1. Chapter 2 Introduction to business combinations

2. Outline  The nature of combination  Motivates of combination  Historical perspective of business combination  Takeover premiums  Determining price and method of payment

3. growth profit risk

4. bidder target shareholders Cash or other assets or rights Control rights shareholders

5. Motivate for combination  Operating synergies  Enlarge internal marketplace at a specific risk  Benefit from tax law  Diversification  Divestiture

6. Determining price and method of payment in business combinations 1.Determining price is very important thing. 2.Method of payment  Dilution, accounting method  Stock, no particular problems but normal functioning of stock market,and in cash  Stock Swap,stock exchange ratio,negotiated price

7. Net asset and future earnings contribution  The valuation of net assets as well as their expected contribution to the future earnings is essential for determining price.  Methods: discounting of expected future cash flows (free cash flow), earnings,or excess earnings approach  The less liquidate the asset is, the more necessary and difficult to evaluate, therefore, the more complicated method and techniques for valuation.

8. Excess earnings approach to estimating goodwill  Identify a normal rate of return  Apply above normal rate to the identifiable assets to estimate the normal earning  Estimate the expected future earnings of target  Subtract the normal earnings from expected target earnings to calculate “excess earnings”  Compute estimated value of goodwill, time periods and discount rate  Add the estimated goodwill to the fair value of IA to arrive at a possible offering price

9. Summary of calculation  Normal earnings =IA ×normal rate of return  Expected earnings of target: ① exclude the nonrecurring gains and losses; ② exclude amortization of goodwill; ③ adjustment of depreciation  Excess earnings  Estimated goodwill  Implied offering price

10. Discussion for determining price  Ignore continuous items, back out nonrecurring items,and adjust changeable items; so in practice, more information should be available to identify every item and to what degree it changes.  Determining price is effected by comparable data, constituents, professional judgment and bargaining ability  Dilution and accretion