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CHAPTER 23

MERGERS AND ACQUISITIONS

Learning Objectives

LO1 The different types of mergers and acquisitions, why they should (or shouldnt)take place, and the terminology associated with them.

LO2 How accountants construct the combined balance sheet of a new company.LO3 Taxable ersus tax!free acquisitions.LO "ome financial side effects of mergers and acquisitions.LO! #ash ersus common stock financing in mergers and acquisitions.LO" How to estimate the $%& of a merger or an acquisition.LO# The gains from a merger or acquisition and how to alue the transaction.LO$ 'iestitures inoling equity care!outs and spin!offs.

Ans%ers t& C&nce'ts Revie% an( Critica) T*in+ing Q,esti&ns

1- .LO1/a. reenmail refers to the practice of paying unwanted suitors who hold an equity stake in thefirm a premium oer the market alue of their shares, to eliminate the potential takeoer threat.b. white knight refers to an outside bidder that a target firm brings in to acquire it, rescuingthe firm from a takeoer by some other unwanted hostile bidder.c. golden parachute refers to lucratie compensation and termination packages granted tomanagement in the eent the firm is acquired.d. The crown *ewels usually refer to the most aluable or prestigious assets of the firm, whichin the eent of a hostile takeoer attempt, the target sometimes threatens to sell.e. "hark repellent generally refers to any defensie tactic employed by the firm to resist

hostile takeoer attempts.f. corporate raider usually refers to a person or firm that speciali+es in the hostile takeoerof other firms.

g. poison pill is an amendment to the corporate charter granting the shareholders the rightto purchase shares at little or no cost in the eent of a hostile takeoer, thus making the acquisitionprohibitiely expensie for the hostile bidder.h. tender offer is the legal mechanism required by the exchange when a bidding firm goesdirectly to the shareholders of the target firm in an effort to purchase their shares.i. leeraged buyout refers to the purchase of the shares of a publicly!held company and itssubsequent conersion into a priately!held company, financed primarily with debt.

2- .LO/'iersification doesnt create alue in and of itself because diersification reduces unsystematic,not systematic, risk. s discussed in the chapter on options, there is a more subtle issue as well.

educing unsystematic risk benefits bondholders by making default less likely. Howeer, if a merger isdone purely to diersify (i.e., no operating synergy), then the $%& of the merger is +ero. -f the $%& is+ero, and the bondholders are better off, then stockholders must be worse off.

3- .LO1/ firm might choose to split up because the newer, smaller firms may be better able to focus ontheir particular markets. Thus, reerse synergy is a possibility. n added adantage is that performanceealuation becomes much easier once the split is made because the new firms financial results (andstock prices) are no longer commingled.

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S&),ti&ns t& Q,esti&ns an( r&b)es

NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps.

ue to space and readability constraints! when these intermediate steps are included in this solutionsmanual! rounding may appear to have occurred. "owever! the final answer for each problem is found

without rounding during any step in the problem.

Basic

1- .LO#/6or the merger to make economic sense, the acquirer must feel the acquisition will increasealue by at least the amount of the premium oer the market alue, so7

9inimum economic alue < =:0>,???,??? @ />A,???,??? < =:0,???,???

2- .LO#/The maximum cash price per share for 'eonshire that should be paid is the existing share priceplus the one!time benefit per share7

9aximum share price < =>? B (=0?,???,??? C :,???,???)9aximum share price < =D?

3- .LO2/a# "ince neither company has any debt, using the pooling method, the asset alue of the combined

must equal the alue of the equity, so7

ssets < 4quity < :?,???(=0:) B 0;,???(=:) < =A?,???

b# 5ith the purchase accounting method, the assets of the combined firm will be the book alue of6irm E, the acquiring company, plus the market alue of 6irm F, the target company, so7

ssets from E < :?,???(=0:) < =;A?,??? (book alue)

ssets from F < 0;,???(=0>) < =;;,??? (market alue)

The purchase price of 6irm F is the number of shares outstanding times the sum of the currentstock price per share plus the premium per share, so7

%urchase price of F < 0;,???(=0> B A) < =/:;,???

The goodwill created will be7

oodwill < =/:;,??? @ ;;,??? < =D?,???

nd the total asset of the combined company will be7

Total assets EF < Total equity EF < =;A?,??? B ;;,??? B D?,??? < =D?;,???

$% &o.! post'merger

ssets =G0;,???oodwill D?,??? 4quity =D?;,???

Total =D?;,??? =D?;,???

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- .LO2/-n the pooling method, all accounts of both companies are added together to total the accounts inthe new company, so the post!merger balance sheet will be7

mherst&o.! post'merger

#urrent assets =0;,:?? #urrent liabilities = A,A??6ixed assets :,:?? 2ong!term debt 00,>??

