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Chap 21 solutions manual
Missouri State University
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Chapter 21 Mergers and Acquisitions Answers to Concept 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 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 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 nontaxable. In a taxable merger, there are two opposing factors to consider, the capital gains effect and the 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 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 making default less likely. However, if a merger is done purely to diversify (i., 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 financial results (and stock prices) are no longer commingled. 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 management to negotiate the best possible terms of a merger, then they are good for stockholders. 6. One of the primary advantages of a taxable merger is the in the basis of the target assets, while one of the primary disadvantages is the capital gains tax that is payable. The situation is the reverse for a merger. The basic determinant of tax status is whether or not the old stockholders will continue to participate in the new company, which is usually determined whether they get any shares in the bidding firm. An LBO is usually taxable because the acquiring group pays off the current stockholders in full, usually in cash. 7. Economies of scale occur when average cost declines as output levels increase. A merger in this particular case might make sense because Eastern and Western may need less total capital investment to handle the peak power needs, there reducing average generation costs. 8. Among the defensive tactics often employed management are seeking white knights, threatening to sell the crown jewels, appealing to regulatory agencies and the courts (if possible), and targeted share repurchases. Frequently, antitakeover charter amendments are available as well, such as poison pills, poison puts, golden parachutes, lockup agreements, and supermajority amendments, but these require shareholder approval, so they be immediately used if time is short. While target firm shareholders may benefit from management actively fighting acquisition bids, in that it encourages higher bidding and may solicit bids from other parties as well, there is also the danger that such defensive tactics will discourage potential bidders from seeking the firm in the first place, which harms the shareholders. 9. In a cash offer, it almost surely does not make sense. In a stock offer, management may feel that one suitor is a better investment than the other, but this is only valid if the market is not efficient. In general, the highest offer is the best one. 10. Various reasons include: (1) Anticipated gains may be smaller than (2) Bidding firms are typically much larger, so any gains are spread thinly across (3) Management may not be acting in the best interest with many (4) Competition in the market for takeovers may force prices for target firms up to the zero NPV and (5) Market participants may have already discounted the gains from the merger before it is announced. 4. Since the acquisition is funded debt, the balance sheet will have debt equal to the original debt of balance sheet plus the new debt issue, so: debt Goodwill will be created since the acquisition price is greater than the book value. The goodwill amount is equal to the purchase price minus the market value of assets. Generally, the market value of current assets is equal to the book value, so: Goodwill created (market value FA) (market value CA) Current liabilities and equity will remain the same as the balance sheet of the acquiring firm. Current assets will be the sum of the two balance sheet accounts, and the fixed assets will be the sum of the fixed assets of the acquirer and the market value of fixed assets of the target firm. The balance sheet will be: Jurion Co., Current assets Fixed assets Goodwill Total 5. a. 62,500 2,700 Current liabilities debt Equity 8,400 32,600 The cash cost is the amount of cash offered, so the cash cost is million. To calculate the cost of the stock offer, we first need to calculate the value of the target to the acquirer. The value of the target firm to the acquiring firm will be the market value of the target plus the PV of the incremental cash flows generated the target firm. The cash flows are a perpetuity, so The cost of the stock offer is the percentage of the acquiring firm given up times the sum of the market value of the acquiring firm and the value of the target firm to the acquiring firm. So, the equity cost will be: Equity cost b. The NPV of each offer is the value of the target firm to the acquiring firm minus the cost of acquisition, so: NPV cash NPV stock c. Since the NPV is greater with the stock offer, the acquisition should be with stock. 6. a. The EPS of the combined company will be the sum of the earnings of both companies divided the shares in the combined company. Since the stock offer is one share of the acquiring firm for three shares of the target firm, new shares in the acquiring firm will increase So, the new EPS will be: EPS The market price of Stultz will remain unchanged if it is a zero NPV acquisition. Using the PE ratio, we find the current market price of Stultz stock, which is: P If the acquisition has a zero NPV, the stock price should remain unchanged. Therefore, the new PE will be: 19 b. The value of Flannery to Stultz must be the market value of the company since the NPV of the acquisition is zero. Therefore, the value is: The cost of the acquisition is the number of shares offered times the share price, so the cost is: Cost So, the NPV of the acquisition is: NPV 0 V Cost V 1,220,800 V Although there is a negative economic value to the takeover, it is possible that Stultz is motivated to purchase Flannery for other than financial reasons. 7. The decision hinges upon the risk of surviving. That is, consider the wealth transfer from bondholders to stockholders when risky projects are undertaken. projects will reduce the expected value of the claims on the firm. The telecommunications business is riskier than the utilities business. If the total value of the firm does not change, the increase in risk should favor the stockholder. Hence, management should approve this transaction. If the total value of the firm drops because of the transaction, and the wealth effect is lower than the reduction in total value, management should reject the project. Intermediate 9. The cash offer is better for the target firm shareholders since they receive per share. In the share offer, the target shareholders will receive: Equity offer value per share From Problem 8, we know the value of the merged assets will be The number of shares in the new firm will be: Shares in new firm 2,700 1,100x that is, the number of shares outstanding in the bidding form, plus the number of shares outstanding in the target firm, times the exchange ratio. This means the post merger share price will be: P 1,100x) To