Exam 20: Mergers and Acquisitions and Financial Distress

Department Stores, Inc., is asking a price of $25 million to be purchased by Discount Stores Corp. The two firms currently have cumulative total cash flows of $2 million which are growing at 2.5 percent annually. Managers estimate that because of synergies the merged firm's cash flows will increase to 5 percent for the first four years following the merger. After the first four years cash flows will grow at a rate of 4.5 percent. The WACC for the merged firms is 13 percent. Calculate the NPV of the merger. Should Discount Stores Corporation agree to acquire Department Stores, Inc., for the asking price of $25 million?

A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the sales-to-total assets ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PD_i = 0.60 (debt/equity) + 0.02 (sales/total assets) A firm you are thinking of lending to has a sales-to-assets ratio of 1.75 and its expected probability of default, or bankruptcy, is estimated to be 8.1 percent. Calculate the firm's debt-to-assets ratio.

A survey of a local market provided the following average cost data: Johnson Construction Corp. (JCC) has assets of $5 million and an average cost of 15 percent; Anderson Architects (AA) has assets of $8 million and an average cost of 20 percent; Cole Home Builders (CHB) has assets of $8 million and an average cost of 17 percent. For each firm, average costs are measured as a proportion of assets. JCC is planning to acquire AA and CHB with the expectation of reducing overall average costs by eliminating the duplication of services. What should be the average cost after the acquisition for JCC to justify this merger?

Baby Supplies is considering a merger with Tot Toy Stores. Baby's total operating costs of producing services are $450,000 for sales volume of $2.15 million. Tot's total operating costs of producing services are $250,000 for a sales volume (JP) of $975,000. Calculate the average cost of production for the Baby and Tot Toy firms, respectively.

Market-specific reasons for financial distress include all of the following EXCEPT:

Flowers Galore is considering a merger with Balloons N More. Flowers Galore's total operating costs of producing services are $800,000 for a sales volume of $3 million. Balloons' total operating costs of producing services are $60,000 for a sales volume of $100,000. If the two firms merge, calculate the total average cost for the merged firm assuming no synergies.

All of the following are problems associated with using the Z-score model to make credit risk evaluations EXCEPT:

You own stock in Carpet City, Inc., which has just made a bid of $165 million to purchase Tile Corporation. The two firms currently have cumulative total cash flows of $25 million which are growing at 2 percent annually. Managers estimate that because of synergies the merged firm's cash flows will increase to 4 percent for the first three years following the merger. After the first three years cash flows will grow at a rate of 3 percent. The merged firms are expected to have a beta = 1.75, the risk-free rate is 5.5 percent, and the market risk premium is currently 7.5 percent. Calculate the NPV of the merger. Will you vote in favor of the merger?

Jewelry Designs is considering a merger with Beads Supply Stores. Jewelry's total operating costs of producing services are $300,000 for sales volume of $2 million. Beads' total operating costs of producing services are $125,000 for a sales volume (JP) of $2.25 million. Calculate the average cost of production for the Jewelry and Beads firms, respectively.

Which of these terms is defined as the value of the combined firms being greater than the sum of the value of the two firms individually?

Peter's TV Supplies is considering a merger with Jan's Radio Supply Stores. Peter's total operating costs of producing services are $330,000 for a sales volume (SP) of $4.5 million. Jan's total operating costs of producing services are $60,000 for a sales volume (SJ) of $550,000. Suppose that synergies in the production process result in a cost of production for the merged firms totalling $360,000 for a sales volume of $5,050,000. Calculate the total average cost (TAC) for the merged firm.

Baby Supplies is considering a merger with Tot Toy Stores. Baby's total operating costs of producing services are $450,000 for sales volume of $2.15 million. Tot's total operating costs of producing services are $250,000 for a sales volume (JP) of $975,000. For a sales volume of $3.125 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 19.5 percent.

Which of the following is the termination of the firm as a going concern in which assets are sold and any proceeds go to pay off the firm's creditors?

Which of the following is a poor justification for a merger?

The managers of BSW Inc. have been approached by EAG Corp. for a possible merger. EAG Corp. is asking a price of $50 million to be purchased by BSW Inc. The two firms currently have cumulative total cash flows of $2.5 million that are growing at 2 percent annually. Managers of EAG estimate that because of synergies the merged firm's cash flows will increase to 5 percent for the first three years following the merger. After the first three years, managers of EAG have estimated that cash flows will grow at a rate of 2 percent. The WACC for the merged firms is 12 percent. Managers of BSW Inc. agree that cash flows should grow at an additional 5 percent for the first three years, but are unsure of the long-term growth rate in cash flows estimated by EAG. Calculate the minimum growth rate needed after the first three years such that BSW Inc. would see this merger as a positive NPV project.

All of the following are an advantage of prepackaged bankruptcy EXCEPT:

Which of the following is defined as a merged firm's ability to generate synergistic cost savings through the joint use of inputs in producing multiple products?

Building Supplies is considering a merger with Tools and More. Building's total operating costs of producing services are $4 million for a sales volume of $20 million. Tools' total operating costs of producing services are $1 million for a sales volume of $5 million. Suppose that synergies in the production process result in a cost of production for the merged firms totalling $4.8 million with total sales remaining unchanged. Calculate the total average cost for the merged firm.

A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the equity multiplier and the total asset turnover ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PD_i = 0.04 (equity multiplier) + 0.01 (total asset turnover) A firm has an equity multiplier of 1.5 times and a probability of default of 7 percent. Calculate the firm's total asset turnover ratio.

Suppose a linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt ratio and the profit margin. Based on past bankruptcy experience, the linear probability model is estimated as: PD_i = 0.28 (debt ratio) + 0.51 (profit margin) You know a particular firm has a debt ratio of 46 percent and a probability of default of 18 percent. Calculate the firm's profit margin.