Download session3test - NYU Stern School of Business

Session 3: Post Class tests
1. Cipra Inc. is a large, publicly traded pharmaceutical company with 100 million
shares outstanding, trading at $ 20/share. It has just announced an acquisition
bid at $15 share, for Lexma Inc., a smaller pharmaceutical company, with 50
million shares, currently trading at $10 a share, arguing that the premium is
justified by the synergy in the deal. If Cipra’s stock price drops to $18/share after
the bid is announced and the market is right, estimate the synergy that the
market expects from the deal:
a. $250 million
b. -$200 million
c. $50 million
d. $100 million
e. Impossible to tell
2. You are a bank that has made a fixed rate, long-term loan to a publicly traded
company. The company has a significant cash balance and is under pressure to
act. Which of the following actions would you view as favorable to you as a
lender?
a. Pay higher dividends
b. Make an acquisition with the cash
c. Buy back stock
d. Retire short term debt and hold on to the remaining cash
e. None of the above
3. When lenders worry about what borrowers will do with the borrowed money,
which of the following would you expect to see as a potential borrower?
a. Much higher interest rates on your borrowing
b. Much lower interest rates on your borrowing
4. If you maximize stock prices, you are effectively assuming that the market is
rational and efficient. Many managers and management thinkers argue that
markets are too short term. Which of the following is clear proof that markets
are short term?
a. The stock price goes down on the announcement of an acquisition
b. The stock price goes up when a company lays off employees
c. The stock price goes up when a company borrows money
d. The stock price goes up when a company reports poor earnings
e. All of the above
f. None of the above
5. One of the problems with the information flow to financial markets is that
companies delay revealing bad news to markets, waiting for a good time. If this
is the norm, which of the following would you expect to observe in a rational
market when it comes to companies?
a. No news is no news
b. No news is good news
c. No news is bad news
Session 3: Post class test solutions
1. c. $50 million. The premium paid on the acquisition is $250 million ($5/share *
50 million shares). The price of Cipra drops by $200 million ($2 per share * 100
million shares). The net change in value for the combined company is $50
million.
2. d. Retire short-term debt and hold on to the remaining cash. As a lender to
the firm, with a long term, fixed rate loan, you get no upside. Hence, even if an
investment or acquisition is a good one or if stockholders will be better off with
a dividend or buyback, your primary concern is that the company be able to pay
you and have less default risk. Paying off short-term debt and holding on the
cash will make you happiest, since it makes your debt more secure (safer).
3. a. Much higher interest rates on your borrowing. When lenders feel exposed,
they lend out less and charge much higher interest rates. Hence, the ultimate
cost is borne by borrowers.
4. f. None of the above. While any of these can be evidence of short termism in
some companies, none of them is clear evidence of it. After all, if the market’s
role is to capture the value of a business, in some companies, these actions may
be creating the change in value that the stock price is reflecting.
5. c. No news is bad news. This is a tricky one. When companies are quick to
reveal good news and sit on bad news, the absence of news can be construed as
bad news. I knows it sounds convoluted… but the market fills information
vacuums with its own suppositions (many of which are not good).