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All HOMEWORK ANSWER KEY
All HOMEWORK ANSWER KEY
1.5 An arbitrage firm (A) notes that a bidder (B) whose stock is selling at $30 makes an offer for a
target (T) selling at $40 to exchange 1.5 shares of B for 1 share of T. Shares to T rise to $44; B stays at
$30. A sells 1.5 B short for $45 and goes long on T at $44. One month later the deal is completed with B
at $30 and T at $45. What is A’s dollar and percentage annualized gain, assuming a required 50% margin
and 8% cost of funds on both transactions?
(Weston 16-17)
QUESTIONS
C2.8.1 The DOJ’s blocking of the merger rested on the case that it would greatly reduce
competition along the East Coast because the merging parties were often the only two major
airlines in some markets. Should potential competition, for example, arising from Southwest
Airlines, a mover into the East Coast market, factor into the DOJ’s decision?
C2.8.2 US Airways is a failing firm and has a substantial probability of bankruptcy.
Should the antitrust authorities consider a “failing firm” defense from the merging parties?
That is, should mergers be allowed to occur if otherwise the target firm faces bankruptcy?
(Weston 57-58)
Yes, potential competition is relevant and is often factored into DOJ’s decisions regarding
merger approval. Apparently in this case, DOJ held the view that United Airlines and US
Airways would have such a strong lock on the East Coast market that another airline such as
Southwest Airlines would be dissuaded from entering the market.
The antitrust authorities should, and often does, consider a failing firm defense from the merging
parties. In many cases, a merger is the only outcome that will save the target firm from outright
failure. The issue is not that the target firm should not be permitted from failing, rather that if
the merger creates value that otherwise would be destroyed in case of the target being forced to
go it alone, then there is economic value to allowing the merger to proceed. There are numerous
cases of negative shocks to industries whereby many of the firms are negatively impacted such
that mergers are an efficient reallocation of assets. Such appears to be the case in the airline
industry which has been undergoing immense pressure due to high union wage rates and
reduction in air travel demand due to the tragic events of September 2001. Indeed, since the time
that DOJ disqualified the merger of US Airways and United Airlines, both firms have filed for
bankruptcy.
C3.31 :Merger announcement date: January 7, 2000. What was the premium paid by AOL for
TWX?
Price per share paid to TWX = exchange ratio × AOL price per share = 1.5 × $72.88
= $109.32
Premium to TWX shareholders = ($109.32 – $64.75) / $64.75 = $44.57 / $64.75 = 68.8%
= $109.32/$64.75 – 1 = 1.69 – 1 = 68.8%
C3.3.2: The value of AOL on September 10, 2002, was $13.36, and the number of shares
outstanding was 4.45 billion. What was the decline in value of AOL from its immediate
postmerger market capitalization?
Value of AOL on 9/10/02 = share price × number of shares = $13.36 × 4.45 billion
= $59.5 billion
Dollar Decline = $342.6 billion – $59.5 billion = $283.1 billion
Percent Decline = $283.1 billion / $342.6 billion = 82.6%
C3.3.3: Explain the pro forma accounting adjustments (except for the miscellaneous
items) as an example of purchase accounting.
AOL paid $153.1 billion in stock value for TWX. So this is the total adjustment to be accounted
for. The basic entries for purchase accounting are:
Eliminate TWX book equity by a debit of $10 billion. Next, miscellaneous adjustments reflected
in a debit of $30.9 billion were made. The total increase in goodwill is $174 billion. So the sum
of the pro forma debit adjustments equals the market value of AOL stock paid for TWX.
We next consider the credits. The AOL common stock at par issued to pay for the purchase of
TWX is a credit of $0.1 billion (rounded). This is deducted from the amount paid for TWX to
obtain $153.0 billion which becomes the addition to AOL paid in capital.
.
C3.3.4: Calculate the percent of goodwill and other intangibles to total assets for AOL
The total assets of AOL pre-merger were about $11 billion. Total assets of TWX were $50
billion. Their sum is $61 billion. But as a result of purchase accounting total assets became
$235 billion – much greater than the $61 billion. The reason is the great increase in goodwill
plus other intangibles. Tangible assets were $10 billion plus $26 billion to total $36 billion.
C.3.3.5:
Calculate the percent of total liabilities and of shareholders’ equity to total assets for AOL and
for TWX premerger and for the pro forma combined company postmerger. Discuss.
On 3/26/02, AOL announced a $54 billion write down to reflect the impairment of goodwill.
FASB’s Statement of Financial Standards No. 142 on Goodwill and Other Intangible Assets
issued June 2001 states in ¶43 p. 16: “The aggregate amount of goodwill impairment losses shall
be presented as a separate line in the income statement before the subtotal income from
continuing operations (or similar caption) …”
5.2
Porter identifies attractive industries as those with the following characteristics:
a. High entry barriers.
b. Suppliers and/or buyers have weak bargaining power.
c. Few available substitute products/services.
d. Stable rivalry among competitors.
5.3
Cost leadership versus product differentiation.
a. Competitive advantage through cost leadership is based on a wide-ranging checklist which
includes the Boston Consulting Group Experience Curve theory.
b. Competitive advantage through product differentiation relates to formulating a strategy based
on product qualities not easily imitated by other firms.
5.4
a. Possible entry barriers:
1. Lower costs due to greater efficiencies.
2. Lower costs due to economies of scale.
3. Lower costs due to position on learning curve.
4. Advertising advantages.
5. Product differentiation advantages.
6. Large capital requirements for minimum required investment.
b. Significance. If they exist, they would confer market power to the holder; the ability to
restrict output and raise prices without the competition of supply increases by other firms.
As a result, firms within the industry need only concern themselves with a finite group of
rivals and have a greater ability to achieve above normal rates of return. But it is difficult to
separate entry barriers from superior efficiency of incumbent firms.