1. 1 - 0 Advanced Accounting by Debra Jeter and Paul Chaney Chapter 1: Introduction to Business Combinations Slides Authored by Hannah Wong, Ph.D. Rutgers University

2. 1 - 1 Types of Business Combinations Friendly Combinations l Boards of directors of combining companies negotiate terms of proposed combination.

3. 1 - 2 Types of Business Combinations Unfriendly (Hostile) Combinations l Board of directors of target company resists the combination. l The acquiring company deals directly with individual shareholders through a tender offer.

4. 1 - 3 Defense Tactics l Poison pill: stock rights of shareholders to purchase additional shares at a bargain price in the event of a potential takeover. l Greenmail: purchase of shares held by acquiring company at a premium price.

5. 1 - 4 Defense Tactics l White knight or white squire: encourage a friendly firm to acquire the target company. l Selling the crown jewels: sale of valuable assets to make the firm less attractive. l Leveraged buyout: managers and investors purchase controlling interests and take the firm private.

6. 1 - 5 Business Combinations: Why? l Operating synergies l Competitiveness in the international marketplace l Financial synergy l Diversification l Divestitures ? ? ? ? ?

7. 1 - 6 Business Combinations: Why Not? l Insufficient management control over the resulting conglomerate, resulting in future divestitures. l Business combinations may enable suboptimal allocation of capital. l Accounting method may encourage firms to pay too much.

8. 1 - 7 Business Combinations: Historical Perspective l1880-1904: horizontal integration l1905-1930: vertical integration l1945-present: merger mania n 1970s: conglomerate mergers n 1980s - present: strategic acquisitions

9. 1 - 8 Types of Combinations Net assets of S Company What is acquired: Combination of above Stock Debt Cash Common stock of S Company Pooling of Interests Method Purchase Method What is given up:How it is accounted for:

10. 1 - 9 Stock Acquisition VS Asset Acquisition Stock Acquisition lmay obtain control by acquiring 50% of voting common stock lcan avoid formal negotiation with target management lmaintain separate legal entity n limited liability n greater flexibility in filing tax returns n regulations apply to one firm only Asset Acquisition lmust acquire 100% of target firm, hence higher cost lneed to negotiate with target management lno separate legal entity

11. 1 - 10 Types of Combinations A CompanyB Company A Company + B Company C Company + Financial Statements of A Company Financial Statements of B Company Consolidated Financial Statements of A and B Companies + Statutory Merger Statutory Consolidation Stock Acquisition

12. 1 - 11 Determining Price lPrice n effect of acquisition on future earnings n value of the firm’s identifiable net assets n estimated value of implied goodwill lStock exchange ratio n number of shares of acquiring company to be exchanged for each share of the acquired company

13. 1 - 12 Determining Method of Payment lCash or stock? lFactors affecting method of payment: n liquidity position of acquiring firm n willingness of sellers to accept alternative forms of payment n tax and accounting issues

14. 1 - 13 Estimate Implied Goodwill By discounting expected future excess earnings n identify normal rate of return for similar firms n apply rate of return to net assets of target firm to estimate normal earnings n estimate expected future earnings of target n excess earnings = expected normal earnings earnings n goodwill = discounted value of excess earnings -

15. 1 - 14 Advanced Accounting by Debra Jeter and Paul Chaney Copyright © 2001 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.