Questions

This file contains questions only, and is provided for those who prefer to self-test without immediate access
to the answers. The answers can be found in the file Questions and Answers.
Chapter 1 Questions
1. Best practice in M&A requires that we augment the deterministic focus on
structure with a probabilistic focus on conduct. What does this mean?

2. The chapter described six elements of structure that influence M&A transactions.
What are these and how do they influence success or failure in M&A? 3. Why is conduct important in due diligence? 4. How might conduct play a role in the search for partners?
5.
In what other areas of M&A might conduct have an influence?
6. Why is process so important in deal development?
7. What are some benchmarks against which a deals outcomes might be measured?
8. Why is a deal a system? It being a system, what are the implications in terms of
unanticipated side effects? Explain.

9. Should one use the same blueprint for all M&A deals? Explain. 10. An enhanced brand in M&A should be one of the goals that deal makers aspire to.
Why is this important?
Chapter 2 Questions
True or False
1. The field of business ethics is important because it provides detailed solutions to the ethical dilemmas one encounters in M&A.
2. Ethical business practices build trust, but they do not yield economic gains.
3. Following and paying attention to the law are necessary but not sufficient requisites for acting ethically.
4. The U.S. legal framework generally requires directors and managers to operate a company in the best interests of its shareholders.
5. Edward Freeman argues that a firms activities should be primarily focused on maximizing value for shareholders.
6. Utilitarianism is an ethical theory stating that actions should provide the greatest good for a few people deemed to be the most important.
7. A focus on duties defines right versus wrong based on virtues. A person who follows this ethical theory would consider what a virtuous person would do in a given situation.
8. The tradition of ancient Greek philosophy, which defines right and wrong by virtues, primarily focuses on personal pride and characternot duty.
9. Incorporating business ethics in the workplace builds stronger teams and leaders.
10. A companys only defense against unethical business behavior is to institute a code of ethics in the workplace.
Short Answer
1. Describe and explain the role of ethics in mergers and acquisitions by providing some key reasons for its importance in this field.
2. If ethics is so important in M&A, why hasnt it been given more attention?
3. Does Milton Friedmans stockholder school of thought promote or not promote ethical decision making in business? Explain why.
4. James, the chief learning officer of Best Investments, has just been charged with the task of implementing a structured program to promote ethical behavior at his company. What would you recommend that he do?
5. What is greenmail and why might it be considered unethical?
Chapter 3 Questions
True or False
1. Despite the unique characteristics of M&A deals and their respective targets and buyers, benchmarking against value creation permits generalizations to be drawn about factors correlated with successful and failed deals.
2. Since the 1970s, event studies have dominated the field of M&A research. This technique was considered a genuine innovation, theoretically well-grounded, cheap to execute, and able to evade the problem of holding constant other factors that plague ex post studies of mergers effects.
3. Clinical studies can be characterized as inductive research, because researchers often induce unanticipated insights by focusing on one transaction (or a small number of transactions) in great depth.
4. Statistical significance is essentially the same thing as economic materiality, and each can independently shed light on whether M&A transactions create or destroy value.
5. Average returns to target and buyer company shareholders are stable over time.
Short Answer
1. What does it mean to conserve value?
2. Why shouldnt the gains from M&A activity be evaluated using benchmarks other than the economic one? Shouldnt strategic benefits such as human capital, economies of scale, and improved operations be considered?
3. Suppose you are an investor in Company A, which has just completed an acquisition. The returns resulting from the event are 1.2 percent in the first week. Theoretically, how does this compare to those of Company B, another stock in your portfolio, which experienced a 75 percent annualized gain in the last year? What assumption underlies this comparison
4. What are some positive drivers of M&A profitability?
5. What are some negative drivers of M&A profitability?
6. Why are hostile takeovers more profitable to buyers than friendly offers?
7. The main challenge of evaluating the profitability of M&A to combined entities (the buyer and target firms combined) stems from the size differential between the buyer and target. How have research studies addressed this issue?
8. Suppose two business school students are asked to look at and evaluate the same statistical study of M&A deals. The sample size is large and random; the data results are clear. One student says that 60 percent of the M&A transactions failed, while the other says that 60 percent of the M&A deals succeeded. Could they both be right? How might you explain the difference in their responses?
9. A popular notion is that the acquisition premiums that buyers pay represent expected future value. How would you explain why buyers, on average, receive zero to slightly negative returns?
Chapter 4 Questions
True or False
1. Despite the correlation between certain economic conditions and M&A activity, scholars have cited the occurrences of M&A waves as one of the ten most important unresolved questions in financial economics.
2. The second wave of M&A activity (19251929) was characterized by horizontal mergers and produced the following firms: General Electric, Eastman Kodak and U.S. Steel.
3. M& A waves are procyclical to the stock market; they occur in line with increases in stock prices.
4. Possible explanations for waves of M&A activity include bargaining power effects in segments of supply chains, as well as managerial psychology.
5. Schumpeter stresses the importance of paying particular attention to entrepreneurs not only because of their important function in creative destruction but also
because their independence and tendency to appear singly makes them easy to miss in the crowd.
6. Holding the view that market manias always drive M&A activity is consistent with the assumption that managers and markets are rational.
Multiple Choice: Please pick the best answer.
1. Wave 1, from 1895 to 1904, was characterized by the following:
I. II. III.
Economic and capital market buoyancy Technological innovation Vertical mergers
a. I only b. I & II only c. II & III only d. I, II, & III
2. In which of the following periods did M&A activity involve more hostile takeovers and more going-private transactions?
a. 19651970 b. 19922000 c. 19811987 d. None of the above
3. In the most recent merger wave, from 1992 to 2000,
I. M&A activity increased briskly in all segments of the economy. II. M&A activity was high in the banking and high technology sectors. III. Defense spending increased and led to high M&A activity in the defense sector.
a. I only b. I & II only c. II & III only d. I, II & III
4. Merger activity appears to slow when
I. Bond yields rise. II. Bond prices rise.
III. The cost of capital increases.
a. III only b. I & II only c. II & III only d. I & III only
5. According to Schumpeter, to understand M&A activity we should listen to turbulence
I. II. III.
At the level of markets. At the level of firms. At the level of the economy.
a. I & II only b. II & III only c. I & III only d. I, II & III
Short Answer
1. What are some common characteristics among the different merger waves between 1895 and 2000?
2. Provide examples of industry-specific drivers that spur M&A activity.
3. Why does Schumpeter identify turbulence as the driver of M&A activity?
4. After 1989, Western firms were able to make toehold acquisitions in Central and Eastern Europe. What was the turbulence that created this opportunity? How does Schumpeters theory creative destruction apply here?
5. Describe an inside-out approach and an outside-in approach for identifying turbulence and monitoring M&A activity.
Chapter 5 Questions
1. The volume of cross-border M&A transactions has risen to record levels in recent years. What, in your view, are some of the factors that have contributed to this trend?
2. In what ways do cross-border transactions usually differ from domestic acquisitions? What might explain these differences?
3. What motivations might drive companies to look for acquisition targets overseas?
4. For purposes of reducing risk through diversification, does it make more sense to invest in a globally integrated market or one that isnt? Explain.
5. How does free trade encourage cross-border merger activity?
6. What factors must one look at to assess a countrys investment climate?
7. What factors, according to Porters diamond model, must an analyst consider when evaluating a countrys competitive advantage?
8. What do researchers suggest is the reason behind cross-border acquisition targets being mostly manufacturing companies?
Chapter 6 Questions
1. Describe the role of strategy in M&A.
2. Briefly describe the BCG growth-share matrix, and cite its advantages and disadvantages.
3. According to Porter, what are the five factors that drive economic attractiveness of an industry? Please identify and briefly describe these factors.
4. What are the strategic map and the strategic canvas? What are they used for?
5. Briefly describe the attractiveness-strength matrix and its use. What is its chief drawback?
6. Why is business definition so important?
7. What are the three classic successful strategies? Describe each.
8. What are some reasons why firms pursue inorganic growth?
9. How might diversification actually create value?
10. What are the alternatives to M&A for achieving inorganic growth? How do these avenues differ from each other? 11. What are some of the benefits that joint ventures and strategic alliances might bring?
12. What is Tobins Q?
13. What does a business manager need to consider when choosing a path for inorganic growth?
14. What are some common motives for business managers to consider restructuring or exiting a business?
15. What are some transactions to restructure, redeploy, or sell?
16. What is a carve-out? A spin-off? A split-off? What is tracking stock?
17. What is financial recapitalization? What is a leveraged restructuring? An ESOP restructuring?
Chapter 7 Questions
1. List some characteristics of a good acquisition search process.
2. In the acquisition search phase, what might be some screening criteria used to evaluate potential targets?
3. Where can one find the sweet spot of acquisition searches?
4. What is the efficient markets hypothesis and what are its implications for the acquisition search process?
5. Why are networks important in the acquisition search process? How can one be a member of and enhance ones position in a network?
6. What characteristics increase the value of a network?
7. What is the role of navigators in the acquisition search field? Who are these navigators? What were the two categories of navigators discussed in the chapter, and what functions do they serve?
8. Is there a role for opportunism in acquisition searches? Why or why not?
9. How can a searcher increase the probability of a positive payoff from the acquisition search process?
10. What lessons about the acquisition search process did the example of Kestrel Ventures illustrate?
11. A traditional view is that quality matters more than quantity. However, with social networks, it may be quite the opposite: Weaker ties may matter more than strong ties, and the breadth (quantity) of contacts may be more meaningful than the quality. Please explain.
12. What does Metcalfes Law say and what implications does it have in the acquisition search process?
Chapter 8 Questions
True or False: If false, please explain why.
1. A compliance mentality will prepare for M&A success better than an investor mentality. 2. When conducting due diligence, it is advisable to focus on specific issues, particularly accounting and legal issues, rather than to try to cover many areas. 3. Obtaining facts is the main objective of due diligence. 4. Professionals can be held liable for the failure to know of potential risks. 5. Due diligence should begin when the buyer approaches the target. 6. Cultural compatibility is no less important than financial, product, or market compatibilities between buyer and target.
Short Answer 1. In what situations might a narrower scope of due diligence be justified? 2. In acquiring a target, when should the process of due diligence be begun? 3. How is investing in due diligence like buying an option?
For each of the following issues, write out some due diligence questions you would want to ask:
Legal issues
Accounting issues
Tax issues
Information technology
Risk and insurance issues
Environmental issues
Market presence and sales issues Operations
Real and personal property issues Intellectual and intangible assets Finance
Cross-border issues
Human resources
Cultural issues
Ethics
Chapter 9 Questions
1. What does it mean to think like an investor?
2. Is intrinsic value something that can be measured precisely? Why or why not? How does one arrive at intrinsic value through valuation?
3. What is the theory of value additivity? How does knowing this theory enable one to create value?
4. Describe and define the nine estimators of value discussed in this chapter. List an advantage and disadvantage for each and explain why it is an advantage/disadvantage. Describe situations in which certain valuation approaches are more useful than others.
5. Think through each of the eight big-picture rules on valuation discussed in this chapter. What might happen if these rules are violated?
6. Discuss the differences between the enterprise value and equity value approaches of DCF.
7. What are the different ways of estimating the cost of equity? Describe the methods and explain the rationale behind each of them.
8. What factors might bound low-side and high-side bids of buyers?
9. When is it necessary to unlever and relever betas?
10. List and define the two approaches discussed in this chapter for estimating terminal value growth rates. Which approach is better?
11. Suppose you are establishing the terminal value growth rate for a large industrial goods manufacturer. In recent years, the companys return on equity has averaged 10 percent, and it has paid out roughly 10 percent of its annual profit in dividends. Economists project both the real rate of growth and inflation to be 3 percent.
a. Calculate the terminal value growth rate using the sustainable growth model and the Fisher equation.
b. Which of your two results do you think is more appropriate to use? Why?
12. Why does the terminal value, rather than near-term forecasts of cash flows, often account for a majority of the value of a firm? Why is the terminal value growth rate the tail that wags the dog?
Chapter 10 Questions
1. Critique the following arguments:
a. An option is the right but not the obligation to do something. For this reason, it is always less risky to invest in options than in stocks. b. When an option is out-of-the-money, it is worthless. c. An American option may be exercised at any moment before expiration. Therefore, it has a higher value than a European option with exactly the same terms. d. Options are very risky instruments. Therefore, the addition of an option to your portfolio will increase the risk of your holdings.
2. Suppose that a stock trades at $50 today, and that you can buy call options that expire in one month at exercise prices $40, $50, and $60.
