CHAPTER 25
MERGERS, LBOs, DIVESTITURES, AND HOLDING COMPANIES
(Difficulty: E = Easy, M = Medium, and T = Tough)
True-False
Easy:
Synergistic merger
1.
Answer: a
Diff: E
In a synergistic merger, the post-merger value exceeds the sum of the
separate companies' pre-merger values.
a. True
b. False
Sources of synergy
2.
Answer: a
Diff: E
Synergistic merger effects can arise from a number of different sources
including operating economies of scale, financial economies, and
increased managerial efficiency.
a. True
b. False
Spin-off
3.
Answer: b
Diff: E
A spin-off is a type of divestiture in which the assets of a division
are sold to another firm.
a. True
b. False
Holding companies
4.
Answer: b
Diff: E
The two principal advantages of holding companies are (1) that the
holding company can control a great deal of assets with limited equity
and (2) that the dividends received by the parent from the subsidiary
are not taxed if the parent holds at least 50 percent of the
subsidiary's stock.
a. True
b. False
Defensive mergers
5.
Most defensive mergers occur
maximize shareholder's wealth.
Answer: b
as
a
result
of
managers'
Diff: E
actions
to
a. True
b. False
Chapter 25 - Page 1
Conglomerate merger
6.
Answer: b
Diff: E
A conglomerate merger occurs when two firms combine that have both
horizontal and vertical business relationships.
a. True
b. False
Merger analysis
7.
Answer: a
Diff: E
Since the basic rationale for any operating merger is synergy, in
planning such mergers, the development of accurate pro forma cash flows
is the single most important aspect of the analysis.
a. True
b. False
Merger terms
8.
Answer: a
Post-merger control and the negotiated price are two
important issues in agreeing on the terms of a merger.
of
Diff: E
the
most
a. True
b. False
Defensive tactics
9.
Answer: a
Diff: E
A company seeking to fight off a hostile takeover might employ the
services of an investment banking firm to develop a defensive strategy.
a. True
b. False
Poison pill defense
10.
Answer: a
Diff: E
Borrowing funds on terms that would require immediate repayment of all
funds if the firm is acquired or selling off valuable assets are two
methods of defending against hostile takeovers.
These strategies are
known as poison pill defenses.
a. True
b. False
Chapter 25 - Page 2
Joint venture
11.
Answer: a
Diff: E
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.
a. True
b. False
Leveraged buyout
12.
Answer: a
Diff: E
Leveraged buyouts (LBOs), popularized in the 1980s, occur when a firm's
managers decide to try and gain control of their publicly owned company
by buying out existing shareholders using large amounts of borrowed
money.
a. True
b. False
Mergers and interest rates
13.
Answer: b
Diff: E
Mergers are more likely to occur when interest rates are high because
target firms can expect to get a higher premium in the acquisition
price.
a. True
b. False
Merger accounting
14.
Mergers can be accounted for using either the
accounting or the pooling method of accounting.
Answer: b
purchase
Diff: E
method
of
a. True
b. False
Merger accounting
15.
Answer: b
Diff: E
Goodwill created in a merger must be amortized over its expected life,
usually 40 years, for shareholder reporting purposes.
a. True
b. False
Merger accounting
16.
Answer: a
Diff: E
Although goodwill created in a merger may not be amortized for
shareholder reporting purposes, it may be amortized for Federal tax
purposes.
a. True
b. False
Chapter 25 - Page 3
Medium:
Holding company advantages
17.
Answer: b
Diff: M
The three main advantages of holding companies are (1) control with
fractional ownership, (2) taxation benefits, and (3) isolation of
operating risks.
a. True
b. False
International mergers
18.
Answer: a
Diff: M
One of the main reasons why foreign firms are interested in buying U.S.
companies is to gain entrance to the U.S. market.
A decline in the
value of the dollar relative to most foreign currencies makes this
competitive strategy more feasible.
a. True
b. False
Merger cash flows
19.
Answer: b
Diff: M
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
Relevant merger cash flows
20.
Answer: a
Diff: M
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 to be operated independently.
a. True
b. False
Financial merger
21.
Answer: a
Diff: M
Coca-Cola's acquisition of Columbia Pictures and its announcement that
it would operate its new subsidiary separately could be described as
primarily a financial merger.
a. True
b. False
Chapter 25 - Page 4
Two-tier offer
22.
Answer: b
Diff: M
A two-tier merger offer is one in which the acquiring company offers to
purchase the target company in a two-part transaction. Cash is paid to
some stockholders, bonds are issued to others, but the total values of
each part of the transaction are equal.
a. True
b. False
Vertical merger
23.
