Set Problem 7 - FINA 4200 Spring 2010
Due Tuesday April 27 before class
I.
Multiple Choices
Chapter 26
1.
In a merger with true synergies, the post-merger value exceeds the sum of the separate
companies' pre-merger values.
a. True
b. False
2.
Synergistic benefits can arise from a number of different sources, including operating
economies of scale, financial economies, and increased managerial efficiency.
a. True
b. False
3.
A spin-off is a type of divestiture in which the assets of a division are sold to another
firm.
a. True
b. False
4.
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
5.
The purchase of assets at below their replacement cost and tax considerations are two
factors that motivate mergers.
a. True
b. False
6.
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.
a. True
b. False
7.
Since a managers central goal is to maximize the firms stock price, any merger offer
that provides stockholders with significant gains over the current stock price will be
approved by the current management team.
a. True
b. False
8.
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.
a. True
b. False
9.
The distribution of synergistic gains between the stockholders of 2 merged firms is
almost always based strictly on their respective market values before the announcement
of the merger.
a. True
b. False
10.
The present value of the free cash flows discounted at the unlevered cost of equity is the
value of the firms operations if it had no debt.
a. True
b. False
11.
Which of the following statements is most CORRECT?
a. Tax considerations often play a part in mergers. If one firm has excess cash,
purchasing another firm exposes the purchasing firm to additional taxes. Thus, firms
with excess cash rarely undertake mergers.
b. The smaller the synergistic benefits of a particular merger, the greater the scope for
striking a bargain in negotiations, and the higher the probability that the merger will
be completed.
c. Purchase of assets at below replacement cost is a bad reason for the merger.
d. Managers who purchase other firms often assert that the new combined firm will
enjoy benefits from diversification, including more stable earnings. However, since
shareholders are free to diversify their own holdings, and at whats probably a lower
cost, diversification benefits is generally not a valid motive for a publicly held firm.
e. All of the answers above are correct.
12.
Great Subs Inc., a regional sandwich chain, is considering purchasing a smaller chain,
Eastern Pizza, which is currently financed using 20% debt at a cost of 8%. Great Subs 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. Eastern's pre-merger is beta 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.
b.
c.
d.
e.
12.0%
13.9%
14.4%
16.0%
16.9%
13.
Dunbar Hardware, a national hardware chain, is considering purchasing a smaller chain,
Eastern Hardware. Dunbar'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 Eastern is 16%.
Eastern has 4 million shares outstanding and no debt. Eastern's current price is $16.25.
What is the maximum price per share that Dunbar should offer?
a.
b.
c.
d.
e.
14.
$16.25
$16.97
$17.42
$18.13
$19.00
Blazer Inc. is thinking of acquiring Laker Company. Blazer expects Lakers NOPAT to
be $9 million the first year, with no net new investment in operating capital and no
interest expense. For the second year, Laker is expected to have NOPAT of $25 million
and interest expense of $5 million. Also, in the second year only, Laker will need $10
million of net new investment in operating capital. Laker's marginal tax rate is 40%.
After the second year, the free cash flows and the tax shields from Laker to Blazer will
both grow at a constant rate of 4%. Blazer has determined that Lakers cost of equity is
17.5%, and Laker currently has no debt outstanding. Assume that all cash flows occur at
the end of the year, Blazer must pay $45 million to acquire Laker. What it the NPV of
the proposed acquisition? Note that you must first calculate the value to Blazer of
Lakers equity.
a.
b.
c.
d.
e.
$ 45.0 million
$ 68.2 million
$ 86.5 million
$113.2 million
$133.0 million
(The following data apply to Problems 15 through 17. The problems MUST be kept together.)
Magiclean Corporation is considering the acquisition of Dustvac Company. Dustvac has a
capital structure consisting of $5 million (market value) of 11% bonds and $10 million (market
value) of common stock. Dustvac's pre-merger beta is 1.36. Magiclean's beta is 1.02, and both it
and Dustvac face a 40% tax rate. Magiclean's capital structure is 40% debt and 60% equity. The
free cash flows from Dustvac 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%. (note: Horizon
value in Year 4 is the present value in Year 4 of corresponding cash flows from Year 5 onwards)
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15.
What Dustvacs pre-merger WACC?
a.
b.
c.
d.
e.
16.
What discount rate should you use to discount Dustvacs free cash flows and interest tax
savings using the APV approach?
a.
b.
c.
d.
e.
17.
9.02%
9.50%
9.83%
10.01%
11.29%
10.01%
10.06%
11.29%
11.44%
13.49%
What is the value of Dustvacs equity to Magiclean? (Round your answer to the closest
thousand dollars.)
a.
b.
c.
d.
e.
$16,019,000
$17,111,000
$18,916,000
$22,111,000
$22,916,000
II. Essay Questions
BD Chapter 26 Problems (p938): Q5, Q6 (excluding part c)
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