a. Calculate your potential payoff one month later for these three options by assuming the stock will trade at $30, $35, $40, $45, $50, $55, $60, $65, and $70 at expiration. b. Draw the payoffs on one graph and intuitively decide which option is more valuable.
3. Briefly explain why a call option price rises as stock price increases, exercise price decreases, time to maturity increases, volatility increases, and risk-free rate increases.
4. Briefly explain why it is never optimal for an investor to exercise an American call option for a stock that does not pay dividends.
5. By using various combinations of simple call and put options, one can implement different trading strategies. Draw the payoff diagram for a portfolio that includes
a. one short call at exercise price $15 b. two long calls at exercise price $20, and c. one short call at exercise price $25. All the options expire at the same time and the stock trades at $20 today. Explain what someone who holds this portfolio might be thinking about this stock, and, conversely, what someone who is selling this portfolio might be thinking.
6. On May 21, 2003, the S&P 100 (OEX) closed at 463.58, the Dow Jones Industrials (DJX) at 84.91, and the NASDAQ 100 (NDX) at 1112.85. The following option prices were quoted from the Wall Street Journal:
Expiration June 20 July 18 September 12 OEX 465 Call ($) $13.50 $14.90 $25.00 OEX 465 Put ($) $9.50 $14.50 $20.50 DJX 84 Call ($) $2.40 $3.10 $4.10 DJX 84 Put ($) $1.55 $2.45 $3.70 NDX 1125 Call ($) $31.00 $47.00 NDX 1125 Put ($) $39.00 $59.00 $82.50 Interest rate* 1.04% 1.00% 1.02% * Rates are of Treasury bill rates maturing on the given dates.
Select three sets of data from the table and verify that put-call parity holds. Briefly explain the underlying assumptions of put-call parity and why put-call parity might not always hold in the real world.
7. Refer to problem 6. Select any index and calculate the intrinsic value and time value for the options on that index. Compare the time values among the options on that index that expire at different dates. What do you observe?
8. Why can the equity of a firm be viewed as an option on its assets? How would you calculate the value of this option?
9. Briefly explain how the option analogy can be used to value loan guarantees and debts.
10. Suppose stock ABC trades at $40 today, and there is an equal chance of it going up to $60 or down to $20 next year. The one-year risk-free rate is 10 percent.
a. Calculate the value of at-the-money call and put options. Does put-call parity hold in this case? (Please use the binomial tree approach.) b. What probability of ABC going up to $60 next year will make the put-call parity hold?
11. For $20, you can buy a six-month call option on stock XYZ at exercise price $90. Stock XYZ trades at $100 today. It has a 30 percent annual volatility. The annualized six-month risk-free rate is 8 percent. Is the option overvalued or undervalued? How might you take advantage of this opportunity? Please use Option Valuation.xls, the Black-Scholes option pricing model, to answer these questions.
12. Mr. Thompson was a portfolio manager at a mid-sized asset management firm. Due to current market turbulence, he wanted to diversify the risk in his portfolio by adding three stocks. He picked three industriesfinancial, chemical, and computer servicesand assigned his associate to come up with some choices.
After the associate handed him the folder with the information about three stocks she had picked, Mr. Thompson misplaced the folder and only recovered three pages containing todays stock option quotes. Could you use these data to help Mr. Thompson identify which stock is in which industry from the implied volatilities in these options? Please compute these implied volatilities using Option Valuation.xls and make a judgment about which firm is which.
Stock Stock price Exercise price Expiration date Dividend payout Call option value Put option value Risk free rate Date:
A $ 123.47 $ 125.00 June 20 $ 2.64 $ 2.25 $
B $ 38.85 $ 40.00 June 20 $ 0.80 $ 0.65 $
C $ 13.67 $ 12.50 June 20 $ $ 1.40 $ -
3.70 1.85 0.20 1.04% 1.04% 1.04% Wednesday, May 21, 2003
1. What is the defining feature of a synergistic transaction?
2. Why must one think like an investor when evaluating synergies? What could go wrong when one does not think like an investor?
3. In what instances will a buyers share price rise, fall, or remain the same in connection with an acquisition announcement?
4. Explain in your own words the following equation, and provide definitions and examples of in-place synergies and real option synergies:
In Place Re al Option VSynergies = VSynergies + VSynergies In Place Re al Option VSynergies = VSynergies + VSynergies
5. In each of the following cases, state whether there is an option embedded and if so, what type of option it is.
Case 1
SuperSodas, an international soft drink manufacturing company of Latin American origin, recently acquired a 40 percent interest in a Southeast Asian bottler. SuperSodas stake was limited because laws in the Southeast Asian country prohibited companies that were more than 40 percent foreign-owned from acquiring real estate. Among the synergies projected by SuperSodas was $87 million in revenue enhancements if the Southeast Asian bottler were to build another plant in the countrys southern region, which was currently underserved. Purchasing land and building a new plant would require an initial investment of $2.8 million.
Case 2 A large oil company has agreed to merge with a steel company. Their operations intersect nowhere. But the CEO believes that the debt capacity of Newco will be larger than the sum of the debt capacity of the two firms standing alone. The CEO has no plans to actually use this new debt capacity in the near term.
Case 3 Kinetic Utility, a company in the business of electricity generation, has agreed to acquire Alpine Utility. Kinetics generation plants are all gas-fired, while Alpines plants are all oil-fired. They serve the same market. Part of the rationale for acquiring Alpine was to achieve cost savings through greater flexibility in responding to changes in the relative prices of the two fuels.
6. What are the two forms of WACC synergies described in the chapter? Define each form and explain how each might create economic value. On what conditions are these truly synergies?
7. For valuing each of the synergies described below, explain whether you would use a discount rate equal to WACC, greater than WACC, or less than WACC. Explain the reasoning behind your decision.
a. The French government wants to promote the merger of two companies and guarantees a yearly annuity if the two agree to merge. b. PepsiCo management believed that by acquiring Quaker Oats, they would be able to improve operating income growth from 8 percent to 10 percent through revenue enhancements and cost savings.1 c. In the proposed merger between Hewlett-Packard and Compaq in 2002, the CFO of HP announced that $2.5 billion in cost synergies were expected from the Compaq acquisition. Most of the cost synergies would come from layoffs and organizational restructurings.2 1 Andrew Conway and Christopher O Donnell, PepsiCo Acquires Quaker: Strengthening the Core,
Morgan Stanley Dean Witter, December 5, 2000.
2 Pui-Wing Tam, Hewlett-Packard Tries to Gain Votes for Compaq Deal, Wall Street Journal, February
28, 2002.
d. Among the main arguments for the AOL Time Warner merger was the potential revenue enhancement to be gained from merging broadband delivery (AOL) with content (Time Warner). By combining these offerings, it was expected that both companies could achieve far greater market penetration.
8. Brown Paper Mills is planning to acquire Woodland Pulp and Paper. Michael Brown is trying to determine an offer price and has asked you to estimate the value of synergies. Brown expects that with greater market power, revenues will increase in nominal terms by $50 million in the first year, by another 8 percent in years 2 and 3, by 5 percent in year 4, and zero in year 5. Increased revenues will require an increase in working capital equivalent to 2 percent of the first years sales. Thereafter, additional working capital needs will increase at the rate of 0.5 percent of revenues per year. Cost savings of $25 million are expected in the first year, $30 million in the second year, and $40 million thereafter. The cost savings after year 3 will have to be adjusted to reflect inflation. An initial investment of $90 million is required to realize the cost savings. Expected inflation is 2 percent,
and expected operating margins are 10 percent. Brown wants you to discount the synergies at 10 percent. The tax rate is 35 percent.
1. Cite some country factors that analysts must consider when evaluating crossborder acquisitions.
2. How does a worldwide tax credit system differ from a territorial tax system? Which tax system does your country use?
3. At the end of August 1998, the exchange rate between the U.S. dollar and the Chilean peso stood at US$ 1: CLP 473.5. The one-year Treasury rate in Chile stood at 15.84 percent, while the yield on the one-year US Treasury was 4.71 percent. Based on these numbers, what would be the peso-dollar exchange rate one year hence?
4. You are reviewing a DCF valuation for an overseas acquisition target. You feel that the valuation is too optimistic given the high political risks of operating in the country. In what ways might you adjust the DCF valuation?
5. Assume you have acquired manufacturing equipment for $800 million, and that it has a useful life of 10 years. Inflation is 2.5 percent, the real discount rate is 4.00 percent, and the tax rate is 40 percent.
a. What would be the present value of the depreciation tax shields from year 1 to year 5? Use the nominal discount rate to calculate present value. b. Now assume that you can inflate depreciation expense at a rate of 2.5 percent annually. Using the same discount rate, what is the present value of depreciation tax shields from year 1 to year 5? c. Go back to (a). This time, use the real discount rate to calculate the present value of the tax shields. What do you observe? How would you interpret the results?
6. Below is a free cash flow estimate and valuation for a Taiwanese company. Values are given in Taiwan dollars (NT$), and the NPV is translated into US dollars at the current exchange rate of US$ 1 : NT$ 34.96
(NT$, in millions) Free cash flows Terminal value Cash flows including terminal value Present value in Taiwan dollars Present value in US dollars
2003 231 231 1,178,817 33,719
2004 9,567 9,567
2005 15,830 15,830
2006 30,942 30,942
2007 44,875 1,219,335 1,264,210
2008 59,419
Assume the following:
Inflation rate, US Inflation rate, Taiwan Exchange rate at time 0 (Taiwan dollars per US dollar) Real discount rate
2.4% -0.2% 34.96 5.0%
a. Translate the cash flows into US dollars. b. Estimate the discounted cash flow value of the investment under the two forecasts (U.S. dollars and Taiwan dollars). Did you come up with the same present value? What rate did you use to discount the U.S. dollar flows? What assumptions are necessary to obtain equivalency between approaches A (converting local flows into dollars and discounting at a dollar rate) and B (forecasting in local currency and discounting at a local rate)?
7. What factors might contribute to the segmentation of an economy? Would identical assets in separate segmented markets command identical prices?
8. You are trying to determine the cost of equity for a foreign target whose cash flows you have projected in dollars. You have the following data:
10-year Treasury bond rate, US 10-year rate, US dollar denominated sovereign bonds Beta of target versus foreign country stock index Beta of foreign country stock index versus US index Market risk premium, US Market risk premium, foreign country
5.50% 7.75% 0.96 1.30 6.00% 8.00%
What would your estimate of this firms cost of equity be?
9. Assume you are CEO of a U.S. company evaluating three companies listed on the Hong Kong Stock Exchange. China Mobile (Hong Kong) Ltd. provides cellular phone services in China. Hang Seng Bank Ltd. provides banking and other financial services. Hutchison Whampoa Ltd. is a holding company that operates in areas such as ports and related operations, telecommunications, property and hotels, retail and manufacturing, infrastructure, finance and investments, and so on. Their betas relative to the global equity portfolio over the past 12 months were 1.31, 0.74, and 1.21 respectively. You estimate, based on the last 10 years of data, that the equity market risk premium on the global portfolio is approximately 6 percent. Currently, the long-term U.S. Treasury bond yields 1.4 percent. What is your estimate of each companys cost of equity based on the above data?
10. Country A has a local market volatility of 36 percent, and a country beta relative to the United States of 1.0. Country B has a local market volatility of 20 percent, and also a beta of 1.0 versus the U.S. market. The U.S. market has a volatility of 18 percent. Of the two countries, which is more segmented? Explain.
11. List the different ways of calculating Ke discussed in the chapter and provide a brief explanation for each.
Review the following case and then answer the questions that follow.
CASE: GURU TECHNOLOGIES*
In 1984, Jay Forte, a deal maker well known for managing successful company turnarounds, approached Debra Brown for advice on a proposed management buyout of an electronics manufacturer, Guru Technologies Company (GTC), from its parent company, Allegro Electronics Inc. Brown worked in the corporate finance division of Kuchler & Bevill (K&B, or the ank), at which Forte was a well-known customer. With the banks lending and investment criteria in mind, Brown needed to consider making both a bridge loan and an equity investment.
Forte was seeking to borrow $2.5 million from K&B, to be used toward the $3.5 million cash purchase of GTC. He proposed that he and the bank would make an equity investment of $1 million.
Brown created a financial structure that she anticipated would follow the buyout. She developed the forecast of residual cash and the structure of the transaction flow based on specific assumptions (found in Exhibits 1 and 2 below). She assumed that the credit
agreement as finally negotiated would prohibit the payment of dividends to common stockholders until the debt was substantially reduced. She would repay the debt as fast as the required cash balance (2 percent of sales) would allow. Therefore, practically speaking, the only cash flow to be received by common stockholders would come from the terminal value. Brown also made the assumption that the equity would begin at a value of $1 million (the total equity investment value for Forte and K&B).
The management group originating the buyout would benefit from including K&B as an equity investor since the debt provided by the bank would be priced approximately 250 basis points less than had the deal been financed strictly with debt from another lender. Forte indicated that any equity investment negotiated with the bank would reduce the original investors contribution by a similar amount, so new equity invested by Forte and the bank would still total $1.0 million.
To successfully turn the company around, Forte proposed a business plan for a sharp reduction in overhead, a new incentive system for managers to meet their budget, and a restructured marketing effort. His financial analysis projected that in a worst-case scenario, company sales would rise to $5.5 million in fiscal year 1985. _______________________________________________________________________ * This is a disguised case of an actual leveraged buyout.
Please refer to the following exhibits and notes before answering the questions that follow:
Exhibit 1 GURU TECHNOLOGIES INC.

