A) risk-free
B) positive-NPV
C) zero-NPV
D) negative-NPV
Answer: C
Diff: 1 Type: MC
Topic: 28.3 Reasons to Acquire

3) ________ are/is by far the most common justification that bidders give for the premium
they pay for a target.
A) Small risks
B) Value Added
C) Diversification
D) Large synergies
Answer: D
Diff: 1 Type: MC
Topic: 28.3 Reasons to Acquire
4) Cost-reduction synergies are ________ to achieve because they generally translate into
layoffs of overlapping employees and elimination of redundant resources.
A) more common but more difficult
B) more common and easier
C) more uncommon but easier
D) more uncommon and more difficult
Answer: B
Diff: 1 Type: MC
Topic: 28.3 Reasons to Acquire

5) The principal benefit of vertical integration is ________ and major challenge of vertical
integration is ________.
A) net income; effectiveness
B) earnings per share; efficiency
C) coordination; effectiveness
D) control; efficiency
Answer: C
Diff: 1 Type: MC
Topic: 28.3 Reasons to Acquire

6) Savings that come from combining the marketing and distribution of different types of
related products. are called
A) horizontal integration.
B) vertical integration.
C) economies of scale.
D) economies of scope.
Answer: D
Diff: 2 Type: MC
Topic: 28.3 Reasons to Acquire

7) The merger of two companies in the same industry that make products required at
different stages of the production cycle is called
A) economies of scope.
B) vertical integration.
C) economies of scale.
D) horizontal integration.
Answer: B
Diff: 2 Type: MC
Topic: 28.3 Reasons to Acquire
8) The justification for the benefits of diversification from mergers include all of the
following EXCEPT
A) tax loss benefits.
B) lower cost of debt or increased debt capacity.
C) direct risk reduction.
D) liquidity enhancement.
Answer: A
Explanation: A) The justification for these benefits comes in three forms: direct risk
reduction, lower cost of debt or increased debt capacity, and liquidity enhancement. To
justify a takeover based on operating losses, management would have to argue that the tax
savings are over and above what the firm would save using carryback and carryforward
provisions. In addition, the IRS will disallow a tax break if it can show that the principal
reason for a takeover is tax avoidance, so it is unlikely that the tax advantage could, by
itself, be a valid reason to acquire another firm.
Diff: 2 Type: MC
Topic: 28.3 Reasons to Acquire

9) Which of the following statements is false?

A) Chief among the costs associated with size is that larger firms are more difficult to
manage.
B) For most investors an investment in the stock market is a zero-NPV investment.
C) Diversification benefits are by far the most common justification that bidders give for
the premium they pay for a target.
D) An acquirer might be able to add economic value, as a result of an acquisition, that an
individual investor cannot add.
Answer: C
Explanation: C) Large synergies are by far the most common justification that bidders give
for the premium they pay for a target.
Diff: 2 Type: MC
Topic: 28.3 Reasons to Acquire

10) Which of the following statements is false?

A) Cost-reduction synergies are hard to predict and achieve.
B) Because the CEOs of small firms receive information so quickly, small firms are often
able to react in a timely way to changes in the economic environment.
C) Synergies usually fall into two categories: cost reductions and revenue enhancements.
D) There may be costs associated with size.
Answer: A
Explanation: A) Revenue-enhancement synergies are hard to predict and achieve.
Diff: 2 Type: MC
Topic: 28.3 Reasons to Acquire
11) Which of the following statements regarding vertical integration is false?
A) Vertically integrated companies may be large, but unlike other large corporations, since
they remain focused in one industry they are easy to run.
B) A company might not be happy with how its products are being distributed, so it might
decide to take control of its distribution channels.
C) A company might conclude that it can enhance its product if it has direct control of the
inputs required to make the product.
D) The principal benefit of vertical integration is coordination. By putting two companies
under central control, management can ensure that both companies work toward a
common goal.
Answer: A
Explanation: A) Vertically integrated companies are large, and as large corporations they
are more difficult to run.
Diff: 2 Type: MC
Topic: 28.3 Reasons to Acquire

12) Which of the following statements regarding monopoly mergers is false?

