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Merger Motives

Which of the following motives for mergers make economic sense?

a. Merging to achieve economies of scale.

b. Merging to reduce risk by diversification.

c. Merging to redeploy cash generated by a firm with ample profits but limited growth opportunities.

d. Merging to increase earnings per share.

2. Merger Motives. Explain why it might make good sense for Northeast Heating and Northeast Air Conditioning to merge into one company.

3. Empirical Facts. True or false?

a. Sellers almost always gain in mergers.

b. Buyers almost always gain in mergers.

c. Firms that do unusually well tend to be acquisition targets.

d. Merger activity in the United States varies dramatically from year to year.

e. On the average, mergers produce substantial economic gains.

f. Tender offers require the approval of the selling firm`s management.

g. The cost of a merger is always independent of the economic gain produced by the merger.

4. Merger Tactics. Connect each term to its correct definition or description:

A. LBO 1. Attempt to gain control of a firm by winning the votes of its

B. Poison pill stockholders.

C. Tender offer 2. Changes in corporate charter designed to deter unwelcome

D. Shark repellent takeover.

E. Proxy contest 3. Friendly potential acquirer sought by a threatened target firm.

4. Shareholders are issued rights to buy shares if bidder acquires large stake in the firm.

5. Offer to buy shares directly from stockholders.

6. Company or business bought out by private investors, largely debt-financed.

5. Empirical Facts. True or false?

a. One of the first tasks of an LBO`s financial manager is to pay down debt.

b. Shareholders of bidding companies earn higher abnormal returns when the merger is financed with stock than in cash-financed deals.

c. Targets for LBOs in the 1980s tended to be profitable companies in mature industries with limited investment opportunities.

6. Merger Gains. Acquiring Corp. is considering a takeover of Takeover Target Inc. Acquiring has 10 million shares outstanding, which sell for $40 each. Takeover Target has 5 million shares outstanding, which sell for $20 each. If the merger gains are estimated at $20 million, what is the highest price per share that Acquiring should be willing to pay to Takeover Target shareholders?

7. Mergers and P/E Ratios. If Acquiring Corp. from problem 6 has a price-earnings ratio of 12, and Takeover Target has a P/E ratio of 8, what should be the P/E ratio of the merged firm? Assume in this case that the merger is financed by an issue of new Acquiring Corp.

shares. Takeover Target will get one Acquiring share for every two Takeover Target shares held.

8. Merger Gains and Costs. Velcro Saddles is contemplating the acquisition of Pogo Ski Sticks, Inc. The values of the two companies as separate entities are $20 million and $10 million, respectively. Velcro Saddles estimates that by combining the two companies, it will reduce marketing and administrative costs by $500,000 per year in perpetuity. Velcro Saddles is willing to pay $14 million cash for Pogo. The opportunity cost of capital is 10 percent.

a. What is the gain from merger?

b. What is the cost of the cash offer?

c. What is the NPV of the acquisition under the cash offer?

9. Stock versus Cash Offers. Suppose that instead of making a cash offer as in problem 8, Velcro Saddles considers offering Pogo shareholders a 50 percent holding in Velcro Saddles.

a. What is the value of the stock in the merged company held by the original Pogo shareholders?

b. What is the cost of the stock alternative?

c. What is its NPV under the stock offer?

10. Merger Gains. Immense Appetite, Inc., believes that it can acquire Sleepy Industries and improve efficiency to the extent that the market value of Sleepy will increase by $5 million. Sleepy currently sells for $20 a share, and there are 1 million shares outstanding.

a. Sleepy`s management is willing to accept a cash offer of $25 a share. Can the merger be accomplished on a friendly basis?

b. What will happen if Sleepy`s management holds out for an offer of $28 a share?

11. Mergers and P/E Ratios. Castles in the Sand currently sells at a price-earnings multiple of

10. The firm has 2 million shares outstanding, and sells at a price per share of $40. Firm Foundation has a P/E multiple of 8, has 1 million shares outstanding, and sells at a price per share of $20.

a. If Castles acquires the other firm by exchanging one of its shares for every two of Firm Foundation`s, what will be the earnings per share of the merged firm?

b. What should be the P/E of the new firm if the merger has no economic gains? What will happen to Castles`s price per share? Show that shareholders of neither Castles nor Firm Foundation realize any change in wealth.

c. What will happen to Castles`s price per share if the market does not realize that the P/E ratio of the merged firm ought to differ from Castles`s premerger ratio?

d. How are the gains from the merger split between shareholders of the two firms if the market is fooled as in part (c)?

12. Stock versus Cash Offers. Sweet Cola Corp. (SCC) is bidding to take over Salty Dog Pretzels (SDP). SCC has 3,000 shares outstanding, selling at $50 per share. SDP has 2,000 shares outstanding, selling at $17.50 a share. SCC estimates the economic gain from the merger to be $10,000.

a. If SDP can be acquired for $20 a share, what is the NPV of the merger to SCC?

b. What will SCC sell for when the market learns that it plans to acquire SDP for $20 a share? What will SDP sell for? What are the percentage gains to the shareholders of each firm?

c. Now suppose that the merger takes place through an exchange of stock. Based on the premerger prices of the firms, SCC sells for $50, so instead of paying $20 cash, SCC issues .40 of its shares for every SDP share acquired. What will be the price of the merged

firm?

d. What is the NPV of the merger to SCC when it uses an exchange of stock? Why does your answer differ from part (a)