4quity /D,;??Total =;>,G?? =;>,G??

!- .LO2/"ince the acquisition is funded by long!term debt, the post!merger balance sheet will hae long!term debt equal to the original long!term debt of mhersts balance sheet, plus the original long!termdebt on 4ssexs balance sheet, plus the new long!term debt issue, so7

%ost!merger long!term debt < =D,G?? B 0,D?? B 0A,??? < =>,>?D

oodwill will be created since the acquisition price is greater than the book alue. The goodwillamount is equal to the purchase price minus the market alue of assets, plus the market alue of theacquired companys debt. enerally, the market alue of current assets is equal to the book alue, so7

oodwill < =0A,??? @ (=D,/?? market alue 6) @ (=/,:?? market alue #) B (=0,/?? B 0,D??)oodwill < =A,;??

4quity will remain the same as the pre!merger balance sheet of the acquiring firm. #urrent assets anddebt accounts will be the sum of the two firms pre!merger balance sheet accounts, and the fixed assetswill be the sum of the pre!merger fixed assets of the acquirer and the market alue of fixed assets of thetarget firm. The post!merger balance sheet will be7

Amherst &o.! post'merger

#urrent assets =0;,:?? #urrent liabilities = A,A??6ixed assets :;,/?? 2ong!term debt >,>??oodwill A,;?? 4quity /,D??

Total =A>,?? =A>,??

"- .LO2/-n the pooling method, all accounts of both companies are added together to total the accounts inthe new company, so the post!merger balance sheet will be7

(napps Enterprises! post'merger

#urrent assets = A,0?? #urrent liabilities = :,0;?1ther assets 0,>0? 2ong!term debt >,;??$et fixed assets ,0?? 4quity 0G,A?

Total =D,D0? =,D0?

#- .LO2/"ince the acquisition is funded by long!term debt, the post!merger balance sheet will hae long!term debt equal to the original long!term debt of napps balance sheet plus the new long!term debtissue, so7

%ost!merger long!term debt < =>,;?? B 0/??? < =?,;??

4quity will remain the same as the pre!merger balance sheet of the acquiring firm. #urrent assets,current liabilities, long!term debt, and other assets will be the sum of the two firms pre!merger balance

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b. The alue of Tilbury to 'oer must be the market alue of the company since the $%& ofthe acquisition is +ero. Therefore, the alue is7

&I< =0G?,???(0/.;) < =,:/?,???

The cost of the acquisition is the number of shares offered times the share price, so the costis7

#ost < (0C/)(D?,???)(=G0) < =,:/?.???

"o, the $%& of the acquisition is7

$%& < ? < &IB & @ #ost < =,:/?.???B & @ ,:/?.???

& < =?

lthough there is no economic alue to the takeoer, it is possible that 'oer is motiatedto purchase Tilbury for other than financial reasons.

1- .LO!/

a. The $%& of the merger is the market alue of the target firm, plus the alue of the synergy,minus the acquisition costs, so7

$%& < 0,;??(=0D) B =G,>?? @ 0,;??(=0) < =;,>??

b. "ince the $%& goes directly to stockholders, the share price of the merged firm will be themarket alue of the acquiring firm plus the $%& of the acquisition, diided by the number ofshares outstanding, so7

"hare price < J;,:??(=:>) B =;,>??KC;,:?? < =:G.?;

c. The merger premium is the premium per share times the number of shares of the target firmoutstanding, so the merger premium is7

9erger premium < 0,;??(=0 @ 0D) < =/,???

d. The number of new shares will be the number of shares of the target times the exchangeratio, so7

$ew shares created < 0,;??(0C) < >;? new shares

The alue of the merged firm will be the market alue of the acquirer plus the market alueof the target plus the synergy benefits, so7

&3T< ;,:??(=:>) B 0,;??(=0D) B G,>?? < =D0,???

The price per share of the merged firm will be the alue of the merged firm diided by the

total shares of the new firm, which is7

% < =D0,???C(;,:?? B >;?) < =:>./0

e. The $%& of the acquisition using a share exchange is the market alue of the target firmplus synergy benefits, minus the cost. The cost is the alue per share of the merged firm times thenumber of shares offered to the target firm shareholders, so7

$%& < 0,;??(=0D) B =G,>?? @ >;?(=:>./0) < =0/,;:;

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Intermediate

11- .LO!/ The share offer is better for the target firm shareholders since they receie only =0 per share incash . -n the share offer, the target firms shareholders will receie7

4quity offer alue < (0C)(=:>./0) < =/.A;; per share

6rom %roblem 0?, we know the alue of the merged firms assets will be =D0,???. The number ofshares in the new firm will be7