A) It is often argued that merging with or acquiring a major rival enables a firm to
substantially reduce competition within the industry and thereby increase profits.
B) Financial researchers have found that the share prices of other firms in the same
industry did not significantly increase following the announcement of a merger within the
industry.
C) While only the merging company benefits when competition is reduced, all companies in
an industry pay the associated costs.
D) Society as a whole bears the cost of monopoly strategies, so most countries have
antitrust laws that limit such activity.
Answer: C
Explanation: C) While all companies in an industry benefit when competition is reduced,
only the merging company pays the associated costs.
Diff: 3 Type: MC
Topic: 28.3 Reasons to Acquire

13) Which of the following statements regarding efficiency gains is false?

A) Takeovers relying on the improvement of target management are difficult to complete,
and post-takeover resistance to change can be great. Thus not all inefficiently run
organizations are necessarily more efficient following a takeover.
B) Although identifying poorly performing corporations is relatively easy, fixing them is
another matter entirely.
C) A justification that acquirers cite for paying a premium for a target is efficiency gains,
which are often achieved through an elimination of duplication.
D) A chief executive of an inefficiently run corporation can be ousted by current
shareholders voting to replace the board of directors, and in fact a large number of
ineffective managers are replaced in this way.
Answer: D
Explanation: D) Although in theory a chief executive of an inefficiently run corporation can
be ousted by current shareholders voting to replace the board of directors, very few
managers are replaced in this way.
Diff: 3 Type: MC
Topic: 28.3 Reasons to Acquire
14) Which of the following statements regarding mergers and taxes is false?
A) Carryback and carryforward provisions essentially deliver the benefits of
conglomeration to a small firm with volatile earnings.
B) It might appear that a conglomerate has a tax advantage over a single-product firm
simply because losses in one division can offset profits in another division.
C) Companies with current-year losses can also use them to offset earnings (carryback) for
the twenty prior years.
D) The IRS will disallow a tax break if it can show that the principal reason for a takeover is
tax avoidance, so it is unlikely that the tax advantage could, by itself, be a valid reason to
acquire another firm.
Answer: C
Explanation: C) Companies with current-year losses can also use them to offset earnings
for the three prior years in Canada, two in the USA.
Diff: 3 Type: MC
Topic: 28.3 Reasons to Acquire

15) Which of the following statements regarding mergers and taxes is false?
A) Because it may be easier to measure performance accurately in a conglomerate, agency
costs may be reduced and resources may be more efficiently allocated.
B) Because employees holding a large fraction of their wealth in shares of the corporation
for which they work are obligated to hold idiosyncratic risk, they benefit when the firm
reduces that risk by conglomerating.
C) Like a large portfolio, large firms bear less idiosyncratic risk, so often mergers are
justified on the basis that the combined firm is less risky.
D) Because most stockholders will already be holding a well-diversified portfolio, they get
no further benefit from the firm diversifying through acquisition.
Answer: A
Explanation: A) Because it may be harder to measure performance accurately in a
conglomerate, agency costs may increase and resources may be inefficiently allocated
across divisions.
Diff: 3 Type: MC
Topic: 28.3 Reasons to Acquire

16) Which of the following statements is false?

A) All else being equal, larger firms, because they are more diversified, have an increased
probability of bankruptcy.
B) To justify a takeover based on operating losses, management would have to argue that
the tax savings are over and above what the firm would save using carryback and
carryforward provisions.
C) It is possible to combine two companies with the result that the earnings per share of
the merged company exceed the premerger earnings per share of either company, even
when the merger itself creates no economic value.
D) When an acquirer buys a private target, it provides the target's owners with a way to
reduce their risk exposure by cashing out their investment in the private target and
reinvesting in a diversified portfolio.
Answer: A
Explanation: A) All else being equal, larger firms, because they are more diversified, have
a lower probability of bankruptcy.
Diff: 3 Type: MC
Topic: 28.3 Reasons to Acquire
Use the information for the question(s) below.

