Practice exercise “Principles of M&A”

1. Firm A does well in a boom economy. Firm B does well in a bust economy. The
probability of a boom is 50%. The end of period values of the two firms depend on
the economy as shown below:

Economy Probability Value of A Value of B

Boom .5 $1,600 800
Bust .5 800 2,000
Expected Value $1,200 $1,400

Both firms have debt outstanding with a face value of $1,000. In order to diversify,
the two firms have proposed a merger. The NPV of the merger is zero. Determine the
gain or loss under each state of economy for the stockholders of A and B separately
and for the combined firm AB. Should either the stockholders or bondholders be
willing to support the merger (prove and state why)?

2. Chucky Chester Inc. takes over Billy Bob Burgers from Billy himself for $1 million in
cold cash. Billy started the company years ago on an investment of $50,000 in plant
and equipment which has long been paid off. The machinery has no accounting value
today. Consider the takeover price as fair market value for the equipment. Calculate
the tax consequences of the merger, assuming that Chucky Chester decides not to
write-up the machinery. Both Billy and Chucky are in the 28% tax bracket.

3. Shuster merges with Leverne. Shuster agrees to exchange 25 of its shares for every 50
of Leverne's old shares, so that Shuster will have 75 shares available after the merger.
There is no synergy. Calculate the EPS along with other information below for the
combined firm in two cases; one where the market is smart, and another when the
market is fooled.

4. . The Turf-Top Lawn Mower Company has acquired the Quick Clean Power Snow
Shovel Company. Turf-Top has agreed to pay $600 in cash, the money was raised
through a new debt issue. All liabilities will be paid off. The balance sheets of both
companies are at market values which are also the book values before the
combination. Construct the new balance sheet for this purchase. How has the position
of TTLM shareholders changed?

6. The Turf-Top Lawn Mower Company has acquired the Quick Clean Power Snow
Shovel Company. Turf-Top has agreed to pay $400 in stock through a tender offer.
All liabilities will be assumed. The balance sheets of both companies are at market
values which are also the book values before the combination. Construct the new
balance sheet for this tax-free acquisition. How has the position of TTLM
shareholders changed?
7. Bondholders can be made better off in a merger, this is known as the co-insurance
effect. Explain how this can happen using an example.
8. Dexter Department Stores has a market value of $400 million and 20 million shares
outstanding. Walnut Stores has a market value of $134 million and 13.4 million
shares outstanding. Dexter is deciding to acquire Walnut Stores. The top management
of Dexter's have determined that due to the synergies between the firms the
combination will worth $667 million. Dexter expect to pay a $67 million premium for
Walnut Stores. If Dexter were to make an offer of $201 million in stock for Walnut
what would the exchange ratio be?