Answer: a
Diff: M
If a petrochemical firm merged with an oil producer which had assets
including oil reserves, a refinery, and a drilling subsidiary, this
would be an example of a vertical merger.
a. True
b. False
Congeneric merger
24.
Answer: a
Diff: M
A congeneric merger is one where the merging firms operate in related
businesses but do not necessarily produce the same products or have a
producer-supplier relationship.
a. True
b. False
Merger motivation
25.
The purchase of assets at below
considerations
are
two
factors
historically.
Answer: a
their
that
replacement cost
have
stimulated
Diff: M
and tax
mergers
a. True
b. False
Merger motivation
26.
Answer: b
Diff: M
The primary motivation for most mergers is to acquire more assets so as
to increase sales and market share.
a. True
b. False
Managerial control
27.
Answer: b
Diff: M
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
Chapter 25 - Page 5
Managerial opposition
28.
Answer: b
Diff: M
Since managers' central goal is to maximize stock price, any merger
offer which provides stockholders with significant gains over the
current stock price will not be opposed by incumbent management.
a. True
b. False
Merger discount rate
29.
Answer: b
Diff: M
The discount rate used to discount projected merger cash flows should be
the cost of capital of the new consolidated firm because it incorporates
the actual capital structure of the new firm.
a. True
b. False
Synergistic gain
30.
Answer: b
Diff: M
The distribution of the synergistic gain between the stockholders of two
merged firms is determined by their respective market values before they
merged.
a. True
b. False
Merger analysis
31.
Answer: a
Diff: M
Only if a target firm's value is greater to the acquiring firm than the
target's market value as a separate entity will the merger be
financially justified.
a. True
b. False
Merger analysis
32.
Answer: b
Diff: M
If the capital structure is stable and free cash flows are growing at a
constant rate at the horizon, 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.
a. True
b. False
Merger analysis
33.
Answer: a
Diff: M
The present value of the free cash flows discounted at the unlevered
cost of equity is the value of the firm’s operations if it had no debt.
a. True
b. False
Chapter 25 - Page 6
Multiple Choice: Conceptual
Easy:
Merger tactics
34.
Firms use defensive tactics to fight off undesired mergers.
tactics include
a.
b.
c.
d.
e.
These
Answer: e
Diff: E
Which of the following are given as reasons for the high level of merger
activity in the U.S. during the 1980s?
a.
b.
c.
d.
e.
Synergistic benefits arising from mergers.
Reduction in competition resulting from mergers.
Attempts to stabilize earnings by diversifying.
All of the above.
Both a and c above.
Defensive strategies
36.
Diff: E
Raising antitrust issues.
Taking poison pills.
Getting a white knight to bid for the firm.
Repurchasing their own stock.
All of the above.
Mergers
35.
Answer: e
Answer: d
Diff: E
Which of the following actions assist managers in defending against a
hostile takeover?
a. Establishing a poison pill provision.
b. Granting lucrative golden parachutes to senior managers.
c. Establishing a super-majority provision in the company’s bylaws which
raises the percentage of the board of directors that must approve an
acquisition from 50 percent to 75 percent.
d. All of the answers above are correct.
e. None of the answers above is correct.
Chapter 25 - Page 7
Miscellaneous concepts
37.
Answer: c
Diff: E
Which of the following statements is most correct?
a. A conglomerate merger is where a firm combines with another firm in
the same industry.
b. Regulations in the United States prohibit acquiring firms from using
common stock to purchase another firm.
c. Defensive mergers are designed to make a company less vulnerable to a
takeover.
d. Answers a and b are correct.
e. All of the answers above are correct.
Medium:
Merger motivation
38.
Answer: d
Diff: M
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 incentive to bargain in negotiations, and the higher the
probability that the merger will be completed.
c. Since mergers are frequently financed by debt more than equity,
financial economies which imply a lower cost of debt or greater debt
capacity are rarely a relevant rationale for mergers.
d. Managers who purchase other firms often assert that the new combined
firm will enjoy benefits from diversification such as more stable
earnings.
However, since shareholders are free to diversify their
own holdings at lower cost, such a rationale is generally not a valid
motive for publicly held firms.
e. All of the answers above are correct.
Chapter 25 - Page 8
Level of merger activity
39.
