Why Merge

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Why Merge?

• Value Future Cash Flows/WACC
• Can a merger increase Future Cash Flow?
• Can a merger decrease Weighted Average Cost of
  Capital?

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Motivations for Combining

• Technical Alliances
• Risk Sharing
• Initial Investments In New Markets and
  Technologies
• Precursor to Acquisition
• Legal Convenience

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Joint Ventures

• Economies of Scale
• Risk Sharing
• Technology Sharing
• Access to Restricted Market (Nations)
• Legal Forms
• No New Entity- Contractual Agreement
• Common Ownership of Assets Liabilities
• New Entity-Partnership or Corporation

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Information Economics
Disaggregation (Detail) versus Aggregation
(Summary)
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Rules vs Principles
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Acquisition of Another Firm

• Buy Assets and Liabilities
• Buy Assets Only
• Buy All of Fraction of Shares

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What is the Useful Reporting EntityAfter
Acquisition?

• The Corporate Entity
• The Economic Entity
• What about Industry Membership
• FAS 94, GE vs GE Capital,
• Segment or Line of Business, FAS 131
• The Equity Method
• Cost versus Market Value Method, FAS 115
• Fin 46 Special Purpose Entities

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FACTS
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Hawk Purchase Method

• Hawk issues its own no par shares valued at 100
  for Assets and Liabilities of Sparrow
• Cash 100
• OA 150
• Liab 175
• CS,Hawk ? 75 or 100

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Why the Excess?

• Book Value Acquired 75
• Consideration Given 100Reasons for the
  Difference
• A Mistake
• FMV of Sparrows Net Tangible Assets is gt 75
• Consideration is Overvalued
• Unrecorded Intangible Assets
• Goodwill Exists

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Hawk Purchases Assets Liab.
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Hawk Pooling Method

• Hawk issues its own no par shares valued at 100
  for Assets and Liabilities of Sparrow
• Cash 100
• OA 150
• Liab 175
• CS, Hawk 25
• RE, Hawk 50

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Hawk and Pooling Method
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Hawk Buys All Sparrows SharesPurchase Method

• Investment in S 100
• CS, Hawk 100

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Hawk Buys All Sparrows SharesPurchase Method
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Hawk Buys All Sparrows SharesPooling Method

• Investment in S 75
• CS, Hawk 25
• RE, Hawk 50

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Hawk Buys All Sparrows SharesPooling Method
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New Facts Hawk Issues Shares Valued at 100 But
Only Buys 80 Of Sparrows Shares

• Total BV, Sparrow 75
• BV, Acquired, 80 60
• Consideration
• Given 100
• Why The Excess?

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What if FMV of Sparrows OA is 180 not 150

• Cash OA Liab CS RE
• 100 150 175 25 50
• 250 - 175 75 of Net Assets
• But
• 280 - 175 105 of Net Assets

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Summary of New Facts ForSparrows Assets

• BV of Sparrows Net Assets 75
• FMV of Sparrows Net Assets 105
• 80 of BV 60
• OA,adj
• 80 of FMV 84
• GW
• Consideration Given 100

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What is Total Goodwill of Sparrow?

• Consideration Given
• ?
• Percentage Acquired
• 100 80 125 Total Going Concern Value of
  Sparrow
• 125 - 105 FMV of Net Assets 20 Total GW

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Total Excess Explained

• Total BV, Sparrow 75
• 50 x 8040
• Total Going Concern Value 125
• 30 Increase FMV of Net Assets x 80 24
• 20 Total GW x 80 16

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Buy 80 of Shares, Use Purchase Method
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Intercorporate Investments

• Cost/Market Value (FAS 115)
• No significant influence(lt 20)
• Trading Securities
• Market Value, Unrealized Gains/Losses on IS
• Available for Sale Securities
• Market Value, Unrealized Gains/Losses in SE
• Held to Maturity Securities
• Cost or Market

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Intercorporate Investments

• Equity Method
• Significant Influence but not control, 20-50
• Cost NI - Div Received
• Consolidation
• Control, gt 50
• Combine? Assets and Liabilities

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Special Purpose Entities

• FIN 46, What is Control?Voting Control (Now 10
  not 3)
• Financial Control
• Economic Control (Partitioned Return Risk

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2 Ideas of Goodwill

• Annual Excess Earnings Industry Rate of Return
• Consideration Given - FMV of Identifiable Assets

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Goodwill Impairment Tests

• Step 1 Compare Market Value of Firm (RU) with
  Book Value of Firm including Goodwill, if MV is
  less than BV, then there is an impairment.
• Step 2 Calculate the Implied Goodwill. Compare
  Market Value of Firm (RU) with Book Value of Firm
  excluding Goodwill. The excess of MV over BV is
  implied Goodwill.
• Write down recorded goodwill to implied goodwill.

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Impairment Tests

• Intangible Assets Subject to Amortization Is
  Book Value Recoverable? If no, compare Book
  Value and Fair Value
• Intangible Assets not Subject to
  Amortization Compare Book Value and Fair Value

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Impairment Tests

• Long-live Assets (FASB 144 121) Is Book Value
  Recoverable?
• If no, compare Fair Value or Net Present Value
  to Book Value

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Criteria

• Purchase Method
• A purchase takes place, Cash Consideration
• Pooling Method
• A sale and purchase of a business has not
  occurred a fusion of interests, No Cash
  Consideration
• APB 16, 12 Criteria

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Comparison of Methods