"hares in new firm < ;,:?? B 0,;??x

that is, the number of shares outstanding in the bidding form, plus the number of shares outstanding inthe target firm, times the exchange ratio. This means the post merger share price will be7

% < =D0,???C(;,:?? B 0,;??x)

To make the target firms shareholders indifferent, they must receie the same wealth, so7

0,;??(x)% < 0,;??(=0)

This equation shows that the new offer is the shares outstanding in the target company times theexchange ratio times the new stock price. The alue under the cash offer is the shares outstanding timesthe cash offer price. "oling this equation for %, we find7

% < =0 C x

#ombining the two equations, we find7

=D0,???C(;,:?? B 0,;??x) < =0 C xx < .:/>

There is a simpler solution that requires an economic understanding of the merger terms. -f the target

firms shareholders are indifferent, the bidding firms shareholders are indifferent as well. That is, theoffer is a +ero sum game. Lsing the new stock price produced by the cash deal, we find7

4xchange ratio < =0C=:G.?; < .:/>

12- .LO1/The cost of the acquisition is7

#ost < ??(=:D) < =D,G??

"ince the stock price of the acquiring firm is =:/, the firm will hae to gie up7

"hares offered < =D,G??C=:/ < >.D?> shares (assuming $%& < ?)

a. The 4%" of the merged firm will be the combined 4%" of the existing firms diided by thenew shares outstanding, so7

4%" < (=0,:?? B A??)C(0??? B >.D?>) < =0.AGG

b. The %4 of the acquiring firm is7

1riginal %C4 < =:/C(=0,:??C0???) < /?.>0: times

ssuming the %4 ratio does not change, the new stock price will be7

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$ew % < =0.AGG(/?.>0:) < =;?.?/

c. -f the market correctly analy+es the earnings, the stock price will remain unchanged sincethis is a +ero $%& acquisition, so7

$ew %C4 < =:/C=0.AGG < ;.:0 timesd. The new share price will be the combined market alue of the two existing companiesdiided by the number of shares outstanding in the merged company. "o7

% < J(0???)(=:/) B ??(=:>)KC(0??? B >.D?>) < =:.A>/

nd the %4 ratio of the merged company will be7

%C4 < =:.A>C=0.AGG < A.0D times

t the proposed bid price, this is a negatie $%& acquisition for since the share pricedeclines. They should reise their bid downward until the $%& is +ero.

13- .LO"/3eginning with the fact that the $%& of a merger is the alue of the target minus the cost, we

get7

$%& < &3I@ #ost

$%& < & B &3@ #ost

$%& < & @ (#ost @ &3)

$%& < & @ 9erger premium

1- .LO"4 #/

a. The present alue of the merger gain is the alue of the perpetual saings7

%resent alue of merger gain < =G??,??? C .0:%resent alue of merger gain < =;,>0:,G;.>0

b. The cost of the cash offer is the total price paid for shares7

#ost < =; x ,;??,???#ost < =A,;??,???

c. The $%& of the offer is the %& of the merger gain plus the %& of the shares minus the cash cost7

$%& of cash offer < =0G x ,;??,??? B =;,>0:,G;.>0 @ =A,;??,??? < =;?,>0:,G;.>0 @=A.;9$%& of cash offer < !=00,>G;,>0:.D

1!- .LO"4 #/a. The synergy will be the present alue of the incremental cash flows of the proposed purchase.

"ince the cash flows are perpetual, the synergy alue is7

"ynergy alue < =/;?,??? C .?G"ynergy alue < =:,/>;,???

b. The alue of Harwich to aleigh is the synergy plus the current market alue of Harwich, whichis7

&alue < =:,/>;,???B D,???,???&alue < =0/,/>;,???

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c. The alue of the cash option is the amount of cash paid, or =0 million. The alue of the stockacquisition is the percentage of ownership in the merged company, times the alue of the mergedcompany, so7

"tock acquisition alue < .;(=0/,/>;,??? B /,???,???)"tock acquisition alue < =D,?D/,>;?

d. The $%& is the alue of the acquisition minus the cost, so the $%& of each alternatie is7

$%& of cash offer < =0/,/>;,??? @ 0,???,???$%& of cash offer < =0,/>;,???

$%& of stock offer < =0/,/>;,??? @ D,?D/,>;?$%& of stock offer < =:,G0,;?

e. The acquirer should make the stock offer since its $%& is greater.

1"- .LO!4 #/a. The number of shares after the acquisition will be the current number of shares outstanding for the

acquiring firm, plus the number of new shares created for the acquisition, which is7

$umber of shares after acquisition < ;,???,??? B 0,??,???$umber of shares after acquisition < A,??,???

nd the share price will be the alue of the combined company diided by the shares outstanding,which will be7

$ew stock price < =0G;,???,??? C A,??,???$ew stock price < =D.G/G>?DAG

b. 2et equal the fraction of ownership for the target shareholders in the new firm. 5e can set the

percentage of ownership in the new firm equal to the alue of the cash offer, so7

(=0G;,???,???) < =;?,???,???