Dollar Figures in thousands ($000)
Pro Forma Assumptions Tax rate Shares outstanding Other net working capital/sales Cash/sales
48% 100,000 23% 2.0% Bank requirment 1985 13.50% $5,500 16.3% $ $ $ 260 600 200 $ $ $ 1986 13.50% $7,500 19.0% 550 550 $ $ $ 1987 13.50% $8,800 19.0% 750 500 $ $ $ 1988 13.50% $10,000 19.0% 750 500 $ $ $ 1989 13.50% $11,200 19.0% 750 500 -
Base rate Sales (000) Operating margin Capital expenditures Depreciation Organizational expenses
Cost of capital assumptions (as of April, 1984) Risk free rate Internal rate (base + 3.5%) Market risk premium Beta-unlevered
12.42% 17.00% 6.00% 1.45
Exhibit 2
Debra Brown's Forecast of Cash Flows and Economic Balance Sheets

Sales EBIT Interest Org'l Expenses Pre-Tax Profit Taxes @ 48% Net Profit Depreciation Capital Expenditures Additions to WC Additions to Cash Debt Amort. Residual Cash Flow Cash (Beginning) Changes Cash (Ending) Cash (Required)
1985 5,500 896.5 339.2 200.0 357.3 171.5 186
1986 7,500 1,425.0 310.2 0.0 1,114.8 535.1 580 550.0 550.0 460.0 40.0 79.7 110.0 40.0 150 150.0
1987 8,800 1,672.0 294.2 0.0 1,377.8 661.4 716 500.0 750.0 299.0 26.0 141.5 150.0 26.0 176 176.0
1988 10,000 1,900.0 262.0 0.0 1,638.0 786.2 852 500.0 750.0 276.0 24.0 301.7 176.0 24.0 200 200.0
1989 $ 11,200 2,128.0 207.6 0.0 1,920.4 921.8 $ 999 500.0 750.0 276.0 24.0 448.6 200.0 24.0 224 224.0
Notes
Exh. 1 Exh. 1 Note 1 Exh. 1 Exh. 1
600.0 260.0 95.0 110.0 320.8 $ 0.0 110.0 110 110.0
Exh. 1 Exh. 1 Exh. 1 Exh. 1 Note 2 Note 3
0.0
Note 4
Debra Brown's Forecast of Economic Balance Sheet and Capital Accounts

