Exam 22: Mergers and Corporate Control

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

Post-merger control and the negotiated price paid by the acquirer are two of the most important issues in agreeing on the terms of a merger.

Since the primary rationale for any operating merger is synergy,in planning such mergers,the development of accurate pro forma cash flows is the single most important action.

Juicers Inc.is thinking of acquiring Fast Fruit Company.Juicers expects Fast Fruit's NOPAT to be $9 million the first year,with no net new investment in operating capital and no interest expense.For the second year,Fast Fruit is expected to have NOPAT of $25 million and interest expense of $5 million.Also,in the second year only,Fast Fruit will need $10 million of net new investment in operating capital.Fast Fruit's marginal tax rate is 40%.After the second year,the free cash flows and the tax shields from Fast Fruit to Juicers will both grow at a constant rate of 4%.Juicers has determined that Fast Fruit's cost of equity is 17.5%,and Fast Fruit currently has no debt outstanding.Assume that all cash flows occur at the end of the year,Juicers must pay $45 million to acquire Fast Fruit.What it the NPV of the proposed acquisition? Note that you must first calculate the value to Juicers of Fast Fruit's equity.

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.

Since managers' central goal is to maximize stock price,managerial control issues do not interfere with mergers that would benefit the target firm's stockholders.

The three main advantages of holding companies are (1)control with fractional ownership, (2)taxation benefits,and (3)isolation of operating risks.

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.

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

The rate used to discount projected merger cash flows should be the cost of capital of the new consolidated firm because it incorporates the actual capital structure of the new firm.

A conglomerate merger occurs when two firms with either a horizontal or a vertical business relationship combine.

A regional restaurant chain,Club Café,is considering purchasing a smaller chain,Sally's Sandwiches,which is currently financed using 20% debt at a cost of 8%.Club Café's analysts project that the merger will result in incremental free cash flows and interest tax savings of $2 million in Year 1,$4 million in Year 2,$5 million in Year 3,and $117 million in Year 4.(The Year 4 cash flow includes a horizon value of $107 million.)The acquisition would be made immediately,if it is to be undertaken.Sally's pre-merger beta is 2.0,and its post-merger tax rate would be 34%.The risk-free rate is 8%,and the market risk premium is 4%.What is the appropriate rate for use in discounting the free cash flows and the interest tax savings?

A 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?

Firms use defensive tactics to fight off undesired mergers.These tactics do not include

A company seeking to fight off a hostile takeover might employ the services of an investment banking firm to develop a defensive strategy.

Which of the following statements about valuing a firm using the APV approach is most CORRECT?

Which of the following statements is most CORRECT?

Only if a target firm's value is greater to the acquiring firm than its market value as a separate entity will a merger be financially justified.

Synergistic benefits can arise from a number of different sources,including operating economies of scale,financial economies,and increased managerial efficiency.

The owners of Arthouse Inc.,a national artist supplies chain,are contemplating purchasing Craftworks Inc,a smaller chain.Arthouse's analysts project that the merger will result in incremental free flows and interest tax savings with a combined present value of $72.52 million,and they have determined that the appropriate discount rate for valuing Craftworks is 16%.Craftworks has 4 million shares outstanding and no debt.Craftworks' current price is $16.25.What is the maximum price per share that Arthouse should offer?