Merger Model Quiz Basic Questions & Answers 100% Correct!!
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Merger Model
Institution
Merger Model
For which of the following reasons below might an acquirer decide to purchase another company?
a. The acquisition represents a good potential Internal Rate of Return (IRR) and Return on Investment (ROI)
b. To acquire a high-growth company to accelerate the buyer's growth rate
c. To increas...
Merger Model Quiz Basic Questions &
Answers 100% Correct!!
For which of the following reasons below might an acquirer decide to purchase another company?
a. The acquisition represents a good potential Internal Rate of Return (IRR) and Return on Investment
(ROI)
b. To acquire a high-growth company to accelerate the buyer's growth rate
c. To increase the buyer's Earnings Per Share (EPS), which may result in a
higher stock price for the buyer
d. Because of office politics, ego, and the need for management or executives
to "prove" themselves or one-up their rivals in the company - ANSWER Explanation: There are many
reasons why an acquirer may purchase
another company - some good and others bad. They can even be broken down as either financial
reasons or more 'fuzzy' reasons. However, the main idea behind an acquisition of another company
is always to earn a satisfactory ROI or IRR to enhance shareholder value, which is what answer choice
A refers to. Sometimes a mature company may acquire a very young fast growing competitor so as to
accelerate its own slower rate of growth, which is what answer choice B refers to. C refers to the
main variable you're solving for in a merger model - whether or not EPS will go up or down, and how
companies are always motivated to increase their EPS. And while D may sound ridiculous, office
politics, ego, and pride motivate a lot of M&A deals (usually these do not end well).
Which of the following points represent "financial motivation" for buying another company?
a. The buyer has run the numbers and determined that the seller represents a potential 18% IRR over
5-years, which exceeds its own cost of capital
, b. By acquiring the seller, the buyer could own 60% of the market and become the dominant player -
and might be valued at a premium as a result
c. The seller has renowned or "famous" executives and the buyer thinks it business will become more
valuable by "acquiring" these employees
d. The seller is dominant in Europe and the buyer wants to gain a foothold into that market
e. The seller's stock is currently trading at $20.00 per share, but the buyer has valued the seller and
believes it's actually worth $30.00 per share - ANSWER Explanation: All of the answer choices, with
the exception of C, represent financial reasons for a M&A transaction. Every business decision boils
down to an acceptable ROI to shareholders, even business acquisitions, thus making answer choice A
correct. In very mature and predictable industries, a key player may acquire a competitor so as to
consolidate a 'fragmented industry' to gain market share and increase shareholder value; these
'consolidation' plays also constitute financial reasons for M&A. Geography also plays a key financial
reason for M&A; perhaps a foreign competitor wants to gain entrance to USA market and does so via
acquisition of a US company in the same industry. And finally, acquisitions often happen when a
seller is perceived to be undervalued. However, acquisitions based on acquiring key employees or
because of intellectual property are not 'financial' reasons for M&A in the strict sense of the word
but rather fall into the category of 'fuzzy' reasons for M&A deals.
All of the following represent "non-financial reasons" to buy another company
EXCEPT:
a. For Acquirer Co. to up-sell and cross-sell its existing products to Target Co.'s customer base
b. Target Co. is growing exponentially and represents a very real threat to Acquirer Co. within the
next few years if it continues at this pace
c. Target Co. has an experienced management team that is deemed the best in the entire industry
d. Target Co. is undervalued by 30% based on a recent decline in its share price - ANSWER
Explanation: The correct answer choice is D. A, B, and C all represent non-financial reasons to do a
deal, because they are based on speculation and future possibilities rather than concrete numbers. If
choice A involved actual cost savings numbers (i.e. cost synergies), it would be closer to a real
financial reason. Buying a company because its market price is undervalued constitutes a financial
reason for M&A as opposed to a "fuzzy reason" and is the only correct answer choice.
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