Martin Manufacturing has earnings per share (EPS) of $3.00, 5 million shares outstanding,
and a share price of $32. Martin is considering buying Luther Industries, which has
earnings per share of $2.50, 2 million shares outstanding, and a share price of $20. Martin
will pay for Luther by issuing new shares. There are no expected synergies from the
transaction.

17) If Martin pays no premium to acquire Luther, what will the earnings per share be after
the merger?
Answer: First, since Martin is paying for the merger with stock we need to calculate the
number of shares that Martin must issue:

Number of new shares = = = 1.25 million

shares. So the total number of shares in the new merged firm equals 5 million (existing
Martin shares) + 1.25 million new shares = 6.25 million shares.

Total earnings for the merged firm = earnings from Martin + earnings from Luther.
Earnings from Martin = EPS × shares outstanding = $3.00 × 5 million = $15 million
Earnings from Luther = EPS × shares outstanding = $2.50 × 2 million = $5 million

Total earnings = $15 + $5 = $20 million

EPS merged firm = = $3.20

Diff: 3 Type: ES
Topic: 28.3 Reasons to Acquire
18) Assume that Martin pays no premium to acquire Luther. Calculate Martin's price-
earnings (P/E) ratio both pre- and post-merger.
Answer: Premerger P/E = = 10.67

First, since Martin is paying for the merger with stock we need to calculate the number of
shares that Martin must issue:

Number of new shares = = = 1.25 million

shares. So the total number of shares in the new merged firm equals 5 million (existing
Martin shares) + 1.25 million new shares = 6.25 million shares.

Total earnings for the merged firm = earnings from Martin + earnings from Luther.
Earnings from Martin = EPS × shares outstanding = $3.00 × 5 million = $15 million
Earnings from Luther = EPS × shares outstanding = $2.50 × 2 million = $5 million

Total earnings = $15 + $5 = $20 million

EPS merged firm = = $3.20

Post-merger P/E = = 10
Diff: 3 Type: ES
Topic: 28.3 Reasons to Acquire

28.4 The Takeover Process

1) Consider the following equation:

<

The term A in this equation refers to

A) the premerger (standalone) value of the acquirer.
B) new shares to pay for the target.
C) the value of the synergies created by the merger.
D) the premerger (standalone) value of the target.
Answer: A
Diff: 1 Type: MC
Topic: 28.4 The Takeover Process
2) Consider the following equation:

<

The term S in this equation refers to

A) the premerger (standalone) value of the target.
B) the premerger (standalone) value of the acquirer.
C) the value of the synergies created by the merger.
D) new shares to pay for the target.
Answer: C
Diff: 1 Type: MC
Topic: 28.4 The Takeover Process

3) Consider the following equation:

<

The term x in this equation refers to

A) the value of the synergies created by the merger.
B) the premerger (standalone) value of the acquirer.
C) new shares to pay for the target.
D) the premerger (standalone) value of the target.
Answer: C
Diff: 1 Type: MC
Topic: 28.4 The Takeover Process

4) Consider the following equation:

<

The term T in this equation refers to

A) the premerger (standalone) value of the acquirer.
B) the value of the synergies created by the merger.
C) the premerger (standalone) value of the target.
D) new shares to pay for the target.
Answer: C
Diff: 1 Type: MC
Topic: 28.4 The Takeover Process
5) A key issue for takeovers is ________ and ________ the value added as a result of the
merger.
A) qualifying; discounting
B) quantifying; compounding
C) qualifying; compounding
D) quantifying; discounting
Answer: D
Diff: 1 Type: MC
Topic: 28.4 The Takeover Process