Cash Other Net Working Cap. Net Fixed Assets Total Assets Debt Equity Debt & Equity Memo: Debt Balances Debt (Beginning) Changes Debt (Ending) Debt (Average) Memo: Equity Balances Equity (Beginning) Changes Ending
@ Closing $ $ 1,170 2,330 $ 3,500 $ 2,500 1,000 3,500 2,500 $ $ 1,000 $
1985 110 1,265 1,990 3,365 2,179.2 1,185.8 3,365
1986 150 1,725 1,990 3,865 2,099.5 1,765.5 3,865
1987 176 2,024 2,240 4,440 1,958.1 2,481.9 4,440
1988 200 2,300 2,490 4,990 1,656.3 3,333.7 4,990
1989 $ 224.00 2,576.0 2,740.0 $ 5,540 1,207.7 4,332.3 $ 5,540
Notes
Note 5
2,500.0 (321) 2,179 $ 2,340 $ 1,000.0 185.8 1,186
2,179 (80) 2,100 $ 2,139 $ 1,185.8 579.7 1,765
2,100 (141) 1,958 $ 2,029 $ 1,765.5 716.5 2,482
1,958 1,656.3 (302) (449) 1,656 $ 1,208 1,807 $ 1,432 2,481.9 851.7 3,334 3,333.7 998.6 $ 4,332
Note 2
NOTES:
Note 1: Interest expense is computed as the interest rate (base rate plus 1 percent, where the base rate is as given in Exhibit 1) times the average debt balance for the year.
Note 2: Assumes debt is repaid as fast as required cash balance will allow. (Requirement equals 2 percent of sales.)
Note 3: Because this residual cash flow nets out the repurchase of Global Electronics Inc.s shares, it is specifically the residual cash flow to Jay Forte and K&B.
Note 4: The sum of residual cash flow plus additions to cash.
Note 5:
Other net working capital is computed by multiplying the ratio of other net working capital/sales) times sales.
Questions:
1. What do you estimate to be the equity value of Guru Technologies (GTC)? Refer to Exhibit 13.4 as a guide for your calculation of the terminal value and the appropriate annual discount rates. Use a perpetual growth rate of 7 percent.
2. From the banks point of view, what is the net present value of the $2.5 million loan? (Hint: Lay out the amortization and payment structure to calculate the NPV.) What percentage of the equity should the bank request as part of its commitment to lend in order to break even on its required return?
3. Perform sensitivity analysis on the terminal growth rate. How sensitive is your valuation to the growth rate? With this information, analyze this deal structure from the point of view of Debra Brown and K&B.
1. Real options are pervasive everywhere, even in daily life. Identify which of the following alternatives are real options. a. Automobile insurance b. Defined benefit retirement plan c. Cash or credit cards in your wallet d. Training a work force to do multiple tasks e. Taking swimming lessons
2. How do options differ from opportunities?
3. Suppose you go to an automobile dealer to buy a car. After you pick the right model, the salesperson recommends four alternatives to you. They are metallic painting, adjustable passenger side seat, automatic transmission, and adjustable steering wheel. Among these four, which one seems like an option to you? Why?
4. Automakers are beginning to develop a hybrid car that can use gasoline or electricity as power sources. Assume one such car sells for $2,000 more than a normal gasoline-powered car. Based on your estimation, a normal gas-powered
car will consume present value of $10,000 over its lifetime if gas prices stay at the current level. If you only use electricity for the hybrid car, it will cost you $15,000 now. But if a new source of energy is developed soon, the cost of electricity for the lifetime of the car may drop to $10,000 in present value term and gas price may double in the future. The probability of status quo is predicted at 60 percent. Does the hybrid car represent an option to you? How much of its premium is accounted for by the option value?
5. You can purchase the right to drill in a natural gas field for $6 million. If you have a dry well, the present value of future payoffs is zero. If you find natural gas, the PV of future payoffs will be $10 million. After consulting with a geologist, you estimate that there is roughly a 70 percent chance of finding gas. He also told you that you can spend a certain amount of money to drill a test well in the field so that you can be sure whether you will find gas or not. Draw a decision tree that determines the value of the test. What kind of option is the test?
6. The CEO of MegaSoftware Inc. considers investing in a software development project. R&D will cost $5 million right now. The software development can be finished in one year. Forecasted profit from the sales of software follows a lognormal distribution with a mean of $10 million and a standard deviation of 50 percent. Marketing and advertising expenses for the sales are estimated at $5 million. The one-year risk-free rate is 7 percent. In your opinion, is the investment
in R&D an option? If so, what kind, and what is its value? (Calculate the option value using OptionValuation.xls.)
7. Suppose you are negotiating an agreement with a start-up company that allows you to buy 50 percent of its equity three years from now at $10 million. The market value of the equity today is $8 million. The annual historical volatility of this companys equity is 25 percent. The three-year government bond yield is 6 percent. Assuming risk neutrality, estimate the value of this option using the binomial method: (a) draw the lattice; (b) fold it back to determine the present value.
8. A big pharmaceutical company XYZ is considering a joint venture deal with biotech company ABC. Company ABC has a promising drug candidate in the pipeline which just passed the Phase II clinical trials. ABC needs cash to push the clinical trials forward and apply for FDA approval. Therefore, it approaches company XYZ to offer XYZ the right to share the future profits from this drug in exchange for a cash payment now. (Assume no time value of money in this problem).
a. Company ABC asks for a $5 million cash payment now in exchange for fifty percent of the future profits from the drugs. There is an 80 percent chance for this drug to pass the Phase III clinical trial and get FDA approval. If FDA approves its use, the forecasted sales will most likely be $200 million with a
minimum of $100 million and a maximum of $300 million. The profit margin on the sales is estimated at 20 percent. To obtain 50 percent of the profit, Company XYZ also needs to share 50 percent of the marketing expense of $20 million. Should company XYZ take this offer?
b. After reexamining the possibility of passing FDA approval, company XYZ found that there is a 90 percent chance for this drug to have a positive result from the Phase III clinical trial and there is a 90 percent chance for it to obtain FDA approval. Company XYZ proposes to ABC that it can pay $2 million if the drug passes the Phase III test and pay a certain amount now. Suppose the sales forecast, profit margin, and other terms stay the same. How much should company ABC ask for the initial payment?
9. Why it is hard to value real options?
1. What is liquidity? Why is it valuable?
2. You are considering an acquisition of a private company, ABC. Based on a standalone valuation, ABC is worth $10 million. The total synergy, if the merger is completed, is estimated to be $4 million. Suppose that in this case, the discount for liquidity for public companies similar to ABC is around 45 percent. Estimate the maximum payment for this company.
3. Give some examples of some illiquid securities in financial markets. Briefly explain why it is important to consider them in the analysis of M&A transactions.
4. Briefly explain why control is valuable to business managers. How does one value control?
5. Suppose a retail company has two major shareholders, Mr. Jones and Mrs. Emily. Other owners of the firm are oceanic voters. Mr. Jones is the first major shareholder and Mrs. Emily is the second major shareholder. Assuming the following three scenarios, please use the Excel model Power.xls to calculate the Shapley Value for all the parties. If power determines the value of votes, whose votes will be worth the most in each situation?
Scenario 1: Jones has 30 percent of votes, Emily has 20 percent of votes, and the other 50 percent of votes are held by oceanic voters. Scenario 2: Jones has 40 percent of votes, Emily has 10 percent of votes, and the other 50 percent of votes are held by oceanic voters. Scenario 3: Jones has 40 percent of votes, Emily has 20 percent of votes, and the other 40 percent of votes are held by oceanic voters.
6. Suppose you are the principal at a private equity firm and are considering an opportunity to purchase the majority of shares in a publicly traded machinery tool company. You think the company is mismanaged and you would like to expand its product lines and to sell them abroad. The purchase of 60 percent of shares will give you control over implementing your expansion project. The base value for this company is estimated at $100 million. The expansion project will cost about
$10 million and has an 80 percent chance of succeeding. If the project succeeds, you believe it will generate a business worth $20 million in present value terms. If it fails, the present value will be zero. Can control in this case be seen as an option? If so, what kind of option is it and what is the value of this option? How much of a premium, in percentage terms, are you willing to pay in this case?
7. Suppose you are the CEO of a firm, and a public company wants to purchase your company. There are several major shareholders that cumulatively hold 60 percent of your firms share. The other 40 percent are oceanic voters. The base value for your firmthe DCF value excluding any value for illiquidity or controlis $100 million. Assume that the public company is willing to pay a 30 percent premium for control. Assume your opponent uses the base price as his bid price and that there are a total of one hundred shares. How much will the individual share price be for bloc shareholders and for oceanic shareholders?
8. You are an M&A adviser, facing an interesting deal. One of your clients is preparing to purchase an oil refining company, which does not have any longterm debt on its balance sheet. The company is worth $100 million today on a stand-alone basis. The deal proposed by both parties is structured so that the buyer will purchase 60 percent of the sellers shares today and is restricted from selling its holdings in the next five years. After your client gains majority control, he plans to hire outside consultants to initiate a cost-cutting program to make the company more profitable. If the program succeeds, you believe it will generate
total savings of $20 million in one year. If it fails, the PV will be zero. The cost of the program is around $5 million and the chance of success is estimated at 70 percent. The historical volatility for the assets of this firm is about 20 percent. What kinds of options are embedded in this deal? Assuming the risk-free rate is at 8 percent annually, how much are the options worth in value? What is your recommended purchase price for this deal?
1. What is purchase accounting?
2. Define goodwill in the context of purchase accounting. Can goodwill be amortized? How does FAS 142 require that goodwill be treated?
3. What criteria determine whether an asset should be classified as intangible, rather than as part of goodwill? Explain each.
4. Should acquired intangible assets be amortized?
5. Describe the consolidation method of accounting for acquisitions. For what percentage of share ownership acquired is this method suggested, and why? How are balance sheet and income statement items of the target reflected? How are balance sheet and income statement items for minority investors reflected?
6. Describe the equity method of accounting for acquisitions. When is this method used? How are the targets balance sheet and income statement items reflected?
7. How is a receipt of dividends from the target recorded under the equity method?
8. Describe the cost method of accounting for acquisitions. When is this method used? What are the three methods of recording acquisitions that fall under the cost method? Explain each.
9.
How do the consolidation method and the equity method of accounting differ in their treatment of cash flows of the target?
True or False: If false, provide the correct answer.
1. In purchase accounting, the buyer records assets acquired at their historical cost rather than at their acquisition price.
2. Purchase accounting requires that the purchase price be allocated among the various asset accounts to the FMV of each.
3. In purchase accounting, liabilities are not recorded at fair market value.
4. In purchase accounting, the buyers past financial results can be retroactively restated.
5. The consolidation method is used when material voting power but not majority control is acquired.
6. Under the consolidation method, balance sheet items attributable to minority investors are carried on the acquirers books.
7. Under the consolidation method, balance sheet items attributable to minority investors are carried at fair market value.
8. Under the equity method, the buyer recognizes its investment in a target through a balance sheet account, Investment in Target Company.
9. Under the equity method, the targets profits and losses are not reflected on the buyers income statement.
10. The equity method recognizes dividends received from the target as an addition to the Investment in Target Company account.
11. The cost method is typically used when the buyer acquires less than a 20 percent share in the target.
1. In the chapter, four cases are discussed to illustrate the concept of momentum acquisition strategies. What are the common features of this strategy?
2. Among different momentum strategies, EPS momentum and revenue momentum are the most common approaches. Briefly describe both strategies.
3. In the chapter, Scott Sterling Johnson, a momentum investor, said, I want to be in the sweet spot of the S curve, which is the point of maximum rate-of-change, acceleration, momentum . . . . There are six things I specifically look for . . . dramatically accelerating earnings . . . strong balance sheet . . . strong relative price strength . . . industries that are doing well . . . low institutional ownership . . . dynamic trends . . . . What is the key bet of an investing strategy such as this?
4. Momentum advocates believe that firms with momentum enjoy higher earnings (or revenue) multiples than firms without. Please critique this belief.
5. Why is momentum acquiring unsustainable indefinitely? How might analysts incorporate this unsustainability in their valuations?
6. Assume that buyer and target agree to a stock-for-stock acquisition. The buyer has 2 million shares outstanding and $2 million in earnings. Its current P/E ratio is 20. The target has 1 million shares outstanding and $500,000 in earnings. The targets current P/E ratio is 16. Suppose the buyer is willing to offer a 20 percent premium for the target and a purchase-related transaction charge of $50,000 is expected. Calculate the earnings per share for Newco after the merger and the percentage change in the buyers EPS.
7. Refer to problem 6. By changing the bid price for the target, the buyer can avoid dilution. Calculate the percentage dilution or accretion for purchase premiums of 0, 10, 20, 30 and 40 percent, and for target earnings of $250,000, $500,000, $750,000, $1,000,000, and $1,250,000, assuming the target still has same P/E ratio. Explain the results.
