fi 410 test 3

) If Microsoft merged with the Coca-Cola Company, this would be an example of a ________ merger. A) conglomerate B) vertical C) horizontal D) diagonal

A) conglomerate

When target shareholders exchange their old stock for new stock in the acquiring firm, this is known as a(n): A) exchange swap. B) stock exchange. C) term swap. D) stock swap.

D) stock swap.

Regarding board size, researchers have found that: A) smaller boards are associated with greater firm value and performance, since small groups make better decisions than larger groups. B) smaller boards are associated with lower firm value and performance, since small groups are more likely to be compromised by connections to management. C) larger boards are associated with greater firm value and performance, since larger boards tend to have directors with a more diverse range of backgrounds and talents. D) larger boards are associated with lower firm value and performance, since larger groups are more likely to be compromised by connections to management.

A) smaller boards are associated with greater firm value and performance, since small groups make better decisions than larger groups.

) Which of the following statements regarding vertical integration is FALSE? A) Vertically integrated companies may be large, but unlike other large corporations, since they remain focused in one industry they are easy to run. B) A company might not be happy with how its products are being distributed, so it might decide to take control of its distribution channels. C) A company might conclude that it can enhance its product if it has direct control of the inputs required to make the product. D) The principal benefit of vertical integration is coordination. By putting two companies under central control, management can ensure that both companies work toward a common goal.

Explanation: A) Vertically integrated companies are large, and as large corporations they are more difficult to run.

: Conceptual 52) Which of the following statements is FALSE? A) A board is said to be classified when its monitoring duties have been compromised by connections or perceived loyalties to management. B) Even the most active independent directors spend only one or two days per month on firm business, and many independent directors sit on multiple boards, further dividing their attention. C) On a board composed of insider, gray, and independent directors, the role of the independent director is really that of a watchdog. D) Because independent directors' personal wealth is likely to be less sensitive to performance than that of insider and gray directors, they have less incentive to closely monitor the firm.

Explanation: A) A board is said to be captured when its monitoring duties have been compromised by connections or perceived loyalties to management.

Which of the following statements is FALSE? A) Any acquirer shares received in full or partial exchange for target shares triggers an immediate tax liability for target shareholders. B) In a friendly takeover, the target board of directors supports the merger, negotiates with potential acquirers, and agrees on a price that is ultimately put to a shareholder vote. C) How the acquirer pays for the target affects the taxes of both the target shareholders and the combined firm. D) If the acquirer purchases the target assets directly (rather than the target stock), then it can step up the book value of the target's assets to the purchase price.

Explanation: A) Any cash received in full or partial exchange for shares triggers an immediate tax liability for target shareholders.

) Which of the following statements is FALSE? A) If managers have large ownership stakes, then shareholders are more likely to use compensation policies or a stronger board to create the desired incentives. B) If all else fails, the shareholders' last line of defense against expropriation by self-interested managers is direct action. C) A shareholder resolution could direct the board to take a specific action, such as discontinue investing in a particular line of business or country, or remove a poison pill. D) Any shareholder can submit a resolution that is put to a vote at the annual meeting.

Explanation: A) If managers have small ownership stakes, shareholders may use compensation policies or a stronger board to create the desired incentives.

Which of the following statements regarding risk arbitrage is FALSE? A) Once a tender offer is announced, the uncertainty about whether the takeover will succeed reduces the volatility of the stock price. This uncertainty creates an opportunity for investors to speculate on the outcome of the deal without bearing the risk of volatility. B) Traders known as risk-arbitrageurs, who believe that they can predict the outcome of a deal, take positions based on their beliefs. C) A potential profit arises from the difference between the target's stock price and the implied offer price, and is referred to as the merger-arbitrage spread. D) It is not true arbitrage because there is a risk that the deal will not go through. If the takeover did not ultimately succeed, the risk-arbitrageur would eventually have to unwind his position at whatever market prices prevailed

Explanation: A) Once a tender offer is announced, the uncertainty about whether the takeover will succeed adds volatility to the stock price. This uncertainty creates an opportunity for investors to speculate on the outcome of the deal.