6) The price paid for a target is equal to the target's ________ plus the ________ paid in the
acquisition.
A) after-bid market capitalization; premium
B) pre-bid market capitalization; administrative cost
C) pre-bid market capitalization; premium
D) pre-bid market capitalization; opportunity cost
Answer: C
Diff: 2 Type: MC
Topic: 28.4 The Takeover Process

7) From the bidder's perspective, the takeover is a ________ only if the premium it pays
________ the synergies created.
A) positive-NPV project; exceeds
B) positive-NPV project; does not exceed
C) zero-NPV project; does not exceed
D) zero-NPV project; exceeds
Answer: B
Diff: 2 Type: MC
Topic: 28.4 The Takeover Process

8) Because of the uncertainty about whether a takeover will succeed, the market price
________ by an amount ________ when the takeover is announced.
A) rises; equal to the premium
B) rises; greater than the premium
C) does not rise; equal to the premium
D) does not rise; greater than the premium
Answer: C
Diff: 2 Type: MC
Topic: 28.4 The Takeover Process

9) In stock-swap transaction, the "price" offered is determined by the ________—the number

of bidder shares received in exchange for each target share—multiplied by ________ of the
acquirer's stock.
A) P/E ratio; the market price
B) exchange ratio; the discounted price
C) P/E ratio; the discounted price
D) exchange ratio; the market price
Answer: D
Diff: 2 Type: MC
Topic: 28.4 The Takeover Process
10) Which of the following statements is false?
A) Any acquirer shares received in full or partial exchange for target shares triggers an
immediate tax liability for target shareholders.
B) In a friendly takeover, the target board of directors supports the merger, negotiates with
potential acquirers, and agrees on a price that is ultimately put to a shareholder vote.
C) How the acquirer pays for the target affects the taxes of both the target shareholders
and the combined firm.
D) If the acquirer purchases the target assets directly (rather than the target stock), then it
can step up the book value of the target's assets to the purchase price.
Answer: A
Explanation: A) Any cash received in full or partial exchange for shares triggers an
immediate tax liability for target shareholders.
Diff: 2 Type: MC
Topic: 28.4 The Takeover Process

11) Which of the following statements is false?

A) The method of payment (cash or stock) affects how the value of the target's assets is
recorded for tax purposes and it affects the combined firm's financial statements for
financial reporting.
B) The combined firm must mark up the value assigned to the target's assets on the
financial statements by allocating the purchase price to target assets according to their fair
market value.
C) Any goodwill created in a merger deal can be amortized for tax purposes over 15 years.
D) Many transactions are carried out as acquisitive reorganizations under the tax code.
These structures allow the target shareholders to defer their tax liability on the part of the
payment made in acquirer stock but they do not allow the acquirer to step up the book
value of the target assets.
Answer: A
Explanation: A) While the method of payment (cash or stock) affects how the value of the
target's assets is recorded for tax purposes, it does not affect the combined firm's financial
statements for financial reporting.
Diff: 3 Type: MC
Topic: 28.4 The Takeover Process

12) Which of the following statements regarding risk arbitrage is false?

A) Once a tender offer is announced, the uncertainty about whether the takeover will
succeed reduces the volatility of the stock price. This uncertainty creates an opportunity
for investors to speculate on the outcome of the deal without bearing the risk of volatility.
B) Traders known as risk-arbitrageurs, who believe that they can predict the outcome of a
deal, take positions based on their beliefs.
C) A potential profit arises from the difference between the target's stock price and the
implied offer price, and is referred to as the merger-arbitrage spread.
D) It is not a true arbitrage opportunity if there is a risk that the deal will not go through. If
the takeover does not ultimately succeed, the risk-arbitrageur will eventually have to
unwind his position at whatever market prices prevailed.
Answer: A
Explanation: A) Once a tender offer is announced, the uncertainty about whether the
takeover will succeed adds volatility to the stock price. This uncertainty creates an
opportunity for investors to speculate on the outcome of the deal.
Diff: 3 Type: MC
Topic: 28.4 The Takeover Process
13) Which of the following statements is false?
A) Once the acquirer has completed the valuation process, it is in the position to make a
tender offer—that is, a public announcement of its intention to purchase a large block of
shares for a specified price.
B) If we view the pre-bid market capitalization as the stand-alone value of the target, then
from the bidder's perspective, the takeover is a positive-NPV project only if the synergies
created do not exceed the premium it pays.
C) Purchasing a corporation usually constitutes a very large capital investment decision, so
it requires a more accurate estimate of value that includes careful analysis of both
operational aspects of the firm and the ultimate cash flows the deal will generate.
D) A stock-swap merger is a positive-NPV investment for the acquiring shareholders if the
share price of the merged firm (the acquirer's share price after the takeover) exceeds the
premerger price of the acquiring firm.
Answer: B
Explanation: B) If we view the pre-bid market capitalization as the stand-alone value of the
target, then from the bidder's perspective, the takeover is a positive-NPV project only if the
premium it pays does not exceed the synergies created.
Diff: 3 Type: MC
Topic: 28.4 The Takeover Process

