Answers - Reading 18 Corporate Restructuring

Question #1 of 13 Question ID: 1481911 Which of the following is least likely an advantage of comparable company analysis? A) The approach does not assume that the market’s valuation of the comparable companies is fair. B) Data for comparable companies is easy to access. C) Estimates of value are derived directly from the market rather than assumptions and estimates about the future. Explanation One disadvantage of comparable company analysis is that it implicitly assumes that the market's valuation of the comparable companies is fair. (Module 18.2, LOS 18.c) Question #2 of 13 Question ID: 1481906 Which corporate transaction is most likely in response to compliance with regulatory requirements? A) Investment. B) Restructuring. C) Divestment. Explanation Motivations for divestment actions include liquidity needs, fetching an attractive price, and compliance with regulatory requirements. (Module 18.1, LOS 18.a) Question #3 of 13 Which of the following statements about materiality is least accurate? Question ID: 1481909 A) The divestment of an unrelated business for a company that had previously been diversifying into such businesses is immaterial. B) Materiality is evaluated based on transaction size and fit. C) Cost restructuring may be evaluated as estimated savings as a percentage of sales. Explanation The divestment of an unrelated business for a company that had previously been diversifying into such businesses is material because it may be an indication of a change in strategy, or that the strategy is not working. (Module 18.1, LOS 18.b) Question #4 of 13 Question ID: 1481910 The first step in evaluation of an announced corporate transaction is: A) the gathering of data. B) initial evaluation. C) preliminary valuation. Explanation The first step in evaluation of an announced corporate transaction is initial evaluation. Within this step, analysts seek to answer four questions: what, why, when, and is it material. (Module 18.1, LOS 18.b) Question #5 of 13 Question ID: 1481908 Peter Small, CFA, makes the following statements: Statement 1: In an opportunistic restructuring, a business changes its balance sheet composition, cuts costs, or alters its business model to improve the return on capital. Statement 2: Moderate- to large-sized business units sought by several potential acquirers might be expected to be spun off as opposed to sold. Which statement is correct? A) Statement 2 only. B) Neither statement is correct. C) Statement 1 only. Explanation Statement 2 is incorrect. Moderate- to large-sized business units sought by several potential acquirers might be expected to fetch a high sale price; therefore, they are more likely to be sold than spun off. (Module 18.1, LOS 18.a) Question #6 of 13 Question ID: 1481907 Kavi Biswas, CFA, makes the following statements: Statement 1: Empirical studies suggest that corporate transactions taken during stronger economic times tend to create more value. Statement 2: Corporate transactions tend to be cyclical, increasing in prevalence during economic expansions and decreasing during contractions. Which statement is correct? A) Statement 2 only. B) Statement 1 only. C) Neither statement is correct. Explanation Statement 1 is incorrect. Empirical studies suggest that corporate transactions taken during weaker economic times tend to create more value. (Module 18.1, LOS 18.a) Question #7 of 13 Question ID: 1481913 Petra Zimuth, CFA, is analyzing an announced acquisition. Under the terms, Apollo, Inc., is to be taken over by Bastille, Inc., at a price of $65 per share. Last week, Apollo stock was trading at a price of $48 and increased to $55 in anticipation of the announcement. The offer premium is closest to: A) 35%. B) 44%. C) 18%. Explanation Deal price (DP) = $65. Unaffected price (UP) = $48. Premium = (DP – UP) / UP = 17 / 65 = 35.4%. (Module 18.2, LOS 18.c) Question #8 of 13 Question ID: 1481919 An analyst is writing a report on the impact of an announced divestment by Ziglair, Inc. The transaction calls for sale of Ziglair's foreign subsidiary. She makes the following two statements in the report: Statement 1: One approach is to use a multiple such as EV-to-EBITDA ratio or EVto-sales ratio to value the various segments of a business and then compare the sum of the values to the conglomerate EV to determine the reasonableness of the transaction. Statement 2: Unlike sales, spinoffs do not generate sale proceeds; hence, they are easier to model. Which statement is correct? A) Statement 2 only. B) Statement 1 only. C) Both statements are correct. Explanation Both statements are correct. (Module 18.3, LOS 18.f) Simon Gracier follows Company P. On