Answer: c
Diff: M
Which of the following statements is most correct?
a. The high value of the U.S. dollar relative to Japanese and European
currencies
in
the
1980s,
made
U.S.
companies
comparatively
inexpensive to foreign buyers, spurring many mergers.
b. During the 1980s, the Reagan and Bush administrations tried to foster
greater competition and they were adamant about preventing the loss
of competition; thus, most large mergers were disallowed.
c. The expansion of the junk bond market made debt more freely available
for large acquisitions and LBOs in the 1980s, and thus, it resulted
in an increased level of merger activity.
d. Increased nationalization of business and a desire to scale down and
focus
on
producing
in
one's
home
country
virtually
halted
international mergers in the 1980s.
e. Answers a and b are correct.
Merger analysis
40.
Answer: e
Diff: M
Which of the following statements is most correct?
a. A firm acquiring another firm in a horizontal merger will not have
its required rate of return affected because the two firms will have
similar betas.
b. Financial theory says that the choice of how to pay for a merger is
really irrelevant because, although it may affect the firm's capital
structure, it will not affect the firm's overall required rate of
return.
c. The basic rationale for any financial merger is synergy and thus,
development of pro-forma cash flows is the single most important part
of the analysis.
d. In most mergers, the benefits of synergy and the price premium the
acquirer pays over market price are summed and then divided equally
between the shareholders of the acquiring and target firms.
e. The primary rationale for any operating merger is synergy, but it is
also possible that mergers can include aspects of both operating and
financial mergers.
Chapter 25 - Page 9
Aspects of mergers
41.
Answer: d
Diff: M
Which of the following statements is most correct?
a. Firms that get acquired usually have a market price below book value
before the merger offer is made. However, once the initial offer is
made, the price can rise above book value, but the purchase price,
especially in large acquisitions, will remain within 20 percent of
book value.
b. When Texaco purchased Getty Oil, many financial analysts felt that
the deal made sense because it increased Texaco's market share and
expanded its shrinking oil reserves.
This merger exemplified the
belief among the natural resource companies that buying reserves
through acquisitions was less costly than exploring and finding them
in the field.
c. When Mobil Oil Company tried to acquire Conoco, another oil company,
stockholders were concerned that the U.S. Justice Department would
try to block this merger because it would lessen competition. Thus,
antitrust considerations affected this proposed horizontal merger.
d. Answers b and c are correct.
e. All of the statements above are false.
LBOs
42.
Answer: e
Diff: M
Which of the following statements is most correct?
a. Leveraged buyouts (LBOs) are where a firm issues equity and uses the
proceeds to take a firm public.
b. In a typical LBO, bondholders do well but shareholders realize a
decline in value.
c. Firms are unable to sell any assets in the first five years following
a leverage buyout.
d. All of the answers above are correct.
e. None of the answers above is correct.
Miscellaneous concepts
43.
Answer: b
Diff: M
Which of the following statements is most correct?
a. If a company which produces military equipment merges with a company
which manages a chain of motels, this is an example of a horizontal
merger.
b. A defensive merger is where the firm's managers merge with another
firm to avoid or lessen the possibility of being acquired through a
hostile takeover.
c. Acquiring firms send a signal that their stock is undervalued if they
choose to use stock to pay for the acquisition.
d. None of the statements above is correct.
e. Answers a and c are correct.
Chapter 25 - Page 10
Merger analysis
44.
Answer: d
Which of the following statements about valuing a firm using the APV is
most correct?
a. The horizon value is calculated by discounting the horizon
free cash flows and tax savings at the levered cost of equity.
b. The horizon value is calculated by discounting the horizon
free cash flows at the levered cost of equity.
c. The horizon value is calculated by discounting the horizon
free cash flows and tax savings at the WACC.
d. The horizon value is calculated by discounting the horizon’s
free cash flows at the WACC.
e. None of the statements above is correct.
Merger analysis
45.
Diff: M
Answer: c
future
future
future
future
Diff: M
Which of the following statements about valuing a firm using the APV is
most correct?
a. The value of operations is calculated by discounting the horizon
value, the tax shields, and the free cash flows at the cost of
equity.
b. The value of equity is calculated by discounting the horizon value,
the tax shields, and the free cash flows at the cost of equity.
c. The value of operations is calculated by discounting the horizon
value, the tax shields, and the free cash flows at the unlevered cost
of equity.
d. The value of equity is calculated by discounting the horizon value
and the free cash flows at the cost of equity.
e. None of the statements above is correct.
Merger accounting
46.
Answer: b
Diff: M
Which of the following statements about accounting for mergers is most
correct?
a.
b.
c.
d.
e.