) Which of the following statements is FALSE? A) The Cadbury Commission stiffened the criminal penalties for providing false information to shareholders. B) The Exchange Acts of 1933 and 1934, among other things, established the Securities and Exchange Commission (SEC) and prohibited trading on private information gained as an insider of a firm. C) Many of the problems at Enron, WorldCom, and elsewhere were kept hidden from boards and shareholders until it was too late. In the wake of these scandals, many people felt that the accounting statements of these companies, while often remaining true to the letter of GAAP, did not present an accurate picture of the financial health of a company. D) While one study found that those firms that separated the position of CEO and chairman performed better, another found no relation between the independence of key board committees and firm performance in the post-Cadbury era.

Explanation: A) The Cadbury Commission offered only recommendations. SOX stiffened the criminal penalties for providing false information to shareholders.

Which of the following statements regarding vertical integration is FALSE? A) Vertically integrated companies may be large, but unlike other large corporations, since they remain focused in one industry they are easy to run. B) A company might not be happy with how its products are being distributed, so it might decide to take control of its distribution channels. C) A company might conclude that it can enhance its product if it has direct control of the inputs required to make the product. D) The principal benefit of vertical integration is coordination. By putting two companies under central control, management can ensure that both companies work toward a common goal.

Explanation: A) Vertically integrated companies are large, and as large corporations they are more difficult to run.

Which of the following statements regarding poison pills is FALSE? A) Companies with poison pills are harder to take over, and when they are taken over, the premium that existing shareholders receive for their stock is higher. B) Because a poison pill increases the cost of a takeover, all else equal, a target company must be in better shape to justify the expense of waging a takeover battle. C) Poison pills also increase the bargaining power of the target firm when negotiating with the acquirer because poison pills make it difficult to complete the takeover without the cooperation of the target board. D) By adopting a poison pill, a company effectively entrenches its management by making it much more difficult for shareholders to replace bad managers, thereby potentially destroying value.

Explanation: B) Because a poison pill increases the cost of a takeover, all else equal, a target company must be in worse shape (there must be a greater opportunity for profit) to justify the expense of waging a takeover battle.

Which of the following statements is FALSE? A) Abandonment options can add value to a project because a firm can drop a project if it turns out to be unsuccessful. B) Corporate bonds often contain embedded abandonment options: The issuing firm sometimes has the option to convert the bond—that is, to repay it. C) An abandonment option is the option to walk away. D) An important abandonment option that most people encounter at some point in their lives is the option to abandon their mortgage.

Explanation: B) Corporate bonds often contain embedded abandonment options: The issuing firm sometimes has the option to call the bond—that is, to repay it.

Which of the following statements is FALSE? A) SEC rules make it difficult for investors to buy much more than about 10% of a firm in secret. After an acquirer acquires such an initial stake in the target, called a toehold, they would have to make their intentions public by informing investors of his large stake. B) With the availability of both the freezeout merger and the leveraged buyout as acquisition strategies, most of the value added accrues to the acquiring shareholders. C) The laws on tender offers allow the acquiring company to freeze existing shareholders out of the gains from merging by forcing non-tendering shareholders to sell their shares for the tender offer price. D) Premiums in LBO transactions are often quite substantial—while they can avoid the free-rider problem acquirers must still get board approval to overcome other defenses such as poison pills, as well as outbid other potential acquirers.

Explanation: B) Despite the availability of both the freezeout merger and the leveraged buyout as acquisition strategies, most of the value added still appears to accrue to the target shareholders.

) Which of the following statements is FALSE? A) Once the acquirer has completed the valuation process, it is in the position to make a tender offer - that is, a public announcement of its intention to purchase a large block of shares for a specified price. B) If we view the pre-bid market capitalization as the stand-alone value of the target, then from the bidder's perspective, the takeover is a positive-NPV project only if the synergies created do not exceed the premium it pays. C) Purchasing a corporation usually constitutes a very large capital investment decision, so it requires a more accurate estimate of value that includes careful analysis of both operational aspects of the firm and the ultimate cash flows the deal will generate. D) A stock-swap merger is a positive-NPV investment for the acquiring shareholders if the share price of the merged firm (the acquirer's share price after the takeover) exceeds the premerger price of the acquiring firm.

