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

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Question 1

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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.

A) True
B) False

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Question 2

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Leveraged buyouts (LBOs) occur when a firm's managers, generally backed by private equity groups, try to gain control of a publicly owned company by buying out the public shareholders using large amounts of borrowed money.

A) True
B) False

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Question 3

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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."

Which of the following statements is most CORRECT?

a. ?True b. False a. -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.

Although goodwill created in a merger may not be amortized for shareholder reporting purposes, it may be amortized for Federal tax purposes.

In a financial merger, the relevant post-merger cash flows are simply the sum of the expected cash flows of the 2 companies, measured as if they were operated independently.

Currently (2007), mergers can be accounted for using either the purchase method or the pooling method.

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?

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.

The two principal advantages of holding companies are (1) the holding company can control a great deal of assets with limited equity and (2) the dividends received by the parent from the subsidiary are not taxed if the parent holds at least 50% of the subsidiary's stock.

A two-tier merger offer is one where the acquiring company offers to purchase the target company in a two-part transaction. Cash is paid to some stockholders, bonds are issued to others, but the total values of each part of the transaction are equal.

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

Which of the following statements is most CORRECT?

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.

Coca-Cola's acquisition of Columbia Pictures and its announcement that it would operate its new subsidiary separately could be described as primarily a financial merger.

What discount rate should you use to discount Dustvac's free cash flows and interest tax savings?

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

Discounted cash flow methods are not appropriate for evaluating mergers because the cash flows are uncertain and the discount rate can only be determined after the merger is consummated.

Since a manager's central goal is to maximize the firm's stock price, any merger offer that provides stockholders with significant gains over the current stock price will be approved by the current management team.