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Advanced Accounting

by Debra Jeter and Paul Chaney

Chapter 1: Introduction to
Business Combinations

Slides Authored by Hannah Wong, Ph.D.

Rutgers University
Types of Business Combinations

Friendly Combinations
Boards of directors of
combining companies
negotiate terms of
proposed combination.

Types of Business Combinations

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

Defense Tactics

Poison pill: stock rights of shareholders

to purchase additional shares at a
bargain price in the event of a potential
Greenmail: purchase of shares
held by acquiring company at a
premium price.

Defense Tactics

White knight or white squire: encourage a

friendly firm to acquire the target company.

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.
Business Combinations: Why?

Operating synergies
Competitiveness in the international
Financial synergy ?
Diversification ? ?

? ?
Business Combinations: Why Not?

management control over
the resulting conglomerate, resulting in
future divestitures.
combinations may enable
suboptimal allocation of capital.
Accountingmethod may encourage firms
to pay too much.

Business Combinations:
Historical Perspective

1880-1904: horizontal integration

1905-1930: vertical integration

1945-present: merger mania

1970s: conglomerate mergers
1980s - present:
strategic acquisitions

Types of Combinations

What is acquired: What is given up: How it is accounted for:


Net assets of Purchase Method

S Company

Common stock Pooling of
of S Company Interests Method

Combination of
Stock Acquisition VS Asset Acquisition
Stock Acquisition Asset Acquisition
may obtain control by must acquire 100% of
acquiring 50% of voting target firm, hence
common stock higher cost
can avoid formal need to negotiate with
negotiation with target target management
no separate legal
maintain separate legal
limited liability
greater flexibility in filing
tax returns
regulations apply to one
firm only

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Types of Combinations

Statutory Merger

A Company B Company A Company


Statutory Consolidation

A Company B Company C Company


Stock Acquisition
Consolidated Financial
Financial Statements Financial Statements Statements of A
of A Company + of B Company and B Companies

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Determining Price

effect of acquisition on future earnings
value of the firms 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

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Determining Method of Payment

Cash or stock?
Factors affecting method of
liquidity position of acquiring firm
willingnessof sellers to accept
alternative forms of payment
tax and accounting issues

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Estimate Implied Goodwill

By discounting expected future excess

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 - normal
earnings = expected
earnings earnings
goodwill = discounted value of excess earnings
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Advanced Accounting
Debra Jeter and Paul Chaney

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