1. Which of the following statements are correct?
I. Liquidation value of a firm is equal to the present worth of expected future
cash flows from operating activities.
II. When an acquiring firm purchases a target firm’s equity, the acquirer must
assume the target’s liabilities.
III. The market value of a public company reflects the worth of the business to
minority investors.
IV. The fair market value of a business is usually the lower of its liquidation
value and its going-concern value.
A. I and III only
B. II and IV only
C. II and III only
D. I, II, and III only
E. II, III, and IV only
F. None of the above.
2. Ginormous Oil entered into an agreement to purchase
all of the outstanding shares of Slick Company for $60 per share. The number of
outstanding shares at the time of the announcement was 82 million. The book
value of liabilities on the balance sheet of Slick Co. was $1.46 billion. What
was the cost of this acquisition to the shareholders of Ginormous Oil?
A. $1.46 billion
B. $3.46 billion
C. $4.92 billion
D. $6.38 billion
E. $8.38 billion
F. None of the above.
3. Ginormous Oil entered into an agreement to purchase
all of the outstanding shares of Slick Company for $60 per share. The number of
outstanding shares at the time of the announcement was 82 million. The book
value of liabilities on the balance sheet of Slick Co. was $1.46 billion.
Immediately prior to the Ginormous Oil bid, the shares of Slick Co. traded at
$33 per share. What value did Ginormous Oil place on the control of Slick
Co.?
A. $2.21 billion
B. $2.71 billion
C. $4.17 billion
D. $6.38 billion
E. None of the above.
4. Which of the following statements is/are correct?
I. Going-concern value of a firm is equal to the present value of expected net
income.
II. When a buyer values a target firm, the appropriate discount rate is the
buyer’s weighted-average cost of capital.
III. The liquidation value estimate of terminal value usually vastly understates
a healthy company’s terminal value.
IV. The value of a firm’s equity equals the discounted cash flow value of the
firm minus all liabilities.
A. II only
B. III only
C. I and II only
D. II and III only
E. II, III, and IV only
F. None of the above.
5. Which of the following statements are correct?
I. Going-concern value of a firm is equal to the present value of expected
future cash flows to owners and creditors.
II. When an acquiring firm purchases a target firm’s equity, the acquirer need
not assume the target’s liabilities.
III. The market value of a public company reflects the worth of the business to
minority investors.
IV. The fair market value of a business is usually the lower of its liquidation
value and its going-concern value.
A. I and III only
B. II and IV only
C. II and III only
D. I, II, and III only
E. II, III, and IV only
F. None of the above.
6. The following table presents forecasted financial
and other information for Scott’s Miracle-Gro Co.:
What is an appropriate estimate of Scott’s terminal value as of the end of
2014, using the perpetual-growth equation as your estimate?
A. $161 million
B. $363 million
C. $3,690 million
D. $3,838 million
E. $5,357 million
F. None of the above.
7. The following table presents forecasted financial
and other information for Scott’s Miracle-Gro Co.:
What is an appropriate estimate of Scott’s terminal value of equity as of the
end of 2014?
A. $225 million
B. $3,833.0 million
C. $4,207.5 million
D. $4,365.0 million
E. $6,788.1 million
F. None of the above.
8. The following table presents forecasted financial
and other information for Scott’s Miracle-Gro Co.:
What is an appropriate estimate of Scott’s terminal value as of the end of
2014, using a warranted multiple of free cash flow as your estimate?
A. $155 million
B. $2,898.5 million
C. $3,007.0 million
D. $4,365.0 million
E. $7,042.2 million
F. None of the above.
9. Atmosphere, Inc. has offered $860 million cash for
all of the common stock in ACE Corporation. Based on recent market information,
ACE is worth $710 million as an independent operation. For the merger to make
economic sense for Atmosphere, what would the minimum estimated value of the
enhancements from the merger have to be?
A. $0
B. $75 million
C. $150 million
D. $710 million
E. $860 million
F. None of the above.
10. Consider the following premerger information about
a bidding firm (Buyitall Inc.) and a target firm (Tarjay Corp.). Assume that
neither firm has any debt outstanding.