8. Assume you as the CEO of a publicly listed company are considering a purchase in a related industry. There are two opportunities available. Company A is more technologically advanced, which implies a high growth potential. But it also demands a higher premium than company B, which has lower growth opportunities. Both companies have 2 million shares outstanding, and projected earnings for this year for both companies are the same at $2 million. Company As stock trades at $20 and company Bs stock trades at $15. After a careful study of their businesses, you estimate that earnings of company A will grow at a rate of 12 percent and those of company B will grow at 3 percent. You estimate your own
firms earnings will grow at 8 percent. Assume that the earnings of Newco after the merger will be just the simple arithmetic addition of the forecasted earnings of your firm and the target. There are 3 million shares outstanding for your firm; projected earnings for this year are $3 million. Your firms stock trades at $25. If company A asks for a 60 percent premium over its market price and company B only asks for a 20 percent premium, which company would you acquire? Use quantitative evidence to back up your decision.
9. Why is value creation a superior approach compared to momentum acquisition strategies? As a manager, what are the implications of each approach for you?
1. Why is a deal a system?
2. What are some of the classic objectives of deal design in M&A?
3. What are some of the terms that are usually negotiated in an M&A deal?
4. What are some issues to be considered when deciding on a form of payment? What are the general forms of payment? And what are some circumstances under which each might be used?
5. Why might fixed payments have an adverse signaling effect?
6. How might deal terms be designed to deter either party from backing out of an M&A deal?
7. What is an earnout? In what deal situations might it especially be useful?
8. Describe how price might be influenced by the form of payment.
9. How can a deal be tailored to hedge against security price risk in a share-for-share exchange?
10. What impact might the form of payment have on the timing of a deal?
11. Is there a single best feasible deal? Explain.
1.
What three possible kinds of tax benefits are M&A transactions usually associated with?
2.
Which main issues must a deal designer consider when deciding on the form of acquisitive reorganization? Explain.
3.
From a tax standpoint, which alternative is more desirable to the seller, the sale of a companys assets or the sale of its stock? Explain.
4.
Explain how a buyer might realize a tax benefit from purchasing an asset for cash.
5.
In a purchase of assets for cash, how might a conflict of interest due to tax consequences arise between buyer and seller?
6.
What happens in a triangular cash merger?
7.
What is a reverse triangular cash merger? How does the IRS view this transaction?
8.
What is a forward triangular cash merger? How does the IRS view this transaction?
9.
What advantage does a cash merger have over a cash purchase of stock?
10.
Describe what happens in a statutory merger and in a statutory consolidation.
11.
What condition does the IRS require in order for statutory mergers and consolidations to be tax-free?
12.
What happens in a forward triangular merger under a type A reorganization? What is needed in order for this kind of transaction to qualify as tax-free?
13.
What happens in a reverse triangular merger under a type A reorganization? What requirements must be met for this kind of transaction to qualify as tax-free?
14.
What happens in a voting stock-for-stock acquisition (type B reorganization)? How can this transaction qualify as tax-free?
15.
What happens in a voting stock-for-assets acquisition (type C reorganization)? How can this transaction qualify as tax-free?
16.
A CEO wants to acquire a target but faces dissident shareholders in his own company. In addition, he must seek shareholder authorization if he pays for the target with stock. Which among the reorganization structures saves the CEO from a confrontation with dissidents?
1. For each of the following, identify whether stock or cash tends to be the prevalent
form of payment. Explain why.
a. Buoyant period in the stock market cycle. b. Hostile takeover. c. Jumbo deal. d. Ownership is concentrated.
2. A study on shareholder returns found that over the five years following the deal,
share-for-share transactions yielded average excess returns of +14.5 percent, while cash deals yielded +90.1 percent. What might explain this?
3. Why do the following seem to affect the choice of form of payment:
minimization of costs, agency costs, and information asymmetry?
4. Research indicates that for buyer shareholders, payment in cash is associated with
close to zero returns, while payment in stock is associated with significantly negative returns. What might explain this phenomenon?
5. What are the tax implications of a cash deal for the target? What about a stock
deal?
6. Do abnormal returns to target shareholders tend to be larger in stock or in cash deals? Why?
7. How is it that some forms of payment might consume financial slack, and others
might create it?
8. Are there any signaling implications when the target insists on a cash payment?
9. Explain how issuing equity to fund an acquisition might send negative signals to
the markets.
10. Do stock prices of bidders react positively or negatively upon the announcement
of a cash deal? What about a stock deal? Explain.
11. Explain the difference in price, form of payment, and financing between a
preemptive and a contingent strategy. How does the choice of strategy affect the form of payment and financing chosen?
12. The chapter discussed seven dimensions of M&A transaction financing: mix,
maturity, yield basis, currency, exotic terms, control features, and distribution. Explain how each plays into a decision makers choice of financing.
13. What is a risk-neutral maturity structure? Reinvestment risk? Refinancing risk?
14. What are the Six Cs of Credit?
15. What is the FRICTO framework?
1. What is the exchange ratio?
2. Which party does not want to go above a certain maximum exchange ratio? Which party does not want to go below a certain minimum exchange ratio?
3. Why does the value of Newco matter in exchange ratio determination? Put another way, why does the exchange ratio not depend only on the current ratio of the buyers value to the targets value?
4. True or false: In every deal, it is possible to arrive at a sweet spot. Explain.
5. What three factors tend to determine how the middle ground is carved up in cases where there is a large zone of potential agreement between buyer and seller? Explain.
Use the spreadsheet file Deal Boundaries.xls in answering the questions below.
6. An electric utility company is in a stock-for-stock negotiation with an acquirer. The buyers and targets share prices are currently trading at $35 and $20, respectively. The buyer is projected to earn $200 million, and the target, $150
million. Synergies of $10 million are expected from the deal. Each party has 80 million shares outstanding. Both buyer and target expect Newco to trade at a price/earnings ratio of 11 times. What is the range of feasible exchange ratios for this deal?
7. Refer to the problem above. How high must Newcos price/earnings ratio be for a deal to be possible? What does your answer tell you in general about price/earnings expectations of parties that enter into M&A transactions?
8. Referring to the same problem, suppose that buyer and target both estimate Newcos DCF value to be $5 billion. What would be the range of feasible exchange ratios for the deal?
9. Now run a sensitivity analysis using projected DCF values from $3 billion to $7 billion. What are the resulting maximum and minimum exchange ratios? Graph your solution and interpret the results.
10. Now suppose the parties agree to a cash-for-stock transaction instead. Assuming again that the expected P/E ratio for Newco is 11 times, is there a feasible deal? Why or why not?
11. Run a sensitivity analysis using a range of P/E ratios from 11 to 17 times. What should the expected minimum P/E ratio be in order for a deal to be feasible? Graph your solution and interpret the results.
12. Assume again that the expected DCF value for Newco is $5 billion. What would be the range of feasible cash payments?
13. Now run a sensitivity analysis using projected DCF values from $3 billion to $7 billion. Graph your solution and interpret the results.
1. If earnouts are useful, why are they not pervasive in big public deals?
2. Earnouts are options, but there are also some differences between earnouts and options. Describe the differences and explain their implications for value of earnouts.
3. You are the CEO of a local beverage firm that is negotiating a deal with a large national food company. The deal is structured as follows: The acquirer will pay $20 million in cash now. However, if the revenues of your firm reach $200 million after three years, the acquirer will pay another $20 million. In addition, the management team will be awarded a 10 percent bonus on any extra revenues exceeding $200 million. Checking your firms financial statement over the past several years, you estimate that its revenues have a volatility of 18 percent. You expect $180 million in revenues this year. Assuming a risk-free rate of 6 percent, what is the probability that your firms shareholders will get a $20 million payment three years later? How much is the bonus plan to the management team worth? Try using the binomial option-pricing model to value this bonus plan.
4. Refer to problem 3. After consulting with an outside marketing firm, your estimation of the volatility of revenues for the next three years increases from 18 percent to 30 percent.
a. How much is the bonus plan to the management team worth now? b. Moreover, if the three-year time period is reduced to two years, are you better off in terms of the chances of getting the bonus as well as the value of the bonus plan?
5. Refer to problem 3 again. After careful consideration, the buyer changes the bonus plan. The management team will still get 10 percent of any revenues exceeding $200 million, but there will be a $5 million cap on the amount of the bonus. This means that the management team will only get $5 million even if the revenues exceed $250 million. Keeping other parameters the same, how much is the bonus plan worth now?
6. Refer to problem 5.
a. Using volatilities of 12, 15, 18, 21, 24, and 27 percent for the revenues, recalculate the value of the bonus plan. b. Then, changing the agreement from three years to two years, recalculate the value of the bonus plan for the above range of volatilities. Plot the values and time periods in one table and explain the results.
7. A buyer approached you and expressed his interest to buy your firm for $10 million. Your estimation of the value of your firm is $12 million. To bridge the gap between you and the buyer, both of you agree on an earnout plan with the following terms: You will get $5 million now; the earnout, which is based on the EBITDA of your firm, will last for three years. An earnout trigger will start at $2 million and increase by that amount each year. Currently, the sales of your firm are $55 million. Based on your knowledge, sales growth is most likely to be 12 percent with a minimum at 6 percent and a maximum at 15 percent. Your best guess for the EBITDA to sales ratio is 10 percent with a minimum of 5 percent and a maximum of 15 percent. The three-year risk-free rate is at 6 percent. Given the above information, is this deal economically attractive to you?
8. Refer to problem 7. The buyer estimates that sales growth will follow a normal distribution with a mean of 10 percent and a standard deviation of 5 percent. He expects the EBITDA to sales ratio to likewise follow a normal distribution with a mean of 8 percent and a standard deviation of 3 percent. From his perspective, is this deal attractive?
9. As a prominent media company, FreeSpeech is considering an expansion into an online media niche. During negotiations with a start-up Internet service company, JumpOnline, the two sides had a heated debate on the assumptions about future revenue growth and profit margins, which led to different valuation of the firm
based on the DCF model. FreeSpeech thinks the start-up company is worth $30 million, while the investment banker for JumpOnline thinks that it is worth at least $50 million based on the rapid growth of Internet-related businesses over the past several years. To resolve the disagreement, the two sides agree to a payment schedule as follows:
a. FreeSpeech will pay $15 million in cash to acquire JumpOnline now. b. After the acquisition, FreeSpeech will pay JumpOnlines shareholders cash equal to 20 percent of JumpOnlines gross annual revenues, minus a deductible amount which is $10 million now but will increase at a compound annual rate of 50 percent for the next five years. c. In addition, FreeSpeech will pay JumpOnlines shareholders cash equal to 50 percent of JumpOnlines gross profits, minus a deductible amount of $1 million now but which would increase at a compound rate of 50 percent annually for the next five years.
Currently, the sales of JumpOnline are $10 million. Sales growth is most likely to be at 40 percent with a minimum of 30 percent and a maximum of 55 percent. The profit margin will improve gradually over the next five years. Currently the profit margin is 10 percent, but FreeSpeechs estimation of profit margin of the next five years follows a normal distribution with means of 12, 15, 20, 25, and 30 percent respectively and with standard deviations of 20 percent of these numbers respectively. Assuming a risk-free rate of 8 percent, what is the value of
JumpOnline from FreeSpeechs perspective? Please use the Excel sheet on the CD-ROM and run the Crystal Ball model.
10. Refer to problem 9. Suppose you are the financial adviser for JumpOnline. Based on your knowledge, sales growth is most likely to be 60 percent with the minimum at 45 percent and the maximum at 70 percent. The profit margin will improve gradually in the next five years. Currently the profit margin is 10 percent. Your estimations for profit margins during the next five years follow normal distributions with means of 15, 20, 25, 30, and 35 percent respectively and with standard deviations of 15 percent of means. Please use the Excel sheet on the CDROM and run the Crystal Ball model. Compare the result with problem 9 and explain.
1. How can one price risk management features in M&A?
2. What is the true value of a bid?
3. M&A is a risky activity. What costs are associated with deal failure? What value is at risk when a deal fails?
4. What are the four classic profiles of payments in M&A? What are the differences between a floating collar and fixed collar?
5. Suppose the fixed exchange ratio in a deal is 1.2:1, and that at the time of agreement, the buyers share price is $25. The buyer and seller agree to a floating collar, which has a low trigger of $15 and a high trigger of $35. Thus, the exchange ratio is 1.2 to 1, unless (1) the buyers stock price falls below $15, in which case the exchange ratio will be equal to $18 divided by the buyers share price; or (2) the buyers share price is greater than $35, in which case the exchange ratio will equal $42 divided by the buyers share price. Calculate and graph the number of shares issued for one share of the sellers stock, assuming the following share prices for the buyer: $0.01, $5, $10, $15, $20, $25, $30, $35, $40, $45, and $50. Also calculate and graph the value of the bid with the collar at these prices. (Please use the spreadsheet model Collars Analysis.xls.)