Goodwill is amortized for shareholder reporting.
Goodwill is amortized for Federal tax purposes.
Goodwill is no longer created in a merger.
Answers a and b are correct.
None of the statements above is correct.
Chapter 25 - Page 11
Multiple Choice: Problems
Easy:
Maximum price per share
47.
Diff: E
American Hardware, a national hardware chain, is considering purchasing
a smaller chain, Eastern Hardware. American'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
percent. Eastern has 4 million shares outstanding. Eastern's current
price is $16.25.
What is the maximum price per share that American
should offer?
a.
b.
c.
d.
e.
$16.25
$16.97
$17.42
$18.13
$19.00
Intercompany dividends
48.
Answer: d
Answer: a
Diff: E
A parent holding company sells shares in its subsidiary such that the
parent now owns only 65 percent of the subsidiary and thus, the tax
returns of the parent and its subsidiary can't be consolidated.
The
parent receives annual dividends from the subsidiary of $2,500,000. If
the parent's marginal tax rate is 34 percent and if the exclusion on
intercompany dividends is 70 percent, what is the effective tax rate on
the intercompany dividends and what are the net dividends received?
a.
b.
c.
d.
e.
10.2%;
10.2%;
23.8%;
10.2%;
34.0%;
$2,245,000
$2,135,000
$1,905,000
$1,750,000
$1,650,000
Chapter 25 - Page 12
Discount rate
49.
Answer: c
Diff: E
Volunteer Pizza, a regional pizza chain, is considering purchasing a
smaller chain, Eastern Pizza, which is currently financed with 20
percent debt at a cost of 8%.
American's 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 undertaken. Eastern's pre-merger beta is estimated
to be 2.0, and its post-merger tax rate would be 34 percent. The riskfree rate is 8 percent, and the market risk premium is 4 percent. What
is the appropriate rate for 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%
Medium:
Post-merger return to equity
50.
Answer: e
Diff: M
Trumble Oboes is considering a merger with Krieble Trombones. Krieble’s
market determined beta is 0.9 and it is currently financed at a debt
level of 20%, at an interest rate of 8%. Krieble faces a 25% tax rate.
If Trumble acquires Krieble, it will increase the debt level to 60%, at
an interest rate of 9 percent, and the tax rate will increase to 35%.
The risk free rate is 6% and the market risk premium is 4%. What will
Krieble’s required rate of return on equity be after it is acquired?
a.
b.
c.
d.
e.
7.4%
8.9%
9.3%
9.6%
9.7%
Chapter 25 - Page 13
Value of acquisition
51.
Diff: M
Pit Row Auto, a national autoparts chain, is considering purchasing a
smaller chain, Southern Auto.
Pit Row's 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. Assume all cash flows occur at the end of
the year. Southern is currently financed with 30% debt at a rate of 10%.
The acquisition would be made immediately, if it is undertaken and
Southern would retain its current $15 million in debt and issue new debt
in order to continue targeting a 30% debt level. The interest rate will
remain the same. Southern's pre-merger beta is estimated to be 2.0, and
its post-merger tax rate would be 34 percent. The risk-free rate is 8
percent, and the market risk premium is 4 percent. What is the value of
Southern Auto’s equity to Pit Row Auto?
a.
b.
c.
d.
e.
$57.52
$61.96
$64.64
$76.96
$79.64
million
million
million
million
million
WACC for acquired firm
52.
Answer: b
Answer: d
Diff: M
Wildcat Systems currently has 1 million shares outstanding worth $10 per
share, and a capital structure that consists of 30% debt at a 9%
interest rate.
Wildcat is considering purchasing Billybob Industries,
which has 500,000 shares outstanding worth $5 each and no debt.
Billybob’s cost of equity is 12 percent and Wildcat System’s cost of
equity is 15%. If, after the purchase, Wildcat recapitalizes Billybob
to have the same capital structure as Wildcat, with debt at the same
interest rate, what will be Billybob’s WACC? Both firms face a 40% tax
rate.
a.
b.
c.
d.
e.
10.0%
10.9%
12.0%
12.1%
15.0%
Chapter 25 - Page 14
Multiple part:
(The following information applies to the next four questions.)
Magiclean Corporation is considering an acquisition of Dustvac Company.
Dustvac has a capital structure consisting of $5 million (market value) in 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
percent tax rate.
Magiclean's capital structure is 40 percent debt and 60
percent equity. The free cash flows and interest tax savings from Dustvac are
estimated to be $4.0 million for each of the next four years and a horizon
value of $15.0 million in Year 4. Additionally, 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 percent and the
market risk premium is 4.0 percent.
