Mergers and Acquisitions Questions and Answers

Answer: A

Correct answer: $200

A pays 100 shares x $20 = $2,000 for a firm worth 100 x $16 = $1,600, so the cost is $400. The NPV to A is the gain less that cost: 600 - 400 = $200. A’s shareholders keep a third of what the merger creates and B’s shareholders take two thirds, which is what the $4 per share premium buys them.

Answer: B

Correct answer: II only

Disney produced content and ABC distributed it, so the acquisition joined successive stages of the same supply chain - a vertical merger, and specifically forward integration into distribution. It was not horizontal, since the two did different things, and not conglomerate, since the businesses were closely related. Both companies were American, so it was not cross-border.

Answer: B

Correct answer: $20 million

A’s shareholders gain the difference:

NPV = 30 - 10 = $20 million.

Two thirds of the value created accrues to the acquirer here, against three quarters in the earlier example - the difference lying entirely in the premium paid, since the synergy in each case was fixed by the businesses rather than by the bargaining.

Answer: C

Correct answer: Purchase

Goodwill arises only under purchase accounting, where the acquirer records the target’s assets at fair value and books the excess of the price over that value as goodwill. Under the pooling method the two balance sheets were simply added at book value and no goodwill appeared - which is largely why pooling was abolished, since it concealed what had been paid.

Answer: A

Correct answer: I only

Statement I is the correct distinction: in a tax-free acquisition the shareholders exchange shares and defer any gain until they eventually sell, while in a taxable one they are treated as having sold and are taxed on the gain then. The other two statements invert the treatment or invent a requirement about staying with the merged entity that has nothing to do with the tax position.

Answer: D

Correct answer: I, II, III, IV, V, and VI

All six are recognised sources of genuine gain. Economies of scale spread fixed costs; vertical integration secures supply or distribution; complementary resources let each firm use what the other has; surplus funds find a use better than a poor internal project; eliminating inefficiency releases value a weak management was destroying; and industry consolidation removes excess capacity from a shrinking sector.

Answer: D

Correct answer: $4,000

With a share exchange the cost depends on what fraction of the merged firm B’s shareholders receive. They get 500 of the 2,500 shares, that is 20 per cent, and the merged firm is now worth 50,000 + 20,000 = $70,000. So they receive 0.20 x 70,000 = $14,000 for a firm worth $10,000, and the cost is $4,000. The point of the calculation is that in a share deal the cost rises with the gain, because the seller shares in it.

Answer: C

Correct answer: III only

Diversification is the dubious motive here, because shareholders can diversify their own portfolios far more cheaply than a company can by acquisition - so the merger creates no value they could not obtain themselves. The other three are genuine sources of value: economies of scale, resources that complement each other, and the removal of inefficiency from a badly run target.

Answer: A

Correct answer: 12.75

The merged firm earns 600 + 200 = $800 on 100 shares, so earnings per share are $8, and the price is $102. The ratio is 102/8 = 12.75. Note that it has fallen from A’s pre-merger 16.7, because A has bought a firm on a much lower multiple - the arithmetic that lies behind the bootstrap effect.

Answer: C

Correct answer: $5 million

The cost of a merger is the premium paid over what the target was worth standing alone: 75 - 70 = $5 million. It is what B’s shareholders capture out of the $20 million created. Note that the cost is not the purchase price - paying $70 million for a firm worth $70 million would have a cost of nothing.