6. Suppose a seller agrees to receive a payment in a buyers stock worth $30 per target share. Buyer and seller agree to a collar, which has a low trigger of $15 and a high trigger of $40. Thus, the cash payment will be $30 for each share of the sellers stock, unless the buyers stock price falls below $15, in which case the exchange ratio would be equal to 2 shares of stock; or unless the buyers share price is greater than $40, in which case the exchange ratio will equal 0.75 shares of stock. Calculate and graph the number of shares issued for each share of the sellers stock, assuming the following share prices for the buyer: $0.01, $5, $10, $15, $30, $40, $50, and $60. Also calculate and graph the value of the bid with the collar at these prices. (Please use the spreadsheet program Collars Analysis.xls.)
7. Assume you are the CEO of a publicly listed company and have just agreed to acquire a target. You agree on an exchange ratio of two shares of your firms stock for one share of the targets stock, based on todays market prices of both companies: $25 for your firm and $40 for the target. The deal needs to be approved by a government regulatory agency, a process that will take one year. To reduce the risk for the target arising from possible fluctuations in your stock price, you agree to a collar. The collar would give the targets shareholders cash equal to the difference between $22 and your firms share price one year later, with a maximum cash payment of $5 for each share of buyers stock. The annualized volatility for the risk-free rate is 15 percent. Given a risk-free rate of 5 percent
and 22 percent volatility for your stock, how much is this offer truly worth to the targets shareholders in terms of share price? (For simplicity, start by using the Black-Scholes option pricing model found in Option Valuation.xls to get an approximate figure, then see what the simulation analysis reports in Collars Analysis.xls.)
8. Refer to question 7. Suppose the approval period is not certain. Your best guess is that the approval process will take one year, with a minimum time of half a year and a maximum time of two years. The annualized volatility for the risk-free rate is 15 percent. Use the Monte Carlo simulation method to calculate the probability of a cash payment and the expected value of one share of the targets stock in the deal.
9. Assume you are negotiating a deal with company ABC. Your current bid price is $56 per share but ABC asks for $60 per share. To resolve the difference, company ABC proposes that besides the $56 cash payment, there will be a contingent value right that will give ABCs shareholders the right to some cash payment at the end of three years if Newcos stocks do not perform well during this period. Assume one share of Newco is worth $40 today. The contingent value right will permit a holder of Newco to receive a cash payment equal to the difference between $50 and the stock price of Newco after three years, if Newcos stock trades below $50. The cash payment will be capped at $15. The annualized volatility for the riskfree rate is 20 percent. Given a risk-free rate of 6 percent and estimated volatility
of 18 percent for Newcos stock, what does the deal cost the buyer in terms of each share of ABCs stock? (Again as an experiment, use the Black-Scholes option pricing model to estimate the value of the collar. Then estimate the answer using the simulation model in Collars Analysis.xls.)
10. Refer to question 9. Assume you would like to renegotiate with ABC the time period for this contingent value right. Your best guess is that the final agreement will be 2.5 years with a minimum of 2 years and maximum of 3 years. The volatility of interest rates is 20 percent. Use the Monte Carlo simulation method to calculate the expected value of this right and the probability that you will have to make another cash payment in the future.
True or False
1. Social issues usually relate only to a narrow group of people, which includes senior management, boards of directors, and influential middle managers. 2. Highly visible executives, such as CEOs, turn over more quickly than less visible ones, such as division heads and managers. 3. While important, social issues do not directly affect the probability of successfully reaching agreement on an M&A transaction. 4. The merger of equals (MOE) structure is designed to combine partners of roughly equal influence. Industry specialists, however, often claim that the structure of MOEs yields a clear dominance of the buyer over the target firm. 5. The MOE structure is believed to increase the resistance of target managers to a merger, and thus decreases the probability of successfully consummating a deal. 6. Research studies reveal that there is no significant difference in top management turnover between friendly and unfriendly deals. 7. Corporate name changes often involve serious consideration and debate because the management team of the new company will want to create a strong brand identity; luckily, the actual economic costs are negligible.
8. Social issues often stimulate deal-related transactions such as side payments and complex trade-offs. 9. There is a strong positive correlation between the size of firms and the compensation they pay to senior executives (such as CEOs): the larger the firm, the greater the executive compensation. 10. Social issues do not surface in early discussions of M&A; rather, executives wait until after they have discussed the economics of a deal to see if it is even worth considering.
Short Answer
1. What are retention payments? In what form are they paid? What determines the size and period of time in which they are paid? 2. What are golden parachute payments and when are they paid? Who determines and pays for them? What key function do they hold?
3. If target shareholders bear the cost of the MOE structure, how can one calculate an approximation of this cost?
4. What is the benefit of determining CEO leadership succession early in the merger agreement? Are there any drawbacks?
5. In a merger transaction, what are three key considerations for determining the new companys workforce (i.e., who stays and who leaves)?
6. In a merger transaction, the buyer or targets corporate name can be retained or a blended name can be created. What message does each option convey about the ongoing firm?
7. Explain why Daimler and Chrysler decided that a new public parent company should be organized under the laws of the Federal Republic of Germany.
8. In the Hewlett-Packard (HP) and Compaq merger contest, how did Walter Hewlett use information about the prospective compensation of Fiorina and Capellas?
9. Consider the vignette of Wachovia Banks acquisition plans in 2001, provided in the chapter. Wachovia agreed to a merger of equals with First Union Corporation for $12.5 billion, but then SunTrust Bank appealed directly to Wachovias shareholders with an unsolicited offer of $13.7 billion. Why did the WachoviaSunTrust negotiations not succeed?
10. Regarding the 1998 Fleet Bank and BankBoston merger:
a. Why was there a retention plan for employees of BankBoston Robertson Stephens? b. What were the terms of the retention plan? c. How and why did they differ from the retention plans created when BankBoston merged with Robertson Stephens in 1996?
1.
Walk through the usual timeline of a deal.
2.
Are parties to a deal obligated to issue a letter of intent (LOI) during merger negotiations? Does the letter of intent represent a binding agreement? Why are LOIs used?
3.
What are some of the first-round documents that may be drafted in a merger? In general, when and why are first-round documents issued?
4.
What factors might parties to a deal consider when deciding whether to issue a letter of intent or other first-round documents?
5.
What, according to the Supreme Court, are the factors a company must consider in deciding whether and when to disclose a transaction?
6. What is a standstill agreement and what risks does it manage?
7.
Give an example of a material adverse change. How might it derail the deal process?
8.
How might a sudden change in share prices derail the deal process? Explain.
1. What is governance? Through what processes do boards of directors exercise governance?
2. What are agency costs? Why do they arise?
3. What is jawboning? How is it different from exit?
4. How does governance reduce agency costs?
5. Does good governance pay? How?
6. Through what mechanisms can investors influence managers and directors?
7. Describe what happens in a typical dual-class recapitalization.
8. Define the duties of loyalty and care.
9. What is the business judgment rule?
10. What is the enhanced business judgment rule? When does the enhanced business
judgment rule get triggered?
11. What two tests must be met for courts to rule that directors have performed their
duties in accordance with the enhanced business judgment rule?
12. What is the Revlon rule? When does it get triggered?
1. What is the aim of securities laws?
2. How does one determine whether a fact is material?
3. What is the significance of the Securities Act of 1933?
4. What is a registration statement? A prospectus? A red herring?
5. When is a registration deemed to be effective?
6. What is the Securities Act of 1934?
7. What is the Williams Amendment to the Securities Exchange Act of 1934? What are the four important rules of the road imposed by the Williams Amendment?
8. Do states have jurisdiction over securities registration? What are blue-sky laws?
9.
What are the two theories of insider trading liability? Explain each.
10.
Can one buy or sell securities during the waiting period of filing a registration statement with the SEC?
1. What is a trust? Why are trusts harmful to consumers?
2. What is a contestable market?
3. What two conditions are necessary for a merger to have an anticompetitive effect?
4.
What is the Sherman Act?
5.
What is the Clayton Act?
6.
What is the Hart-Scott-Rodino Act?
7. Which government agencies enforce antitrust laws? What are their respective functions?
8.
Define horizontal, vertical, and conglomerate mergers. What motivates each type of merger?
9.
What are the two quantitative measures used to determine degree of market concentration in horizontal mergers? Explain conceptually what each aims to measure.
10.
Firm A, a manufacturer of butter, wants to acquire Firm B, a manufacturer of margarine. The Federal Trade Commission wants to determine the economic relationship between butter and margarine. A review of prices over the last 20 years reveals that the demand for margarine rises 3 percent for every 1 percent increase in the price of butter. Calculate the cross elasticity of demand and interpret the results.
11.
Listed below are the top ten book publishers, ranked according to fiscal year 2000 revenue:1
2000 Revenue (in $ MM) 4,281.0 1,402.5 1,027.6 594.8 265.5 243.3 231.7 148.9 73.3 21.4
McGraw Hill Cos. Inc. Scholastic Corp. Houghton Mifflin Co. John Wiley & Sons Inc. Thomas Nelson Inc. Hungry Minds Inc. Marvel Enterprises Inc. Golden Books Family Ent. Information Holdings Inc. Millbrook Press Inc.
Suppose Scholastic Corporation wanted to acquire Marvel Enterprises. Descriptions of both companies are given below. Calculate the HHI indices premerger and postmerger. Do you think the FTC would approve this transaction?
Scholastic Corporation
Selling more than 325 million books annually, Scholastic Corporation is a leading publisher of childrens books. Its success is based on traditional favorites, including the Babysitters Club and Clifford the Big Red Dog series, as well as on newcomers, most notably the wildly popular Harry Potter series. . . . Scholastic also specializes in educational materials, publishing 35 magazines that are read by more than 20 million elementary and high school students in the United States alone.2
Marvel Enterprises, Inc. Marvel Enterprises, Inc. is one of the worlds most prominent characterbased entertainment companies, with a proprietary library of over 4,700 characters. The company operates in the licensing, comic book publishing, and toy businesses in both domestic and international markets. Marvels library of characters includes Spiderman, X-Men, Captain America, Fantastic Four and the Incredible Hulk.3
12. What other guidelines do the regulatory agencies use to determine whether to approve or disapprove a horizontal merger?
1. What is the role of first-round documents in merger negotiations?
2.
What is a confidentiality agreement?
3.
What does an exclusivity agreement do?
4.
What is a standstill agreement? What is its objective?
5.
What information does a term sheet contain? What is the purpose of having a term sheet?
6.
What is a letter of intent? Why do some M&A advisers advise against issuing an LOI?
7. What is a definitive agreement? How is it a risk management device?
8. What is the importance of the Parties to the Deal component of the definitive agreement?
9. What is the Recitals component?
10. Why is the Definition of Terms component important?
11. What information is contained in the Description of the Basic Transaction section? Why is this section important?
12. What are the three ways in which the sellers right to register shares might appear? Provide an explanation for each of the ways. Why is it important to include a provision in the definitive agreement for registering shares?
13.
What is in the Representations and Warranties section? What is the difference between a representation and a warranty? Why is this section important?
14. Are the following statements true or false? Explain.
a. Sellers are less concerned about the condition of the buyer if the buyer pays in stock rather than in cash. b. If a representation or warranty is found to be false after the closing of the deal, the injured party can always sue for damages.
15.
What purpose does the Covenants section serve?
16.
What purpose does the Conditions to Closing section serve?
17.
What is a bring-down?
18.
What does the Termination section contain?
19. What purpose does the Indemnifications section serve?
20.
What is a proxy statement?
21.
What is a merger proxy statement? What information does a merger proxy statement usually contain?
22.
Infant World and Busy Bee have agreed to a merger of equals. Busy Bee has an employee stock ownership plan (ESOP) with options unexercised on 923,000 shares, 2 percent of the companys total outstanding shares. The ESOP has a clause that would allow shares to vest automatically if Busy Bee were acquired or became party to a merger. The merger proxy statement made no mention of the unexercised options on the shares. Should this information have been disclosed in the proxy statement? Explain.
23.
Does having a fairness opinion from a financial adviser mean that a deal is good for shareholders? Explain.
24.
Why do proxy statements disclose the number of shares held by directors and officers?
25.
Why do proxy statements often contain information on financing arrangements for the buyer? Or, alternatively, why are commitment letters (for funding) so important?
