Exam 26: Mergers and Corporate Control

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 three procedures used to defend against hostile takeovers.These strategies are known as "poison pills."

Which of the following statements is most CORRECT?

Any goodwill created in a merger must be amortized over its expected life,usually 40 years,for shareholder reporting purposes.

Exhibit 26.1 Best Window & Door Corporation is considering the acquisition of Glassmakers Inc. Glassmakers has a capital structure consisting of $5 million (market value) of 11% bonds and $10 million (market value) of common stock. Glassmakers' pre-merger beta is 1.36. Best's beta is 1.02, and both it and Glassmakers face a 40% tax rate. Best's capital structure is 40% debt and 60% equity. The free cash flows from Glassmakers are estimated to be $3.0 million for each of the next 4 years and a horizon value of $10.0 million in Year 4. Tax savings are estimated to be $1 million for each of the next 4 years and a horizon value of $5 million in Year 4. New debt would be issued to finance the acquisition and retire the old debt, and this new debt would have an interest rate of 8%. Currently, the risk-free rate is 6.0% and the market risk premium is 4.0%. -Refer to Exhibit 26.1.What is the value of Glassmakers' equity to Best? (Round your answer to the closest thousand dollars.)

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.

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.

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

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

A joint venture is one in which two,or sometimes more,independent companies agree to combine resources in order to achieve a specific objective,usually limited in scope.