< .>?> or >.?>M

"o, the shareholders of the target firm would be equally as well off if they receied /? percent ofthe stock in the new company as if they receied the cash offer. The ownership percentage of thetarget firm shareholders in the new firm can be expressed as7

1wnership < $ew shares issued C ($ew shares issued B #urrent shares of acquiring firm).>?> < $ew shares issued C ($ew shares issued B ;,???,???)$ew shares issued < 0,G;0,G:D./0

To find the exchange ratio, we diide the new shares issued to the shareholders of the target firm

by the existing number of shares in the target firm, so7

4xchange ratio < $ew shares C 4xisting shares in target firm4xchange ratio < 0,G;0,G:D./0C ,???,???4xchange ratio < .D;D

n exchange ratio of .D;D shares of the merged company for each share of the target companyowned would make the alue of the stock offer equialent to the alue of the cash offer.

Challenge

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1#- .LO!4 "4 #/a. To find the alue of the target to the acquirer, we need to find the share price with the newgrowth rate. 5e begin by finding the required return for shareholders of the target firm. Theearnings per share of the target are7

4%"%< =A:?,???C0>;,??? < =/,A;> per share

The price per share is7

%%< D.(=/.A;>) < =//.A:A

nd the diidends per share are7

'%"%< =/0?,???C0>;,??? < =0.>>

The current required return for 1rford shareholders, which incorporates the risk of thecompany is7

4< J=0.>>(0.?;)C= //.A:AK B .?; < .0?;

The price per share of %ulit+er with the new growth rate is7

%%< =0.>>(0.?>)C(.0?; @ .?>) < =;/.G?/D>>>

The alue of the target firm to the acquiring firm is the number of shares outstanding timesthe price per share under the new growth rate assumptions, so7

&TI< 0>;,???(=;/.G?/D>>>) < =D,:0;,ADA.?

b. The gain to the acquiring firm will be the alue of the target firm to the acquiring firmminus the market alue of the target, so7

ain < =D,:0;,ADA.? @ 0>;,???(=//.A:A) < =/,;>,A:A.?

c. The $%& of the acquisition is the alue of the target firm to the acquiring firm minus thecost of the acquisition, so7

$%& < =D,:0;,ADA.? @ 0>;,???(=/G) < =,>A;,ADA.?

d. The most the acquiring firm should be willing to pay per share is the offer price per shareplus the $%& per share, so7

9aximum bid price < =/G B (=,>A;,ADA.?C0>;,???) < =;/.G?/D>>>

$otice, this is the same alue we calculated earlier in part a as the alue of the target to the

acquirer.

e. The price of the stock in the merged firm would be the market alue of the acquiring firmplus the alue of the target to the acquirer, diided by the number of shares in the merged firm, so7

%6%< (=;A,;;?,??? B D,:0;,ADA.?)C(0,/??,??? B 0??,???) < =:>.00G/;:/

The $%& of the stock offer is the alue of the target to the acquirer minus the alue offeredto the target shareholders. The alue offered to the target shareholders is the stock price of themerged firm times the number of shares offered, so7

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$%& < =D,:0;,ADA.? @ 0??,???(=:>.00G/;:/) < =:,>?/,GA?.;D

f. Fes, the acquisition should go forward, and idgetown should offer the 0??,??? sharessince the $%& is higher.

g. Lsing the new growth rate in the diidend growth model, along with the diidend andrequired return we calculated earlier, the price of the target under these assumptions is7

%%< =0.>>(0.?A)C(.0?; @ .?A) < =:0.;?GG:D;A

nd the alue of the target firm to the acquiring firm is7

&%I< 0>;,???(=:0.;?GG:D;A) < =>,A:,?:G.A>

The gain to the acquiring firm will be7

ain < =>,A:,?:G.A>@ 0>;,???(=//.A:A) < =0,/>;,DDG.A>

The $%& of the cash offer is now7

$%& cash < =>,A:,?:G.A>@ 0>;,???(=/G) < =A0:,?:G.A>

nd the new price per share of the merged firm will be7

%6%< J=;A,;;?,??? B >,A:,?:G.A>KC(0,/??,??? B 0??,???) < =:;.;G0:A//:

nd the $%& of the stock offer under the new assumption will be7

$%& stock < =>,A:,?:G.A>@ 0??,???(=//.:;) < =,>?;,D?./:

4en with the lower pro*ected growth rate, the stock offer still has a positie $%&.

idgetown should pursue the purchase 1rford with a stock offer of 0??,??? shares.

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