14) KT corporation has announced plans to acquire MJ corporation. KT is trading for $45
per share and MJ is trading for $25 per share, with a premerger value for MJ of $3 billion
dollars. If the projected synergies from the merger are $750 million, what is the maximum
exchange ratio that KT could offer in a stock swap and still generate a positive NPV?

Answer: Exchange ratio < = = 2.25

Diff: 3 Type: ES
Topic: 28.4 The Takeover Process

28.5 Takeover Defenses

1) In Canada, ________ monitors potential monopoly combinations.

A) the Ministry of Finance
B) the Bank of Canada
C) the Toronto Stock Exchange (TSX)
D) the Competition Bureau
Answer: D
Diff: 1 Type: MC
Topic: 28.5 Takeover Defenses

2) Canada's Competition Bureau was rated in the "good" category by ________.

A) the World Bank
B) the Global Competition Review
C) the International Monetary Fund
D) the Organization for Economic Co-operation and Development
Answer: B
Diff: 1 Type: MC
Topic: 28.5 Takeover Defenses

3) A rights offering that gives existing target shareholders the right to buy shares in either
the target or the acquirer at a deeply discounted price once certain conditions are met is
called a
A) golden parachute.
B) poison pill.
C) classified board.
D) white knight.
Answer: B
Diff: 1 Type: MC
Topic: 28.5 Takeover Defenses

4) A situation where every director serves a three-year term and the terms are staggered
so that only one-third of the directors are up for election each year is called a
A) white knight.
B) classified board.
C) poison pill.
D) golden parachute.
Answer: B
Diff: 2 Type: MC
Topic: 28.5 Takeover Defenses

5) When a hostile takeover appears to be inevitable, a target company will sometimes look
for another, friendlier company to acquire it called a
A) poison pill.
B) classified board.
C) golden parachute.
D) white knight.
Answer: D
Diff: 2 Type: MC
Topic: 28.5 Takeover Defenses

6) An extremely lucrative severance package that is guaranteed to a firm's senior managers

in the event that the firm is taken over and the managers are let go is called a
A) golden parachute.
B) white knight.
C) poison pill.
D) classified board.
Answer: A
Diff: 2 Type: MC
Topic: 28.5 Takeover Defenses
7) Which of the following statements regarding poison pills is false?
A) Companies with poison pills are harder to take over, and when they are taken over, the
premium that existing shareholders receive for their stock is higher.
B) Because a poison pill increases the cost of a takeover, all else equal, a target company
must be in better shape to justify the expense of waging a takeover battle.
C) Poison pills also increase the bargaining power of the target firm when negotiating with
the acquirer because poison pills make it difficult to complete the takeover without the
cooperation of the target board.
D) By adopting a poison pill, a company effectively entrenches its management by making
it much more difficult for shareholders to replace bad managers, thereby potentially
destroying value.
Answer: B
Explanation: B) Because a poison pill increases the cost of a takeover, all else equal, a
target company must be in worse shape (there must be a greater opportunity for profit) to
justify the expense of waging a takeover battle.
Diff: 3 Type: MC
Topic: 28.5 Takeover Defenses

