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WEEK 1 -
1.5
An arbitrage firm (A) notes that a bidder (B) whose stock is selling at $30 makes an offer for a
target (T) selling at $40 to exchange 1.5 shares of B for 1 share of T. Shares to T rise to $44; B stays at
$30. A sells 1.5 B short for $45 and goes long on T at $44. One month later the deal is completed with B
at $30 and T at $45. What is As dollar and percentage annualized gain, assuming a required 50% margin
and 8% cost of funds on both transactions?
(Weston 16-17)
C2.8.2
US Airways is a failing firm and has a substantial probability of bankruptcy.
Should the antitrust authorities consider a failing firm defense from the merging parties?
That is, should mergers be allowed to occur if otherwise the target firm faces bankruptcy?
(Weston 57-58)
C3.31 :Merger announcement date: January 7, 2000. What was the premium paid by AOL for
TWX?
Price per share paid to TWX = exchange ratio AOL price per share = 1.5 $72.88
= $109.32
Premium to TWX shareholders = ($109.32 $64.75) / $64.75 = $44.57 / $64.75 = 68.8%
= $109.32/$64.75 1 = 1.69 1 = 68.8%
C3.3.2: The value of AOL on September 10, 2002, was $13.36, and the number of shares
outstanding was 4.45 billion. What was the decline in value of AOL from its immediate
postmerger market capitalization?
Value of AOL on 9/10/02 = share price number of shares = $13.36 4.45 billion
= $59.5 billion
Dollar Decline = $342.6 billion $59.5 billion = $283.1 billion
Percent Decline = $283.1 billion / $342.6 billion = 82.6%
C3.3.3:
Explain the pro forma accounting adjustments (except for the miscellaneous
items) as an example of purchase accounting.
AOL paid $153.1 billion in stock value for TWX. So this is the total adjustment to be accounted
for. The basic entries for purchase accounting are:
Eliminate TWX book equity by a debit of $10 billion. Next, miscellaneous adjustments reflected
in a debit of $30.9 billion were made. The total increase in goodwill is $174 billion. So the sum
of the pro forma debit adjustments equals the market value of AOL stock paid for TWX.
We next consider the credits. The AOL common stock at par issued to pay for the purchase of
TWX is a credit of $0.1 billion (rounded). This is deducted from the amount paid for TWX to
obtain $153.0 billion which becomes the addition to AOL paid in capital.
.
C3.3.4:
Calculate the percent of goodwill and other intangibles to total assets for AOL
Asset Structure Changes in AOL and TWX ($ millions)
Pro Forma
Post Merger
Pre Merger
AOL
Amount
Total Assets
Goodwill+other intangibles
Tangible assets
TWX
%
Amount
Combined
%
Amount
$10,789
100.0%
$50,213
100.0%
$235,388
100.0%
$432
4.0%
$24,507
48.8%
$199,325
84.7%
$10,357
96.0%
$25,706
51.2%
$36,063
15.3%
The total assets of AOL pre-merger were about $11 billion. Total assets of TWX were $50
billion. Their sum is $61 billion. But as a result of purchase accounting total assets became
$235 billion much greater than the $61 billion. The reason is the great increase in goodwill
plus other intangibles. Tangible assets were $10 billion plus $26 billion to total $36 billion.
C.3.3.5:
Calculate the percent of total liabilities and of shareholders equity to total assets for AOL and for
TWX premerger and for the pro forma combined company postmerger. Discuss.
Leverage Changes in the AOL and TWX Merger
Pro Forma
Post Merger
Pre Merger
AOL
Total Liabilities
Shareholders' Equity
Total Claims
Liabilities/Equity
Amount
$4,370
$6,419
$10,789
%
40.5%
59.5%
100.0%
TWX
Amount
%
$39,949
79.6%
$10,264
20.4%
$50,213
100.0%
Combined
Amount
%
$79,095
33.6%
$156,293
66.4%
$235,388
100.0%
68.1%
389.2%
50.6%
Leverage changes reduced the combined firms liabilities-to-shareholders equity to 50.6%. This
reflected the large increase in paid in capital because of the large premium paid by AOL to TWX.
On 3/21/02, AOL-TWX had a market value of equity of $110 billion, 29.5% below the book
equity of $156 billion; liabilities-to-market equity were $79 billion/$110 billion equals 72%.
On 3/26/02, AOL announced a $54 billion write down to reflect the impairment of goodwill.
FASBs Statement of Financial Standards No. 142 on Goodwill and Other Intangible Assets
issued June 2001 states in 43 p. 16: The aggregate amount of goodwill impairment losses shall
be presented as a separate line in the income statement before the subtotal income from
continuing operations (or similar caption)