Explanation: B) If we view the pre-bid market capitalization as the stand-alone value of the target, then from the bidder's perspective, the takeover is a positive-NPV project only if the premium it pays does not exceed the synergies created.

Which of the following statements is FALSE? A) Researchers have hypothesized that boards with a majority of outside directors are better monitors of managerial effort and actions. B) Studies have found that firms with independent boards make fewer value-creating acquisitions but are more likely to act in shareholders' interests if targeted in an acquisition. C) One early study showed that a board was more likely to fire the firm's CEO for poor performance if the board had a majority of outside directors. D) Although the firm's stock price increases on the announcement of its addition of an independent board member, the increased firm value appears to come from the potential for the board to make better decisions on acquisitions and CEO turnover rather than from improvements in the firm's operating performance.

Explanation: B) Studies have found that firms with independent boards make fewer value-destroying acquisitions and are more likely to act in shareholders' interests if targeted in an acquisition.

Which of the following statements is FALSE? A) Underwriters appear to use the information they acquire during the book-building stage to intentionally under price the IPO, thereby reducing their exposure to losses. B) The blue tooth option allows the underwriter to issue more stock, amounting to 15% of the original offer size, at the IPO offer price. C) The lead underwriter usually makes a market in the stock and assigns an analyst to cover it. D) In most cases, the preexisting shareholders are subject to a 180-day lockup; they cannot sell their shares for 180 days after the IPO. Once the lockup period expires, they are free to sell their shares.

Explanation: B) The green shoe option allows the underwriter to issue more stock, amounting to 15% of the original offer size, at the IPO offer price.

) Which of the following is NOT one of the four characteristics of IPOs that puzzle financial economists? A) On average, IPOs appear to be underpriced. B) The long-run performance of a newly public company (three to five years from the date of issue) is superior to the overall market return. C) The number of issues is highly cyclical. D) The costs of the IPO are very high, and it is unclear why firms willingly incur such high costs.

Explanation: B) The long-run performance of a newly public company (three to five years from the date of issue) is inferior to the overall market return.

) Which of the following statements is FALSE? A) The incentives come from owning stock in the company and from compensation that is sensitive to performance. B) The role of the corporate governance system is to mitigate the conflict of interest that results from the combination of ownership and control without unduly burdening managers with the risk of the firm. C) Punishment comes when a board fires a manager for poor performance or fraud, or when, upon failure of the board to act, shareholders or raiders launch control contests to replace the board and management. D) The corporate governance system attempts to align interests by providing incentives for taking the right action and punishments for taking the wrong action.

Explanation: B) The role of the corporate governance system is to mitigate the conflict of interest that results from the separation of ownership and control without unduly burdening managers with the risk of the firm.

Which of the following statements is FALSE? A) After deciding to go public, managers of the company work with an underwriter, an investment banking firm that manages the offering and designs its structure. B) The shares that are sold in the IPO may either be new shares that raise new capital, known as a secondary offering, or existing shares that are sold by current shareholders (as part of their exit strategy), known as a primary offering. C) Many IPOs, especially the larger offerings, are managed by a group of underwriters. D) At an IPO, a firm offers a large block of shares for sale to the public for the first time.

Explanation: B) The shares that are sold in the IPO may either be new shares that raise new capital, known as a primary offering, or existing shares that are sold by current shareholders (as part of their exit strategy), known as a secondary offering.

Which of the following statements regarding firm commitment IPOs is FALSE? A) If the entire issue does not sell out, the remaining shares must be sold at a lower price and the underwriter must take the loss. B) The underwriter purchases the entire issue (at a the offer price) and then resells it at a slightly higher price to interested investors. C) It is the most common underwriting arrangement. D) The underwriter guarantees that it will sell all of the stock at the offer price.