Buyitall has estimated that the present value of any enhancements that Buyitall
expects from acquiring Tarjay is $2,600. What is the NPV of the merger assuming
that Tarjay is willing to be acquired for $28 per share in cash?
A. $400
B. $600
C. $1,800
D. $2,200
E. $2,600
F. None of the above.
Figure 9.1
In March of 2011, Macklemore Corp. considered an acquisition of Blue
Scholar Learning, Inc. (BSL), a privately-held educational software firm. As a
first step in deciding what price to bid for BSL, Macklemore’s CFO, Ryan Lewis,
has prepared a five-year financial projection for the company assuming the
acquisition takes place. Use this projection and BSL’s 2010 actual financial
figures to answer the questions below.
11. What is BSL’s free cash flow (in $ millions) for
2011?
A. – $938
B. – $792
C. – $7
D. $122
E. $1,091
F. None of the above.
12. Estimate the present value of BSL’s free cash flow
(in $ millions) for the years 2011 – 2015. Macklemore’s WACC is 8.0 percent.
BSL’s WACC is 11.5 percent, and the average of the two companies’ WACCs,
weighted by sales, is 8.2 percent.
A. – $1.29
B. $628.24
C. $720.58
D. $726.68
E. $743.94
F. None of the above.
13. Estimate BSL’s value (in $ millions) at the end of
2010 assuming it is worth the book value of its assets at the end of 2015.
Macklemore’s WACC is 8.0 percent. BSL’s WACC is 11.5 percent, and the average
of the two companies’ WACCs, weighted by sales, is 8.2 percent.
A. $628.24
B. $3,669.01
C. $4,297.25
D. $4,412.94
E. $4,984.28
F. $6,951.24
G. None of the above.
14. Assume BSL is worth the book value of its assets
at the end of 2015. Macklemore’s WACC is 8.0 percent. BSL’s WACC is 11.5
percent, and the average of the two companies’ WACCs, weighted by sales, is 8.2
percent. What is the maximum acquisition price (in $ millions) Macklemore
should pay to acquire BSL’s equity?
A. $1,702.25
B. $2,227.25
C. $2,342.94
D. $2,383.94
E. $2,603.25
F. $4,297.25
G. None of the above.
15. Estimate BSL’s value (in $ millions) at the end of
2010 assuming that in the years after 2015 the company’s free cash flow grows 4
percent per year in perpetuity. Macklemore’s WACC is 8.0 percent. BSL’s WACC is
11.5 percent, and the average of the two companies’ WACCs, weighted by sales,
is 8.2 percent.
A. $4,297.25
B. $4,571.09
C. $4,686.78
D. $6,181.09
E. $5,351.19
F. $7,423.16
G. None of the above.
16. Assume that in the years after 2015 the company’s
free cash flow grows 4 percent per year in perpetuity. Macklemore’s WACC is 8.0
percent. BSL’s WACC is 11.5 percent, and the average of the two companies’
WACCs, weighted by sales, is 8.2 percent. What is the maximum acquisition price
(in $ millions) Macklemore should pay to acquire BSL’s equity at the end of
2010?
A. $1,976.09
B. $2,501.09
C. $2,877.09
D. $4,195.09
E. $4,571.09
F. None of the above.
17. Estimate BSL’s value (in $ millions) at the end of
2010 assuming that at year-end 2015 the company’s equity is worth 15 times
earnings after tax and its debt is worth book value. Macklemore’s WACC is 8.0
percent. BSL’s WACC is 11.5 percent, and the average of the two companies’
WACCs, weighted by sales, is 8.2 percent.
A. $628.24
B. $3,669.01
C. $7,429.74
D. $6,343.26
E. $6,755.83
F. $7,008.06
G. None of the above.
18. Assume that at year-end 2015 the company’s equity
is worth 15 times earnings after tax and its debt is worth book value.