WACC of target
53.
Answer: c
Diff: M
Answer: c
Diff: M
What Dustvac’s pre-merger WACC?
a. 9.02%
b. 9.50%
c. 9.83%
d. 10.01%
e. 11.29%
Discount rate for value of operations
54.
What discount rate should you use to discount the free cash flows and
interest tax savings?
a.
b.
c.
d.
e.
10.01%
10.06%
11.29%
11.44%
13.49%
Value of equity
55.
Answer: b
Diff: M
What is the value of Dustvac’s equity to Magiclean? (Round your answer
to the closest thousand dollars.)
a.
b.
c.
d.
e.
$17,019,000
$17,109,000
$17,916,000
$22,109,000
$22,916,000
Chapter 25 - Page 15
Tough:
Merger NPV
56.
Answer: c
Diff: T
Blazer Breaks, Inc. is considering an acquisition of Laker Showtime
Company.
Blazer expects Laker’s NOPAT to be of $9 million the first
year with all depreciation cash flows reinvested to replace equipment
and zero 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 require net reinvestment of an
additional $10 million to finance future growth.
Laker's applicable
marginal tax rate is 40 percent. After the second year, the free cash
flows from Laker to Blazer will grow at a constant rate of 4 percent.
The firm has determined that Laker’s cost of equity is 17.5 percent and
has estimated that after the second year the weighted average cost of
capital will be 14%. Laker currently has no debt outstanding. Assume
that all cash flows are end-of-year and that the Laker acquisition will
cost Blazer $45 million. Calculate the value to Blazer of Laker’s equity
and determine the NPV of the proposed acquisition to Blazer.
a.
b.
c.
d.
e.
$ 45.0
$ 68.2
$ 88.0
$113.2
$133.0
million
million
million
million
million
Chapter 25 - Page 16
CHAPTER 25
ANSWERS AND SOLUTIONS
1.
Synergistic merger
Answer: a
Diff: E
2.
Sources of synergy
Answer: a
Diff: E
3.
Spin-off
Answer: b
Diff: E
4.
Holding companies
Answer: b
Diff: E
5.
Defensive mergers
Answer: b
Diff: E
6.
Conglomerate merger
Answer: b
Diff: E
7.
Merger analysis
Answer: a
Diff: E
8.
Merger terms
Answer: a
Diff: E
9.
Defensive tactics
Answer: a
Diff: E
10.
Poison pill defense
Answer: a
Diff: E
11.
Joint venture
Answer: a
Diff: E
12.
Leveraged buyout
Answer: a
Diff: E
13.
Mergers and interest rates
Answer: b
Diff: E
14.
Merger accounting
Answer: b
Diff: E
15.
Merger accounting
Answer: b
Diff: E
16.
Merger accounting
Answer: a
Diff: E
17.
Holding company advantages
Answer: b
Diff: M
18.
International mergers
Answer: a
Diff: M
19.
Merger cash flows
Answer: b
Diff: M
20.
Relevant merger cash flows
Answer: a
Diff: M
21.
Financial merger
Answer: a
Diff: M
22.
Two-tier offer
Answer: b
Diff: M
23.
Vertical merger
Answer: a
Diff: M
24.
Congeneric merger
Answer: a
Diff: M
25.
Merger motivation
Answer: a
Diff: M
26.
Merger motivation
Answer: b
Diff: M
Chapter 25 - Page 17
27.
Managerial control
Answer: b
Diff: M
28.
Managerial opposition
Answer: b
Diff: M
29.
Merger discount rate
Answer: b
Diff: M
30.
Synergistic gain
Answer: b
Diff: M
31.
Merger analysis
Answer: a
Diff: M
32.
Merger analysis
Answer: b
Diff: M
33.
Merger analysis
Answer: a
Diff: M
34.
Merger tactics
Answer: e
Diff: E
35.
Mergers
Answer: e
Diff: E
36.
Defensive strategies
Answer: d
Diff: E
37.
Miscellaneous concepts
Answer: c
Diff: E
38.
Merger motivation
Answer: d
Diff: M
39.
Level of merger activity
Answer: c
Diff: M
40.
Merger analysis
Answer: e
Diff: M
41.
Aspects of mergers
Answer: d
Diff: M
42.
LBOs
Answer: e
Diff: M
43.
Miscellaneous concepts
Answer: b
Diff: M
44.
