MERGERS AND ACQUISITIONS
1. C is correct. These are conglomerate and horizontal mergers, respectively.
2. C is correct. EPS is $2.63. Because Modern Auto’s stock price is $40 and Sky Systems’ stock price is $25, Modern Auto will acquire Sky Systems by exchanging 1 of its shares for 40/25=1.60 shares of Sky Systems. There are 15 million shares of Sky Systems. Their acquisition will take 15/1.60=9.375 million shares of Modern Auto. The total number of shares after the merger=49.375 million. The EPS after the merger=130/49.375=$2.63.
3. A is correct. Both of the statements by Wilhelm are wrong. The first statement is wrong because diversification by itself does not lower risk for shareholders. Investors can diversify very cheaply on their own by purchasing stocks of different companies (for example, a Modern Auto shareholder could purchase stocks of Sky Systems).
The second statement is also wrong. The P/E ratio will not necessarily remain the same following the merger and is more likely to decline. The premerger P/E for Modern Auto is 40/2.50=16. After the merger, the EPS would be $130 million/49.375 million shares, or 2.6329. The post-merger P/E will probably fall to 40/2.6329=15.19.
4. C is correct. HiFly is a white knight.
5. A is correct.
Target shareholders’ gain = Premium = PT – VT
PT = Price paid for the target company = $400 million as provided in the vignette
VT = Pre-merger value of the target = $25 share price×15 million shares = $375 million