Macklemore’s WACC is 8.0 percent. BSL’s WACC is 11.5 percent, and the average
of the two companies’ WACCs, weighted by sales, is 8.2 percent. What is the
maximum acquisition price (in $ millions) Macklemore should pay to acquire
BSL’s equity at the end of 2010?
A. $3,484.68
B. $4,723.26
C. $4,938.06
D. $5,554.68
E. $6,343.26
F. None of the above.
Short Answer Questions
19. The following information is available about
Chiantivino Corp. (CC):
An activist investor is confident that by terminating CC’s money-losing
fortified wine division, she can increase free cash flow by $4 million annually
for the next decade. In addition, she estimates that an immediate, special
dividend of $10 million can be financed by the sale of the division.
a. Assuming these actions do not affect CC’s cost of capital, what is the
maximum price per share the investor would be justified in bidding for control
of CC? What percentage premium does this represent?
b. Show your answer if you conduct a sensitivity analysis by assuming the cost
of capital is 15 percent and the increased cash flow is only $3.5 million per
year.
20. Below is a recent income statement for Gatlin
Camera:
Calculate Gatlin’s free cash flow in this year assuming it spent $510 on new
capital equipment and increased current assets net of noninterest-bearing
current liabilities $340.
The following table presents a four-year forecast for
Kenmore Air, Inc.:
21. Estimate the fair market value of Kenmore Air at
the end of 2012. Assume that after 2016, earnings before interest and tax will
remain constant at $200 million, depreciation will equal capital expenditures
in each year, and working capital will not change. Kenmore Air’s
weighted-average cost of capital is 11 percent and its tax rate is 40
percent.
22. Estimate the fair market value per share of
Kenmore Air’s equity at the end of 2016 if the company has 40 million shares
outstanding and the market value of its interest-bearing liabilities on the
valuation date equals $250 million.
23. Estimate the fair market value of Kenmore Air’s
equity per share at the end of 2012 under the following assumptions:
a. EBIT in year 2016 is $200 million, and then grows at 5 percent per year
forever.
b. To support the perpetual growth in EBIT, capital expenditures in year 2017
exceed depreciation by $30 million, and this difference grows 5 percent per
year forever.
c. Similarly, working capital investments are $15 million in 2017, and this
amount grows 5 percent per year forever.
24. Estimate the fair market value of Kenmore Air’s
equity per share at the end of 2012 under the following assumptions:
a. EBIT in year 2016 will be $200 million.
b. At year-end 2016, Kenmore Air has reached maturity, and analysts expect its
equity will sell for 12 times year 2016 net income.
c. At year-end 2016, Kenmore Air has $250 million of interest-bearing
liabilities outstanding at an average interest rate of 10 percent.
25. Ametek, Inc. is a billion dollar manufacturer of
electronic instruments and motors headquartered in Paoli, Pennsylvania. Use the
following information on Ametek and five other similar companies to value
Ametek, Inc. on December 31, 2010.
*American Power Conversion has no interest-bearing debt
outstanding.
MV = Market value; BV = Book value. Market value is estimated as book value of
interest-bearing debt + market value of equity. Earnings are fiscal year earnings.
26. Rainy City Coffee’s (RCC) free cash flow next year
will be $100 million and it is expected to grow at a 4 percent annual rate
indefinitely. The company’s weighted average cost of capital is 10 percent, the
market value of its liabilities is $1 billion, and it has 20 million shares
outstanding.
a. Estimate the price per share of RCC’s common stock.
b. A hedge fund believes that by selling the company’s private jet and
instituting other cost savings, it can increase RCC’s free cash flow next year
to $110 million and can add a full percentage point to RCC’s growth rate
without affecting its cost of capital. What is the maximum price per share the
hedge fund can justify bidding for control of RCC?
27. Empirical evidence indicates that the returns to
shareholders of the target firm vary significantly from the returns to the
shareholders of the acquiring firm. Identify the shareholders that tend to
realize the smaller return. Does your answer depend on the way the acquisition
is financed?