Explanation: B) The underwriter purchases the entire issue (at a price slightly lower than the offer price) and then resells it at the offer price to interested investors.

Which of the following statements is FALSE? A) Often, the decision to abandon a project entails costs, which may be either positive or negative. B) Mortgage interest rates are higher than Treasury rates because mortgages have an abandonment option that Treasuries do not have: You can prepay your mortgage at any time, while the U.S. government can repay its debt only according to the schedule outlined in the bond contract. C) A popular option gives holders of the bond the option to convert the bond into equity. These kinds of bonds are termed callable bonds. D) More often than not, there is an opportunity cost of abandoning a project: If you shut down the project and later decide to start it up again, you have to pay the costs of restarting the project.

Explanation: C) A popular option gives holders of the bond the option to convert the bond into equity. These kinds of bonds are termed convertible bonds.

) Which of the following statements is FALSE? A) New SEC rules require firms to report option grants within two days of the grant date, which may help prevent further abuses. B) Studies have found evidence that the practice of timing the release of information to maximize the value of CEO stock options is widespread. C) Managers have an incentive to manipulate the release of financial forecasts so that good news comes out before options are granted and bad news is delayed until after the options are granted. D) The factor contributing most to the climb in CEO total compensation for the 1990s was the sharp increase in the value of stock and options granted each year.

Explanation: C) Managers have an incentive to manipulate the release of financial forecasts so that bad news comes out before options are granted and good news comes out after options are granted.

Which of the following statements is FALSE? A) In recent years, the investment banking firm of W.R. Hambrecht and Company has attempted to change the IPO process by selling new issues directly to the public using an online auction IPO mechanism called Open IPO. B) The lead underwriter is the primary banking firm responsible for managing the deal. The lead underwriter provides most of the advice and arranges for a group of other underwriters, called the syndicate, to help market and sell the issue. C) Because of the potential conflict of interest, the underwriter will not make a market in the stock after the issue. D) The SEC requires that companies prepare a registration statement, a legal document that provides financial and other information about the company to investors, prior to an IPO. Company managers work closely with the underwriters to prepare this registration statement and submit it to the SEC.

Explanation: C) Most underwriters will commit to make a market in the stock after the issue.

) Which of the following statements is FALSE? A) An active takeover market is part of the system through which the threat of dismissal is maintained. B) When internal governance systems such as ownership, compensation, board oversight, and shareholder activism fail, the one remaining way to remove poorly performing managers is by mounting a hostile takeover. C) Because hostile takeovers and internal governance systems are substitute mechanisms, researchers have found that boards are less likely to fire managers for poor performance during active takeover markets than they are during lulls in takeover activity. D) The effectiveness of the corporate governance structure of a firm depends on how well protected its managers are from removal in a hostile takeover.

Explanation: C) Researchers have found that boards are actually more likely to fire managers for poor performance during active takeover markets than they are during lulls in takeover activity.

Which of the following statements is FALSE? A) When the CEO is also chairman of the board, the nominating letter offering a seat to a new director comes from her. This process merely serves to reinforce the sense that the outside directors owe their positions to the CEO and work for the CEO rather than for the shareholders. B) Over time, most of the independent directors will have been nominated by the CEO. Even though they have no business ties to the firm, they are still likely to be friends or at least acquaintances of the CEO. C) Researchers have found the surprisingly robust result that larger boards are associated with greater firm value and performance. D) The CEO can be expected to stack the board with directors who are less likely to challenge her.

Explanation: C) Researchers have found the surprisingly robust result that smaller boards are associated with greater firm value and performance.

Which of the following statements is FALSE? A) Once a company goes public, it must satisfy all of the requirements of public companies. B) Organizations such as the Securities and Exchange Commission (SEC), the securities exchanges (including the New York Stock Exchange and the Nasdaq), and Congress (through the Sarbanes-Oxley Act of 2002) adopted new standards that focused on more thorough financial disclosure, greater accountability, and more stringent requirements for the board of directors. C) The major advantage of undertaking an IPO is also one of the major disadvantages of an IPO: When investors diversify their holdings, the equity holders of the corporation become more concentrated. D) Several high profile corporate scandals during the early part of the twenty-first century prompted tougher regulations designed to address corporate abuses.