Merger analysis
Answer: d
Diff: M
45.
Merger analysis
Answer: c
Diff: M
46.
Merger accounting
Answer: b
Diff: M
47.
Maximum price per share
Answer: d
Diff: E
Price per share =
Chapter 25 - Page 18
$72.52 million
= $18.13.
$4 million
48.
Intercompany dividends
Answer: a
Diff: E
Effective tax rate = (1 - Exclusion)(Tax rate)
= (1 - 0.70)(0.34) = 10.2%.
Net dividends = Gross dividends - Tax
= $2,500,000 - $2,500,000(1 - 0.70)(0.34)
= $2,500,000 - $255,000 = $2,245,000.
Alternate method
Effective tax rate = Tax amount/Gross dividends.
= 255,000/2,500,000 = 10.2%.
49.
Discount rate
Answer: c
Diff: E
rsL = 8% + 2.0(4%) = 16%; rsU = 0.20(8%) + 0.80(16%) = 14.4%.
50.
Post-merger return to equity
Answer: e
Diff: M
Calculate the current required return to Krieble’s equity:
rK = rf + b(rmrp) = 6% + (0.9)4% = 9.6%
Calculate Krieble’s unlevered cost of equity:
rU = wdrd + wsrs = 0.20(8%) + 0.80(9.6%) = 9.28%
Calculate Krieble’s levered cost of equity at new capital structure with
new cost of debt:
rL = rU + (ru – rd)(D/S) = 9.28% + (9.28% - 9%)/(0.6/0.4) = 9.7%
51.
Value of acquisition
Answer: b
Diff: M
rL = rf + b(rmrp) = 8% + 2.0(4%) = 16%
rU = wdrd + wsrs = 0.30(10%) + 0.70(16%) = 14.2%
Time line: (In millions)
0 r = 14.2% 1
|
|
PV = ?
2
2
|
4
3
|
5
4 Years
|
10
HV = 107
FCF4 = 117
Financial calculator solution: (In millions)
Inputs: CF0 = 0; CF1 = 2; CF2 = 4; CF3 = 5; CF4 = 117; I = 14.2
Output: NPV = $76.96 = Value of operations.
Value of equity = value of operations – value of debt = $76.96 – 15 =
$61.96 million.
Chapter 25 - Page 19
52.
WACC for acquired firm
Answer: d
Diff: M
Billybob’s unlevered cost of equity is 12%, because it has no debt. At
a debt level of 30%, and a debt interest rate of 9% the levered cost of
equity is:
rsL = rsU + (rsU – rd)(D/S) = 12% + (12% - 9%)(0.3/0.7) = 13.3%.
WACC = wdrd(1-T) + wSrS = 0.3(9%)(1 – 0.4) + 0.7(13.3%) = 10.9%
53.
WACC of target
Answer: c
Diff: M
The pre merger weight on debt is 5/(5+10) = 0.333
The pre-merger required rate on equity is 6% + 1.36(4%) = 11.44%
WACC = wdrd(1-T) + wSrS = 0.333(11%)(1-0.40) + 0.667(11.44%) = 9.83%
54.
Discount rate for value of operations
Answer: c
Diff: M
The correct discount rate is the unlevered cost of equity. The levered
cost of equity is 6% + 1.36(4%) = 11.44%, the percent of debt is
5/(5+10) = 0.333. The rate on the debt is 11%
The unlevered cost of equity is wdrd + wersL = 0.333(11%) + 0.667(11.44%)
= 11.29%
55.
Value of equity
Time line:
Answer: b
Diff: M
(In millions)
0 r=11.29% 1
|
|
PV = ?
4.0
2
|
4.0
3
|
4.0
4 Years
|
19.0
Financial calculator solution:
Inputs: CF0 = 0; CF1 = 4,000,000; Nj = 3; CF2 = 19,000,000; I = 11.29
Output: PVInflows = $22,109,662 = vops.
Value of equity = vops – debt = 22.109 – 5 = $17.109 million.
Chapter 25 - Page 20
56.
Merger NPV
Time line: (In millions)
0 ru = 17.5% 1
|
|
-45
+9
Answer: c
Diff: T
2
3 Years
g = 4%
|
|
+25
15(1.04)
-10
HV =
15(1.04)
15 = FCF
(0.14 – 0.04)
+ 2
= 156
17
156
173
Vops = 9/(1.175) + 173/(1.175)2 = $133.0 = V equity since there is no
debt.
The npv is 133 – 45 = $88 million
Chapter 25 - Page 21