26.
Why are the targets articles of incorporation and bylaws often amended in connection with a merger?
27.
Companies often have what is called a rights agreement. What is this and what is its purpose?
28.
What is a keepwell covenant? Why is it important?
29.
What is the purpose of the Conditions to the Offer section of a proxy statement?
1. What is ZOPA? When does it exist?
2. What is BATNA? Why is it important to have one during negotiations? Give an example of a BATNA.
3. What is anchoring? In terms of strategy, is it a good idea to anchor?
4. What is the endowment effect? What is status quo bias? What causes both phenomena? What does the occurrence of these two phenomena suggest about behavior in deal making?
5. What steps must one take to prepare for a negotiation?
6. How might sunk costs negatively affect a party to a negotiation?
7. Why is it advisable to conduct multi-issue, parallel bargaining rather than single-issue, serial bargaining?
8. What does it mean to create, rather than claim, value?
9. What are three ways to address a stalemate during negotiations?
1.
What are the five methods of sale discussed in the chapter? Describe each method and discuss advantages and disadvantages associated with each.
2.
Auctions can be classified as open versus sealed, single versus double, common value versus private value. Briefly describe each.
3.
What is an English auction? A Dutch auction? A first price sealed bid auction? A second price sealed bid auction? What are the advantages and disadvantages of each method?
4.
Which auction method would maximize revenues to the seller?
5.
What are the main advantages of using auctions for asset sales? What are the main disadvantages?
6.
What is the Winners curse?
7.
Why must the effective M&A practitioner master the art of multi-attribute bidding in auctions?
8.
If an asset for sale is unique, is it advisable for the seller to use an auction process? Explain.
1. What is a hostile takeover?
2. True or false: The investment opportunities hypothesis says that takeovers are motivated by the buyers desire to purchase a target at a low valuation, improve its operations and gains in efficiency, and profit from the gains in investment.
3. What is an M&A arbitrageur? How might M&A arbitrageurs determine the outcome of a takeover contest?
4. To what factors are an M&A arbitrageurs returns most sensitive? Explain.
5. What is a leveraged recapitalization? Why might a target resort to it?
6. All things equal, should a bidder make a tender offer with a shorter or longer holding period? Explain.
7. What should a bidder consider in determining its highest or walk-away bid and its lowest bid?
8. What is a minority shareholder freeze-out?
9. What is EVNT? How is it calculated?
10. In economic terms, what needs to happen for target shareholders to tender their shares?
11. What are stub shares?
12. What is a bear hug? What is the advantage of using this strategy?
13. When would a low-bid strategy be appropriate?
14. Scott Siegel, manager of an M&A hedge fund, watched the tape go across his Bloomberg screen at 4:00 p.m. on June 13, 2001. Celera Genomics, a Rockville company known for mapping the human genome, announced it would acquire AXYS Pharmaceuticals Inc., an integrated small molecule drug discovery and development company. The deal was structured as a stock swap in which AXYS shareholders would receive 0.1016 Celera share for each AXYS share. Celera had
closed the previous day at $41.75, and AXYS at $3.45. What would Siegel do as an M&A arbitrageur? Explain.
15. Assume that the acquisition was completed in 5 months (150 days). Assume further that Siegel purchased 300,000 shares of AXYS at an average cost of $4.15, and shorted 29,800 shares of Celera. Siegel funded 70 percent of his purchase with debt. Celeras share price on the closing date was $27.43. Assuming a borrowing cost of 8 percent, calculate the return on Siegels investment for the holding period and on an annualized basis.
16. Healthy Land, Inc. (HLI), a waste management services company, wants to acquire Spitzers Environmental Services (SES). HLI has determined that its purchase price should not exceed $44 per Spitzer share. The shares currently trade at $28.50 apiece. Members of the Spitzer family (which owns 40 percent of the company) occupy all board seats and are determined to keep the company within their control. Their consultants have drawn up a restructuring plan that, by their estimates, could raise the value of Spitzer to $42 a share. An aggressive raider named Mathias Martin is reportedly going to join the bidding contest. HLI thinks Mathias will place a bid of $35.00. HLI estimates a 50 percent chance that the Spitzer family will win the bid, a 30 percent chance that Martin will win, and a 20 percent chance that neither scenario will materialize. Should HLI put in a bid? If so, how much should HLI bid? Draw a decision diagram facing the investor.
True or False
1. Whether defensive tactics create or destroy value for target shareholders depends on both corporate governance and uncertainty.
2. Research evidence shows that targets of hostile bids have higher debt and inside ownership and lower liquidity and debt capacity.
3. Defense tactics are particularly discouraging to arbitrageurs.
4. The Saturday Night special is a surprising offer to the target board that is left open for only a brief period of time.
5. A godfather offer is a cash offer that is accompanied with an implied threat, which makes directors feel pressured to accept.
6. Golden parachutes grant target managers generous payments if they decide to stay at the combined firm following an acquisition.
7. A board of directors has the power to rescind a poison pill.
8. The poison pill is a nondetachable shareholder right to obtain shares at nominal cost upon the occurrence of a triggering event.
9. Governments can give external presentation to targets through the implementation of discriminatory laws and regulations.
Short Answer
1.
If most public corporations have not been subject to a hostile takeover contest, why are takeover defenses so prevalent?
2. What is a street sweep? What is a drop and sweep?
3. What do toehold purchases attempt to do? 4. What is the Williams Act and why is it important? 5. What is the key difference between a proxy contest and consent solicitation? 6. What are four things to consider in choosing a form of takeover attack? 7. Where do deal-embedded defenses appear and what are they intended to do? Do they discriminate among specific bidders? 8. What is the fair price provision and does it have much of a presence in the U.S. markets? 9. What is the difference between a white knight and a white squire? 10. A targets litigation can cover a number of possible claims regarding M&A bids and transactions. Please give a few examples.
True or False
1. A crash in the stock market might serve to temporarily remove a takeover threat for a company. 2. A stock undervaluation can make a company susceptible to a hostile takeover attack. 3. A consent solicitation is similar to a proxy fight in that it requires a shareholder meeting, in which shareholder approval must be obtained. 4. The special rights afforded by a poison pill can be amended and rescinded by a board of directors with shareholder approval. 5. Leveraged recapitalizations can be structured as a going-private transaction or as a restructuring in which the target will remain a public company. 6. With the MBO, managers are absolved from having to concern themselves with the reactions of public shareholders. 7. The Revlon standard stems from a 1986 case in which the court ruled that when a company puts itself up for sale, stakeholder interests can be considered only in light of increasing shareholder value. 8. For a leveraged recapitalization, the target company needs to be one that is levered with a high debt-to-total-capital ratio.
9. A leveraged recap can be particularly effective when the initial hostile bid is high. 10. Management must be able to finance the equity portion of a recapitalization.
Short Answer Questions 1. The diverse nature of American Standard was thought to be a deterrent to many potential buyers. Why can business diversity make a company less attractive for acquisition? 2. What does the Delaware Antitakeover Statute stipulate? Why was it designed?
3. Aqua Toys Inc. wanted to acquire Toy Land Company (TLC) and thus made a tender offer to the shareholders of Toy Land at $45, a price that represented a significant premium to TLCs current stock price. The offer was set to expire on January 31.
Aqua Toys then decided to raise its bid to $60 and extend the deadline because only a small fraction of shares had been tendered as of January 30. How might you explain why so few shares were tendered?
4. If there has been no instance in which a companys golden parachute has defeated a hostile bid, why do over 350 firms of the Fortune 500 have golden parachutes in place?
5. Why might a white knight pay for a hostile bidders tender offer expenses?
6. How can a company employ a double attack against a poison pill?
7. What are some benefits and drawbacks of an MBO?
8. How can the substantial increase in corporate leverage resulting from a restructuring increase value for the firm?
9. What are some key differences between an MBO and a leveraged recapitalization?
10. What is the main drawback of leveraged restructurings?
1. Why is it important to prepare carefully for a deal presentation?
2. Reflecting on the classic challenges to preparing an effective presentation, what steps should the presenter take in advance to meet those challenges?
3. What would you say are some characteristics of a good deal presentation? How does good deal presentation facilitate corporate governance?
4. What are the four classic kinds of deal presentations discussed in the chapter? For each type, what should be the deal presenters main objective?
5. When first announcing a deal to the public, is it advisable to say as little as possible? Why or why not?
6. Explain how an investor estimates the new share prices for target and buyer upon the announcement of a deal. In this context, what is the specific objective that the deal presenter hopes to achieve?
7. What kind of decision is a CEO making when he/she evaluates a deal? In this light, how must a deal presentation be framed in order to gain CEO approval?
8. Explain the guiding principles by which board directors make their decisions. In view of these, what should be the focus of a deal presentation to the board?
1. When should planning for postmerger integration begin?
2. From where should postmerger integration strategies originate?
3. How are autonomy, interdependence, and control defined in the chapter, in the context of postmerger integration?
4. What are the four types of integration strategy presented in the chapter? Describe the degree of autonomy, interdependence, and control required by each strategy. In what kinds of situations might each be appropriate?
5. When might none of the four models be advisable but instead might a totally new organizational culture be superior? In what types of deals is it advisable to impose/merge cultures? In what types of deals is it advisable to keep distinct cultures? Explain.
6. What business areas should integration planning cover?
7. Should postmerger integration be done piecewise or in a systemic fashion? Explain.
8. Can integration execution begin before a deal is consummated?
9. What are some crucial elements for success in integration execution?
10. What are some pitfalls to be avoided in postmerger integration?
True or False
1. A strategic capability is difficult to imitate. 2. A companys larger business units are always the least acquisitive; the smaller business units are often the most acquisitive because of their need for growth and expansion. 3. Employing a bottom-up deal pipeline is the best approach for developing M&A business. 4. The first contact between a potential buyer and target should be a cold call from a sales or marketing professional in the division. 5. Lawyers are the only functional experts that become a part of a business development team. 6. Antitrust and other regulatory filings are submitted to the U.S. federal and state governments (and, as required in certain cases, to foreign governments) upon entering the LOI (letter of intent) stage. 7. Merger integration planning becomes rigorous between the signing of the definitive agreement and closing of the deal.
8. The electronic digitization of company information can enhance effective merger process flow. 9. It is beneficial when integration teams get involved early on in the due diligence because they can access information that will help steer the integration planning process.
Short Answer
1. Identify the two sources from which GEPS discovers new acquisition opportunities.
2. What are GEPS four key criteria for screening acquisition opportunities?
3. What are the three buckets of information that GEPS sought from a target firm?
4. Why did GEPS develop and organize Centers of Excellence (COE)?
5. Why does the business development unit of GEPS perform postacquisition audits on all of their deals? What is the main purpose and focus of the post-audit?
For questions 6 to 15, identify the corporate development stage in which the stated GEPS activity takes place: initial planning stage (IS), LOI development stage (LOI), definitive agreement phase (DA), and postmerger integration (PMI).
6. _____GEPS appoints leadership of the postmerger integration plan.
7. _____GE operating unit leader and business development leader review recent GEPS acquisitions and discuss their success.
8. _____ GE and the target firm sign a confidentiality agreement.
9. _____GEPS evaluates the target firm to see if it meets certain quantitative criteria.
10. _____GEPS business development leader, a GE M&A lawyer, and outside counsel begin drafting a standard contract and tailoring it to the particular needs of the transaction.
11. _____The comprehensive due diligence report is near completion.
12. _____Integration plans become rigorous at this stage.
13. _____An Integrity Briefing is scheduled.
14. _____GE senior counsel and lawyers become involved.
15. _____The CEO of GEPS gives his internal support for the deal.
True or False
1. Given the inherent variability in M&A, it may not be worthwhile to formulate an opinion about the future of M&A activity.
2. The increasing automation of analytical techniques will allow deal designers to focus less on number crunching and more on the creative task of shaping good deals.
3. Any potential advantage gained from real option valuation will likely diminish over time.
4. Learning from current events is passive and easy.
5. Research has answered all the important questions in M&A.
Short Answer
1. Why is it imperative to develop ones view about the future of M&A?
2. How will continuous technological change and progress affect M&A practitioners and how they conduct business?
3. Why can the application of real option valuation in the field of M&A be both a curse and a blessing? 4. Why is it a good idea for serious M&A professionals to get professional help? 5. How do you define or characterize an M&A deal leader?
11 Jack W. Plunkett, Plunketts Entertainment & Media Industry Almanac 2002-2003, p. 87. 2 Ibid., p. 411. 3 Ibid., p. 326.

