29 - CHAPTER 29 MERGERS AND ACQUISITIONS Answers to...

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CHAPTER 29 MERGERS AND ACQUISITIONS Answers to Concepts Review and Critical Thinking Questions 1. In the purchase method, assets are recorded at market value, and goodwill is created to account for the excess of the purchase price over this recorded value. In the pooling of interests method, the balance sheets of the two firms are simply combined; no goodwill is created. The choice of accounting method has no direct impact on the cash flows of the firms. EPS will probably be lower under the purchase method because reported income is usually lower due to the required amortization of the goodwill created in the purchase. 2. a. False. Although the reasoning seems correct, in general, the new firms do not have monopoly power. This is especially true since many countries have laws limiting mergers when it would create a monopoly. b. True. When managers act in their own interest, acquisitions are an important control device for shareholders. It appears that some acquisitions and takeovers are the consequence of underlying conflicts between managers and shareholders. c. False. Even if markets are efficient, the presence of synergy will make the value of the combined firm different from the sum of the values of the separate firms. Incremental cash flows provide the positive NPV of the transaction. d. False. In an efficient market, traders will value takeovers based on “fundamental factors” regardless of the time horizon. Recall that the evidence as a whole suggests efficiency in the markets. Mergers should be no different. e. False. The tax effect of an acquisition depends on whether the merger is taxable or non-taxable. In a taxable merger, there are two opposing factors to consider, the capital gains effect and the write-up effect. The net effect is the sum of these two effects. f. True. Because of the coinsurance effect, wealth might be transferred from the stockholders to the bondholders. Acquisition analysis usually disregards this effect and considers only the total value. 3. Diversification doesn’t create value in and of itself because diversification reduces unsystematic, not systematic, risk. As discussed in the chapter on options, there is a more subtle issue as well. Reducing unsystematic risk benefits bondholders by making default less likely. However, if a merger is done purely to diversify (i.e., no operating synergy), then the NPV of the merger is zero. If the NPV is zero, and the bondholders are better off, then stockholders must be worse off. 4. A firm might choose to split up because the newer, smaller firms may be better able to focus on their particular markets. Thus, reverse synergy is a possibility. An added advantage is that performance evaluation becomes much easier once the split is made because the new firm’s financial results (and stock prices) are no longer commingled.
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5. It depends on how they are used. If they are used to protect management, then they are not good for stockholders. If they are used by management to negotiate the best possible terms of a merger, then
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29 - CHAPTER 29 MERGERS AND ACQUISITIONS Answers to...

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