Explanation: C) The major advantage of undertaking an IPO is also one of the major disadvantages of an IPO: When investors diversify their holdings, the equity holders of the corporation become more dispersed.

) Which of the following statements regarding monopoly mergers is FALSE? A) It is often argued that merging with or acquiring a major rival enables a firm to substantially reduce competition within the industry and thereby increase profits. B) Financial researchers have found that the share prices of other firms in the same industry did not significantly increase following the announcement of a merger within the industry. C) While only the merging company benefits when competition is reduced, all companies in an industry pay the associated costs. D) Society as a whole bears the cost of monopoly strategies, so most countries have antitrust laws that limit such activity

Explanation: C) While all companies in an industry benefit when competition is reduced, only the merging company pays the associated costs.

) Which of the following statements regarding monopoly mergers is FALSE? A) It is often argued that merging with or acquiring a major rival enables a firm to substantially reduce competition within the industry and thereby increase profits. B) Financial researchers have found that the share prices of other firms in the same industry did not significantly increase following the announcement of a merger within the industry. C) While only the merging company benefits when competition is reduced, all companies in an industry pay the associated costs. D) Society as a whole bears the cost of monopoly strategies, so most countries have antitrust laws that limit such activity.

Explanation: C) While all companies in an industry benefit when competition is reduced, only the merging company pays the associated costs.

Which of the following statements is FALSE? A) An alternative to using the Black-Scholes formula is to compute the value of growth options using risk neutral probabilities. B) Future growth options are not only important to firm value, but can also be important in the value of an individual project. C) While the Black-Scholes formula values American options, most growth options cannot be exercised at any time. D) Out-of-the-money calls are riskier than in-the-money calls, and because most growth options are likely to be out-of-the-money, the growth component of firm value is likely to be riskier than the ongoing assets of the firm.

Explanation: C) While the Black-Scholes formula values European options, most growth options can be exercised at any time

Which of the following statements is FALSE? A) Once the issue price (or offer price) is set, underwriters may invoke another mechanism to protect themselves against a loss—the over-allotment allocation. B) Before the offer price is set, the underwriters work closely with the company to come up with a price range that they believe provides a reasonable valuation for the firm. C) Before an IPO, the company prepares the final registration statement and final prospectus containing all the details of the IPO, including the number of shares offered and the offer price. D) A "road trip" is where senior management and the lead underwriters travel around the country (and sometimes around the world) promoting the company and explaining their rationale for the offer price to the underwriters' largest customers—mainly institutional investors such as mutual funds and pension funds.

Explanation: D) A "road show" is where senior management and the lead underwriters travel around the country (and sometimes around the world) promoting the company and explaining their rationale for the offer price to the underwriters' largest customers—mainly institutional investors such as mutual funds and pension funds.

) Which of the following statements is FALSE? A) Backdating refers to the practice of choosing the grant date of a stock option retroactively, so that the date of the grant would coincide with a date when the stock price was at its low for the quarter or for the year. B) Unless it is reported in a timely manner to the IRS and to shareholders, and reflected in the firm's financial statements, backdating is illegal. C) The use of backdating suggests that some executive stock option compensation may not truly have been earned as the result of good future performance of the firm. D) By backdating the option the executive receives a stock option that is already out-of-the-money, with a strike price equal to the higher price on the supposed grant date.

Explanation: D) By backdating the option the executive receives a stock option that is already in-the-money, with a strike price equal to the lower price on the supposed grant date.

) Which of the following statements is FALSE? A) It is tempting to use the Black-Scholes formula to value future growth options, but often there are good reasons why this formula might not price these options correctly. B) When a firm has a real option to invest in the future it is known as a growth option. C) Because growth options have value, they contribute to the value of any firm that has future possible investment opportunities. D) Future growth opportunities can be thought of as a collection of real put options on potential projects.

