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Unformatted text preview: Chapter 25 Mergers, LBOs, Divestitures, and Holding Companies ANSWERS TO END-OF-CHAPTER QUESTIONS 25-1 a. Synergy occurs when the whole is greater than the sum of its parts. When applied to mergers, a synergistic merger occurs when the postmerger free cash flows exceed the sum of the separate companies' premerger free cash flows. A merger is the joining of two firms to form a single firm. b. A horizontal merger is a merger between two companies in the same line of business. In a vertical merger, a company acquires another firm that is "upstream" or "downstream"; for example, an automobile manufacturer acquires a steel producer. A congeneric merger involves firms that are interrelated, but not identical, lines of business. One example is Prudential's acquisition of Bache & Company. In a con- glomerate merger, unrelated enterprises combine, such as Mobil Oil and Montgomery Ward. c. A friendly merger occurs when the target company's management agrees to the merger and recommends that shareholders approve the deal. In a hostile merger, the management of the target company resists the offer. A defensive merger occurs when one company acquires another to help ward off a hostile merger attempt. A tender offer is the offer of one firm to buy the stock of another by going directly to the stockholders, frequently over the opposition of the target companys management. A target company is a firm that another company seeks to acquire. Breakup value is a firms value if its assets are sold off in pieces. An acquiring company is a company that seeks to acquire another firm. d. An operating merger occurs when the operations of two companies are integrated with the expectation of obtaining synergistic gains. These may occur due to economies of scale, management efficiency, or a host of other reasons. In a pure financial merger, the companies will not be operated as a single unit, and no operating economies are expected. e. The adjusted present value model discounts projected free cash flows and interest tax shields at the unlevered cost of equity to arrive at the value of operations. You add in the value of non-operating assets to get the value of the entire firm (both debt and equity). To get the value of equity, subtract off the value of the debt. This model is especially useful when the acquirer will change the targets capital structure after the acquisition because it separately values the interest tax shields and the unlevered value of the firm. Answers and Solutions: 25 - 1 f. The free cash flow to equity model, or also called the residual dividend model, first calculates FCFE, which is the free cash flow payable to shareholders. FCFE is free cash flow less interest expense plus the interest tax shield. It then discounts the FCFEs at the levered cost of equity to arrive at the value of equity in operations. You add in the value of non-operating assets and you get the value of the equity. To get the value of operations you then add in the value of the debt.the value of operations you then add in the value of the debt....
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