Questions

Enviado por

Dados do documento

Direitos autorais

Formatos disponíveis

Compartilhar este documento

Compartilhar ou incorporar documento

Opções de compartilhamento

Você considera este documento útil?

Este conteúdo é inapropriado?

Direitos autorais:

Formatos disponíveis

Questions

Enviado por

Direitos autorais:

Formatos disponíveis

This file contains questions only, and is provided for those who prefer to self-test without immediate access

1. Best practice in M&A requires that we augment the deterministic focus on

structure with a probabilistic focus on conduct. What does this mean?

In what other areas of M&A might conduct have an influence?

6. Why is process so important in deal development?

unanticipated side effects? Explain.

Why is this important?

2. If ethics is so important in M&A, why hasnt it been given more attention?

5. What is greenmail and why might it be considered unethical?

1. What does it mean to conserve value?

4. What are some positive drivers of M&A profitability?

5. What are some negative drivers of M&A profitability?

Multiple Choice: Please pick the best answer.

1. Wave 1, from 1895 to 1904, was characterized by the following:

Economic and capital market buoyancy Technological innovation Vertical mergers

a. I only b. I & II only c. II & III only d. I, II, & III

a. 19651970 b. 19922000 c. 19811987 d. None of the above

3. In the most recent merger wave, from 1992 to 2000,

a. I only b. I & II only c. II & III only d. I, II & III

4. Merger activity appears to slow when

I. Bond yields rise. II. Bond prices rise.

III. The cost of capital increases.

5. According to Schumpeter, to understand M&A activity we should listen to turbulence

2. Provide examples of industry-specific drivers that spur M&A activity.

3. Why does Schumpeter identify turbulence as the driver of M&A activity?

5. How does free trade encourage cross-border merger activity?

6. What factors must one look at to assess a countrys investment climate?

1. Describe the role of strategy in M&A.

6. Why is business definition so important?

7. What are the three classic successful strategies? Describe each.

8. What are some reasons why firms pursue inorganic growth?

9. How might diversification actually create value?

12. What is Tobins Q?

15. What are some transactions to restructure, redeploy, or sell?

16. What is a carve-out? A spin-off? A split-off? What is tracking stock?

17. What is financial recapitalization? What is a leveraged restructuring? An ESOP restructuring?

1. List some characteristics of a good acquisition search process.

3. Where can one find the sweet spot of acquisition searches?

6. What characteristics increase the value of a network?

8. Is there a role for opportunism in acquisition searches? Why or why not?

True or False: If false, please explain why.

Risk and insurance issues

Market presence and sales issues Operations

1. What does it mean to think like an investor?

8. What factors might bound low-side and high-side bids of buyers?

9. When is it necessary to unlever and relever betas?

1. Critique the following arguments:

A $ 123.47 $ 125.00 June 20 $ 2.64 $ 2.25 $

B $ 38.85 $ 40.00 June 20 $ 0.80 $ 0.65 $

C $ 13.67 $ 12.50 June 20 $ $ 1.40 $ -

1. What is the defining feature of a synergistic transaction?

2003 231 231 1,178,817 33,719

2004 9,567 9,567

2005 15,830 15,830

2006 30,942 30,942

2007 44,875 1,219,335 1,264,210

Assume the following:

2.4% -0.2% 34.96 5.0%

5.50% 7.75% 0.96 1.30 6.00% 8.00%

What would your estimate of this firms cost of equity be?

CASE: GURU TECHNOLOGIES*

Exhibit 1 GURU TECHNOLOGIES INC.

12.42% 17.00% 6.00% 1.45

Debra Brown's Forecast of Cash Flows and Economic Balance Sheets