8) Which of the following statements regarding recapitalization as a takeover defense is

false?
A) Another defense against a takeover is a recapitalization, in which a company changes its
capital structure to make itself less attractive as a target.
B) Restructuring itself can produce efficiency gains, often removing the principal
motivation for the takeover in the first place.
C) By increasing leverage on its own, the target firm can reap the benefit of the interest tax
shields.
D) In many cases, a substantial portion of the synergy gains that an acquirer anticipates
from a takeover are savings from a decrease in leverage as well as other cost reductions.
Answer: D
Explanation: D) In many cases, a substantial portion of the synergy gains that an acquirer
anticipates from a takeover are from tax savings from an increase in leverage as well as
other cost reductions.
Diff: 3 Type: MC
Topic: 28.5 Takeover Defenses

9) What is a white knight?

Answer: When a hostile takeover appears to be inevitable, a target company will
sometimes look for another, friendlier company to acquire it called a white knight.

The white knight will make a more lucrative offer for the target than the hostile bidder.
Incumbent managers of the target maintain control by reaching an agreement with the
white knight to retain their positions.

One variant on the white knight defense is the white squire defense. In this case, a large
investor or firm agrees to purchase a substantial block of shares in the target with special
voting rights.
Diff: 3 Type: ES
Topic: 28.5 Takeover Defenses
28.6 Who Gets the Value Added from a Takeover?

1) Canadian securities laws make it difficult for investors to buy much more than ________.
A) about 10% of a firm in secret
B) about 10% of a firm publicly
C) about 1% of a firm in secret
D) about 1% of a firm publicly
Answer: A
Diff: 1 Type: MC
Topic: 28.6 Who Gets the Value Added from a Takeover?

2) Which of the following statements is false?

A) Canadian provincial SEC rules make it difficult for investors to buy much more than
about 10% of a firm in secret. After an acquirer acquires such an initial stake in the target,
called a toehold, they would have to make their intentions public by informing investors of
this large stake.
B) With the availability of both the freezeout merger and the leveraged buyout as
acquisition strategies, most of the value added accrues to the acquiring shareholders.
C) The laws on tender offers allow the acquiring company to freeze existing shareholders
out of the gains from merging by forcing non-tendering shareholders to sell their shares for
the tender offer price.
D) Premiums in LBO transactions are often quite substantial—while they can avoid the
free-rider problem acquirers must still get board approval to overcome other defenses such
as poison pills, as well as outbid other potential acquirers.
Answer: B
Explanation: B) Despite the availability of both the freezeout merger and the leveraged
buyout as acquisition strategies, most of the value added still appears to accrue to the
target shareholders.
Diff: 2 Type: MC
Topic: 28.6 Who Gets the Value Added from a Takeover?

3) You work for a levered buyout firm and are evaluating a potential buyout of Boogle Inc.
Boogle's stock price is $18, and it has 3 million shares outstanding. You believe that if you
buy the company and replace its dismal management team, its value will increase by 50%.
You are planning on doing a levered buyout of Boogle and will offer $25 per share for
control of the company. Assuming you get 50% control, what will your gain from the
transaction be?
Answer: The initial value of Boogle is $18 × 3 million shares = $54 million. Once you take
control the value of the firm should increase by 50% or by (.50)$54 = $27 million dollars
for a total value of $54 + $27 = $81 million.

You will need to borrow $25 × 1.5 million shares = $37.5 million dollars to acquire 50% of
the outstanding shares.

So, the value of the firm = $81 million - $37.5 million in debt = $43.5 million

Of this $43.5 million, $37.5 belongs to the other 50% of shareholders who did not tender
their shares, so your net gain from the transaction is $43.5 - $37.5 = $6.0 million
Diff: 3 Type: ES
Topic: 28.6 Who Gets the Value Added from a Takeover?