December 31, 20x2, Company P made an offer to acquire 100% of Company S's outstanding shares for a purchase price of €175 million—€122 million is financed by senior unsecured debentures with a yield of 6.5%, and the remaining is in stock based on the €52 per share current market price of Company P. Pre-acquisition financial statements are presented in Financial Statements (€ thousands) for the Year Ended December 31, 20X2 . Financial Statements (€ thousands) for the Year Ended December 31, 20X2 Balance Sheet Company P Company S Working capital €25,098 €3,692 Fixed assets €1,807,088 €265,800 Total assets €1,832,186 €269,492 Debt €24,460 €9,262 Equity €1,807,726 €260,230 €1,832,186 €269,492 Income Statement Company P Company S Sales €225,886 €33,225 COGS €166,026 €19,603 Gross profit €59,860 €13,622 SG&A €24,845 €3,987 Depreciation €8,442 €2,269 Interest expense €1,223 €741 Income from continuing operations €25,350 €6,625 Gracier is concerned about the impact of the acquisition on Company P's WACC. Peer Comparable Company Analysis for Company S (€ '000s) shows data about Company S's peers. Peer Comparable Company Analysis for Company S (€ '000s) ompany Enterprise Value Revenues EV/Rev Alpha 1,312 298 4.40 Beta 569 115 4.95 Gamma 1,994 391 5.10 Zeta 812 167 4.86 Question #9 - 12 of 13 Question ID: 1481915 Using data in Financial Statements (€ thousands) for the Year Ended December 31, 20X2 , Company P's consolidated-debt-to-EBITDA ratio after acquisition will most likely: A) increase. B) remain the same. C) decrease. Explanation Company P's EBITDA = gross profit – SG&A = 35,015 Company S's EBITDA = 9,635 Consolidated EBITDA = 35,015 + 9,635 = 44,650 Company P's debt (after new issue) = 24,460 + 122,000 = 146,460 Consolidated debt = 146,640 + 9,262 = 155,722 Debt/EBITDA (Company P) = 24,460 / 35,015 = 0.70 Debt/EBITDA (consolidated) = 155,722 / 44,650 = 3.49. (Module 18.2, LOS 18.d) Question #10 - 12 of 13 Question ID: 1481916 Which of the following statements about Company P's WACC is most accurate? A) B) Weights of debt and equity are calculated using most recent book values, and include any financing raised or additional equity issued. Several factors influence the cost of debt: profitability, volatility of EBITDA, leverage, collateral, and so on. C) The cost of debt will depend on the historical cost of debt of Company P only. Explanation Several factors influence cost of debt: profitability (EBITDA to sales, or EBIT to sales), volatility of revenues or EBITDA, leverage (debt to EBITDA), collateral (asset specificity, liquidity, existence of an active market), and prevailing interest rates. Weights of debt and equity are calculated using market values, and include any financing raised or additional equity issued. (Module 18.2, LOS 18.d) Question #11 - 12 of 13 Question ID: 1481917 Which of the following is the best estimate of the value of equity of Company S, using the comparable company analysis? A) €151,153,000. B) €171,876,000. C) €160,415,000. Explanation Average EV/sales = (4.40 + 4.95 + 5.10 + 4.86) / 4 = 4.83 Company S's EV = 4.83 × 33,225,000 = 160,476,750 Company S's equity = EV – debt = 160,476,750 – 9,262,000 = 151,153,000. (Module 18.3, LOS 18.e) Question #12 - 12 of 13 Question ID: 1481918 Assuming that Company P and Company S instead agree to enter into a joint venture, which of the following statements is most accurate? A) Both companies would report the investment using the equity method. B) C) Company P would report the investment using the acquisition method, while Company S would report under the equity method. Company P and Company S would cease to exist, and a new company would instead be formed. Explanation The accounting for a joint venture is similar to that of equity investments. The two partners in the joint venture will report their stake in the venture using the equity method, reporting their share of income from the venture in their respective income statements. Any capital raised by the two partners will be accounted for in their own financial statements. (Module 18.3, LOS 18.e) Question #13 of 13 Question ID: 1481912 Which of the following is least likely a disadvantage of comparable transaction analysis (CTA)? A) Historical transactions may have occurred under different conditions. B) C) Estimates of value are derived directly from recent prices for actual deals completed in the marketplace. The CTA approach implicitly assumes that the M&A market valued past transactions appropriately. Explanation Comparable transaction analysis uses market prices of actual transactions; this is an advantage, not a disadvantage (compared to DCF analysis, which is based on several estimated inputs). (Module 18.2, LOS 18.c)