1. Advanced Accounting by Debra Jeter and Paul Chaney
Chapter 1: Introduction to
Business Combinations
Slides Authored by Hannah Wong, Ph.D.
Rutgers University

2. Types of Business Combinations
Friendly Combinations
Boards of directors of both companies negotiate terms of proposed combination.
Obj 1

3. Types of Business Combinations
Unfriendly (Hostile) Combinations
Board of directors of target company resists the combination.
The acquiring company deals directly with individual shareholders through a tender offer.
Obj 1

4. Defense Tactics
Poison pill: stock rights of shareholders to purchase additional shares at a bargain price in the event of a potential takeover.
Greenmail: purchase of shares held by acquiring company at a premium price.
Obj 4

5. Defense Tactics
White knight or white squire: encourage a friendly firm to acquire the target company.
Selling the crown jewels: sale of valuable assets to make the firm less attractive.
Leveraged buyout: managers and investors purchase controlling interests and take the firm private.
Obj 4

6. Business Combinations: Why?
Operating synergies
Competitiveness in the international marketplace
Financial synergy
Diversification
Divestitures ? ? ? ? ?
Obj 2

7. Business Combinations: Why Not?
Insufficient management control over the resulting conglomerate, resulting in future divestitures.
Business combinations may enable suboptimal allocation of capital.
Accounting method may encourage firms to pay too much. ? ? ? ? ?
Obj 2

8. Business Combinations: Historical Perspective
: horizontal integration
: vertical integration
1945-present: merger mania
1970s: conglomerate mergers
1980s - present: strategic acquisitions
Obj 1

9. How it is accounted for:
Types of Combinations
What is acquired:
What is given up:
How it is accounted for:
Cash
Purchase Method
Net assets of
S Company
Debt
Stock
Common stock
of S Company
Combination of
above
Obj 5

10. Stock Acquisition VS Asset Acquisition
may obtain control by acquiring 50% of voting common stock
can avoid formal negotiation with target management
maintain separate legal entity
Asset Acquisition
must acquire 100% of target firm, hence higher cost
need to negotiate with target management
no separate legal entity
Obj 5

11. Statutory Consolidation
Types of Combinations
Statutory Merger
A Company
A Company
B Company +
Statutory Consolidation
C Company
A Company
B Company +
Stock Acquisition
Consolidated Financial
Statements of A
and B Companies
Financial Statements
of A Company
Financial Statements
of B Company +
Obj 5

12. Determining Price Price Stock exchange ratio
effect of acquisition on future earnings
value of the firm’s identifiable net assets
estimated value of implied goodwill
Stock exchange ratio
number of shares of acquiring company to be exchanged for each share of the acquired company
Obj 6

13. Determining Method of Payment
Cash or stock?
Factors affecting method of payment:
liquidity position of acquiring firm
willingness of sellers to accept alternative forms of payment
tax and accounting issues
Obj 6

14. Estimate Implied Goodwill
By discounting expected future excess earnings
identify normal rate of return for similar firms
apply rate of return to net assets of target firm to estimate normal earnings
estimate expected future earnings of target
excess earnings = expected normal earnings earnings
goodwill = discounted value of excess earnings -
Obj 7

15. Implied Goodwill Example Parent Co. is buying Sub Co.
Parent estimates Sub will earn $824,000 next year
Companies similar to Sub Co. earned $532,000 last year
Parent requires a 15% rate of return on this investment
Parent assumes excess earnings will continue for seven years
Obj 7

16. Obj 7

17. Advanced Accounting by Debra Jeter and Paul Chaney
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