Pepperdine University

FINC 655

Chapter 23

Multiple-Choice Solutions:

1)Alpha Industries is considering acquiring Foxtrot Flooring. Foxtrot is worth $20 million to its current owners under its existing operational methods. Due to some opportunities for synergies between the two companies, Alpha believes that Foxtrot is worth $25 million as part of Alpha Industries. What do you predict for a sales price of Foxtrot?

1. 1. Less than $20 million or Alpha will not buy [According to the rational actor paradigm Alpha will purchase at any value below $25 million]
   2. More than $25 million or Foxtrot will not sell [According to the rational actor paradigm Foxtrot will sell at any value above $20 million]
   3. Something between $20 and $25 million [; the rational actor paradigm indicates that Foxtrot will be willing to sell at anything above their value of $20m, while Alpha is willing to purchase at anything below their valuation of

$25 million; a value between $20 and $25 million satisfies both of these requirements]

1. 4. The different valuations make a sale very unlikely. [Not true, the rational actor paradigm indicates that Foxtrot will be willing to sell at anything above their value, while Alpha will be willing to purchase at anything under theirs]

2. All of the following provide a motive for vertical agreements EXCEPT
   1. effective execution of price discrimination [true; with vertical integration, retailers are able to defeat upstream price discrimination schemes designed by a manufacturer]
   2. elimination of free-riding among retailers [true; vertical contracts such as exclusive territories can overcome the problem of free riding by discount retailers]
   3. quality control [true; vertically integrating can allow a manufacturer to have greater control over the final product]
   4. diversification [; this is false. Diversification represents a company expanding its reach horizontally rather than vertically]

3. Which of the following is an example of vertical integration?
   1. A custom software company purchasing a competing software firm [this is a form of expansion, not vertical integration]
   2. A soft drink producer buying a brand of iced tea [this is an example of horizontal integration, not vertical integration]
   3. A coal producer purchasing a nuclear power plant [this is an example of diversification, not vertical integration]
   4. A gourmet cheese company purchasing a dairy [; dairy is an input into the cheese production process]

4. Why are contact lens manufacturers reluctant to sell their lenses through the Internet?
   1. The Internet price is too high due to double marginalization [double marginalization is more likely to occur with retailers than online]
   2. Search costs are lower, so the Internet sales are too competitive [competition alone is not the reason for their reluctance, there are other factors involved]

1. 3. Doing so reduces the incentives of retailers to provide point-of-sale services [; in order to compete with online prices, retailer would likely be forced to eliminate their point of sale services, which could affect customer's overall experience with the brand]
   4. It is afraid of antitrust lawsuits [antitrust laws don't apply to a company selling its own product through a different channel]

5. In which of the following instances would an acquisition make the most sense?
   1. The target is a very profitable company [don't just acquire a company because it is profitable]
   2. Synergies exist between the acquirer and the target [synergies are worthless unless you are the one capturing the value]
   3. Integration costs are low between the two [even if integration costs are low, you would only purchase if there was value to you]
   4. Synergy benefits outweigh the costs of integration [; the value of the synergy should outweigh the cost of acquiring it!]

6. Why do vertical agreements typically pose less antitrust risk than horizontal agreements?
   1. Vertical agreements occur less often than horizontal agreements [frequency of occurrence does not contribute to antitrust risk]
   2. Vertical agreements often result in lower prices, which is beneficial to the consumer [; the purpose of antitrust laws are to protect the consumers, who often benefit from vertical integrations]
   3. Vertical agreements are rarely profitable [vertical agreements can be very profitable if done ly]
   4. Vertical agreements do not pose less antitrust risk than horizontal agreements [actually, they do. Consider the different impacts each of these agreements have on the consumers]

7. CUS Pharmacy wishes to carry Pepgro blue pills. But Daisy Pharmaceuticals, the maker of Pepgro, will not supply CUS unless CUS agrees to carry other medications that Daisy makes. This is an example of
   1. Exclusion [exclusion is the practice of blocking competitors from participating in a market. CUS is only impacting their participation in their stores, not the market as a whole]
   2. Tying [; tying is the practice of making the sale of one good conditional on the purchase of an additional, separate good, as you see here]
   3. territory restriction [CUS is not dividing products by territory in this case]
   4. bundling [Bundling refers to offering multiple goods for sale as one product. CUS is not mandating the products be sold together but rather at the same store]

8. A multinational firm acquires many of its components pre-assembled from suppliers. One of these suppliers operates in a country with a much lower corporate income tax rate. How does this affect the vertical relationship between this supplier and the multinational?
   1. This will not affect the relationship [Tax is an important consideration between multinationals and suppliers]
   2. The multinational should stop working with the supplier [not necessarily, there are other ways the multinational can benefit from their relationship with the supplier]