make the target shareholders indifferent, they must receive the same wealth, so: 1,100(x)P This equation shows that the new offer is the shares outstanding in the target company times the exchange ratio times the new stock price. The value under the cash offer is the shares outstanding times the cash offer price. Solving this equation for P, we find: P x Combining the two equations, we find: 1,100x) x x 0 There is a simpler solution that requires an economic understanding of the merger terms. If the target shareholders are indifferent, the bidding shareholders are indifferent as well. That is, the offer is a zero sum game. Using the new stock price produced the cash deal, we find: Exchange ratio 0 10. The cost of the acquisition is: Cost Since the stock price of the acquiring firm is the firm will have to give up: Shares offered 375 shares a. The EPS of the merged firm will be the combined EPS of the existing firms divided the new shares outstanding, so: EPS 375) b. The PE of the acquiring firm is: Original 20 times Assuming the PE ratio does not change, the new stock price will be: New P c. If the market correctly analyzes the earnings, the stock price will remain unchanged since this is a zero NPV acquisition, so: New 18 times d. The new share price will be the combined market value of the two existing companies divided the number of shares outstanding in the merged company. So: P 375) And the PE ratio of the merged company will be: 17 times At the proposed bid price, this is a negative NPV acquisition for A since the share price declines. They should revise their bid downward until the NPV is zero. b. Let equal the fraction of ownership for the target shareholders in the new firm. We can set the percentage of ownership in the new firm equal to the value of the cash offer, so: .2240 or So, the shareholders of the target firm would be equally as well off if they received 22 percent of the stock in the new company as if they received the cash offer. The ownership percentage of the target firm shareholders in the new firm can be expressed as: Ownership New shares issued (New shares issued Current shares of acquiring firm) .2240 New shares issued (New shares issued New shares issued 5,195,876 To find the exchange ratio, we divide the new shares issued to the shareholders of the target firm the existing number of shares in the target firm, so: Exchange ratio New shares Existing shares in target firm Exchange ratio 5,195,876 Exchange ratio .4724 An exchange ratio of .4724 shares of the merged company for each share of the target company owned would make the value of the stock offer equivalent to the value of the cash offer. 14. a. The value of each company is the sum of the probability of each state of the economy times the value of the company in that state of the economy, so: ValueBentley ValueBentley ValueRolls ValueRolls b. The value of each equity is sum of the probability of each state of the economy times the value of the equity in that state of the economy. The value of equity in each state of the economy is the maximum of total company value minus the value of debt, or zero. Since Rolls is an all equity company, the value of its equity is simply the total value of the firm, or The value of equity in a boom is company value minus debt value), and the value of equity in a recession is zero since the value of its debt is greater than the value of the company in that state of the economy. So, the value of equity is: EquityBentley EquityBentley The value of debt in a boom is the full face value of In a recession, the value of the debt is since the value of the debt cannot exceed the value of the company. So, the value of debt today is: DebtBentley DebtBentley Note, this is also the value of the company minus the value of the equity, or: DebtBentley DebtBentley c. The combined value of the the combined equity value, and combined debt value is: Combined value Combined value Combined equity value Combined equity value Combined debt value d. To find the value of the merged company, we need to find the value of the merged company in each state of the economy, which is: Boom merged value Boom merged value Recession merged value Recession merged value So, the value of the merged company today is: Merged company value Merged company value Since the merged company will still have in debt, the value of the equity in a boom is and the value of equity in a recession is So, the value of the merged equity is: Merged equity value Merged equity value The merged company will have a value greater than the face value of debt in both states of the economy, so the value of the debt is d. There is a wealth transfer in this case. The combined equity value before the merger was but the value of the equity in the merged company is only a loss of for stockholders. The value of the debt in the combined companies was only but the value of debt in the merged company is since there is Maximum bid price Notice that this is the same value we calculated earlier in part a as the value of the target to the acquirer. e. The price of the stock in the merged firm would be the market value of the acquiring firm plus the value of the target to the acquirer, divided the number of shares in the merged firm, so: PFP The NPV of the stock offer is the value of the target to the acquirer minus the value offered to the target shareholders. The value offered to the target shareholders is the stock price of the merged firm times the number of shares offered, so: NPV f. Yes, the acquisition should go forward, and Plant should offer the cash since the NPV is higher. g. Using the new growth rate in the dividend growth model, along with the dividend and required return we calculated earlier, the price of the target under these assumptions is: PP .06) And the value of the target firm to the acquiring firm is: The gain to the acquiring firm will be: Gain The NPV of the cash offer is now: NPV cash And the new price per share of the merged firm will be: PFP And the NPV of the stock offer under the new assumption will be: NPV stock Even with the lower projected growth rate, the stock offer still has a positive NPV. Plant should purchase Palmer with a stock offer of shares. 16. a. To find the distribution of joint values, we first must find the joint probabilities. To do this, we need to find the joint probabilities for each possible combination of weather in the two towns. The weather conditions are therefore, the joint probabilities are the products of the individual probabilities. Possible states Joint probability .1(.1) .01 .1(.4) .04 .1(.5) .05 .4(.1) .04 .4(.4) .16 .4(.5) .20 .5(.1) .05 .5(.4) .20 .5(.5) .25 Next, note that the revenue when rainy is the same regardless of which town. So, since the state has the same outcome (revenue) as their probabilities can be added. The same is true of and Thus the joint probabilities are: Possible states Joint probability .01 .08 .10 .16 .40 .25 Finally, the joint values are the sums of the values of the two companies for the particular state. Possible states Joint value
Chap 21 solutions manual
University: Missouri State University
