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Chapter 23

Corporate Restructuring: Combinations and Divestitures

True/False

1. Tax credits that cannot be used by one firm can take on value if the firm is acquired by another firm.

Difficulty: Easy

Keywords: tax credits, value of merger

2. The chop shop approach suggests that the current value of the whole is worth more than the sum of the individual parts of the firm.

Difficulty: Easy

Keywords: chop shop approach

3. Economies of scale are created when sharing of resources increases a firm’s productivity.

Difficulty: Moderate

Keywords: economies of scale

4. According to the free cash flow approach, financial and operating risk is not relevant to valuation.

Difficulty: Moderate

Keywords: free cash flow approach, financial and operating risk

5. A sell-off is the separation of a subsidiary from its parent while allowing the parent company to still obtain operational control.

Difficulty: Moderate

Keywords: sell-off, divestitures

Multiple Choice

6. Which of the following is not a potential advantage of a merger in the United States?

a. A better financing structure

b. A better use of tax-loss carry-forwards

c. A more secure monopolization of an industry

d. A lower operating risk through diversification

Difficulty: Moderate

Keywords: merger, advantages

7. What is a white knight in a merger?

a. A company that acts only as a consultant to a company that is a merger target.

b. A company that purchases stock of the better company when merger talks are broken off.

c. A company that submits a higher purchase price offer and less restrictive post-merger constraints on the merged managers who have received an unsolicited and unfriendly takeover attempt.

d. A company that tries to arbitrage the stocks of likely merger targets.

Difficulty: Moderate

Keywords: white knight, merger

8. A __________ is a business combination of two companies in which the new company maintains the identity of the acquiring company.

a. consolidation

b. holding company

c. conglomerate

d. merger

Difficulty: Easy

Keywords: merger

9. What price must a company typically pay to buy another company? The price will:

a. include some premium over the current market value of the target’s equity.

b. be the market value of the target’s equity.

c. be the book value of the target’s equity.

d. include some discount relative to the current market value of the target’s equity.

Difficulty: Moderate

Keywords: company value

10. Which of the following does not affect earnings per share (EPS) when a merger is concluded?

a. The exchange ratio for the shares of the acquired firm

b. The relative total asset/equity ratios of the firms

c. The premium paid above market value for the acquired firm

d. The relative earnings growth rates of the firms

Difficulty: Moderate

Keywords: merger, earnings per share

11. A dilution in EPS occurs in which type of merger?

a. A merger when a company with a low growth rate in EPS purchases a company with a high growth rate in EPS

b. A merger when a company with a high price-earnings (P/E) ratio purchases a company with a low P/E ratio

c. A merger when a company with a high growth rate in EPS purchases a company with a low growth rate in EPS

d. A merger when a company with a low P/E ratio purchases a company with a high P/E ratio

Difficulty: Moderate

Keywords: dilution of earnings per share

12. A merger that is driven by the potentially large reduction in the staffing of overlapping functions and the integration of the two companies’ strong similar product lines is referred to as a:

a. conglomerate merger.

b. vertical merger.

c. horizontal merger.

d. diversification merger.

Difficulty: Easy

Keywords: horizontal merger

13. Which of the following is not a motive for the owners of the target company to accept the stock of the acquiring company rather than cash?

a. The opportunity to participate in the growth of the new company

b. The understanding that an all-cash sale will lead to less of an immediate income tax liability

c. The ability to receive a more attractive price because the market admires the stock of the acquiring company

d. A desire to make sure that the new firm’s cash position will not be reduced to a dangerous level

Difficulty: Moderate

Keywords: stock versus cash, merger

14. Which of the following types of merger creates the intangible asset goodwill?

a. A merger that purchases the assets of the target company

b. A merger known as a vertical merger

c. A merger known as a horizontal merger

d. A merger known as a pooling of interests

Difficulty: Easy

Keywords: merger, asset purchase

15. In the event that Zoldt Corporation, which has a low P/E ratio, were to acquire Sky Corporation, which has a higher P/E ratio, an analyst can be certain that one of the following will occur.

a. Zoldt Corporation will see an immediate decrease in P/E.

b. Zoldt Corporation will see an immediate decrease in EPS.

c. Zoldt Corporation will see an immediate increase in the growth rate of EPS.

d. Zoldt Corporation will see an immediate increase in EPS.

Difficulty: Moderate

Keywords: merger, price-earnings ratio

16. What effect of a merger is similar to that of a portfolio management approach?

a. Acquiring goodwill

b. Increasing risk

c. Acquiring tax advantages

d. Diversification

Difficulty: Moderate

Keywords: diversification

17. Which of the following types of merger is most likely to foster diversification benefits?

a. A horizontal merger

b. A vertical merger

c. A conglomerate merger

d. A pooling of interests merger

Difficulty: Moderate

Keywords: conglomerate merger

18. Which of the following is an operating motive, as opposed to a financial motive, for a merger?

a. A business synergy motive

b. A portfolio diversification motive

c. A motive based on potentially greater future financing capability

d. An immediate but artificial post-merger increase in EPS

Difficulty: Moderate

Keywords: mergers, business synergy

19. What kind of merger would occur if a plastics firm were to merge with a packaging company?

a. This would be a horizontal merger.

b. This would be a vertical merger.

c. This would be a conglomerate merger.

d. This type of merger is specifically prohibited under United States antitrust laws.

Difficulty: Moderate

Keywords: vertical merger

20. Which of the following is an example of a horizontal merger?

a. A merger between Intel and Target

b. A merger between McDonalds and Tyson Chicken

c. A merger between Coca-Cola and General Electric

d. A merger between Chrysler and Daimler-Benz

Difficulty: Moderate

Keywords: horizontal merger

Short Answer

21. Discuss three sources of synergy in a merger.

Difficulty: Moderate

Keywords: synergies, mergers