Explanation: D) Future growth opportunities can be thought of as a collection of real call options on potential projects.

) Which of the following statements regarding best efforts IPOs is FALSE? A) For smaller IPOs, the underwriter commonly accepts the deal on this basis. B) The underwriter does not guarantee that the stock will be sold, but instead tries to sell the stock for the best possible price. C) Often these arrangements have an all-or-none clause: either all of the shares are sold in the IPO, or the deal is called off. D) If the entire issue does not sell out, the underwriter is on the hook.

Explanation: D) If the entire issue does not sell out, the underwriter is off on the hook since this is not a firm commitment offering.

Which of the following statements is FALSE? A) In a rights offer, the firm offers the new shares only to existing shareholders. B) Secondary shares are shares sold by existing shareholders, including the company's founder. C) If a firm's management is concerned that its equity may be under priced in the market, by using a rights offering the firm can continue to issue equity without imposing a loss on its current shareholders. D) In the United States, most offers are rights offers.

Explanation: D) In the United States, most offers are cash offers.

) Which of the following statements regarding auditors is FALSE? A) Most auditors have a longstanding relationship with their audit clients; this extended relationship and the auditors' desire to keep the lucrative auditing fees makes auditors less willing to challenge management. B) Most accounting firms have developed large and extremely profitable consulting divisions. Obviously, if an audit team refuses to accommodate a request by a client's management, that client will be less likely to choose the accounting firm's consulting division for its next consulting contract. C) Auditing firms are supposed to ensure that a company's financial statements accurately reflect the financial state of the firm. D) In the post Sarbanes-Oxley world, accounting firms are no longer allowed to offer both audit and non-audit services to the same firm.

Explanation: D) In the post Sarbanes-Oxley world, accounting firms are still allowed to offer both audit and non-audit services to the same firm, however strict limits are put on nonaudit fees these audit firms can receive.

Which of the following statements regarding exit strategies is FALSE? A) An alternative way to provide liquidity to its investors is for the company to become a publicly traded company. B) An important consideration for investors in private companies is their exit strategy or how they will eventually realize the return from their investment. C) Often large corporations purchase successful start-up companies. In such a case, the acquiring company purchases the outstanding stock of the private company, allowing all investors to cash out. D) Roughly 25% of venture capital exits from 2002-2012 occurred through mergers or acquisitions.

Explanation: D) Roughly 88% of venture capital exits from 2002-2012 occurred through mergers or acquisitions.

Which of the following statements regarding auditors is FALSE? A) The Sarbanes-Oxley Act called on the SEC to force companies to have audit committees that are dominated by outside directors and required that at least one outside director have a financial background. B) Whether information is material has been defined in the courts as referring to whether the information would have been a significant factor in an investor's decision about the value of the security. C) CEOs and CFOs must return bonuses or profits from the sale of stock or the exercise of options during any period covered by statements that are later restated. D) The law is especially strict with regard to takeover announcements, prohibiting any insider with nonpublic information about a pending or ongoing tender offer from trading on that information or revealing it to someone who is likely to trade on it.

Explanation: D) The law is especially strict with regard to takeover announcements, prohibiting anyone (whether an insider or not) with nonpublic information about a pending or ongoing tender offer from trading on that information or revealing it to someone who is likely to trade on it.

1) Which of the following statements is FALSE? A) One way to see why you sometimes choose not to invest in a positive-NPV project is to think about the decision of when to invest as a choice between two mutually exclusive projects: (1) invest today or (2) wait. B) You invest today only when the NPV of investing today exceeds the value of the option of waiting, which from option pricing theory we know to be always positive. C) When you do not have the option to wait, it is optimal to invest in any positive-NPV project. D) When you have the option of deciding when to invest, it is usually optimal to invest only when the NPV is positive but close to zero.

Explanation: D) When you have the option of deciding when to invest, it is usually optimal to invest only when the NPV is substantially positive.