Key Rule 4

Question 1

Key rule 4

Answer 1

Acquisition effects and synergies

Question 2

Basic acquisition effects

Answer 2

• foregone interest on cash
• additional interest on debt
• additional shares outstanding
• combined financial statements
• creation of goodwill and other intangibles

Question 3

Foregone interest on cash

Answer 3

Buyer loses the interest it would have otherwise earned if it uses cash for the acquisition, reduces pre tax and net income as well as EPS

Question 4

Additional interest on debt

Answer 4

Buyer pays additional interest expense if it uses debt, reduces pre-tax and net income, as well as EPS

Question 5

Additional shares outstanding

Answer 5

If the buyer pays with stock, must issue additional shares which will reduce EPS

Question 6

Combined financial statements

Answer 6

After the acquisition, seller’s financial statements are added to the buyer’s, with a few adjustments

Question 7

creation of goodwill and other intangibles

Answer 7

These balance sheet items represent the premium the buyer paid over the seller’s shareholder’s equity, required to ensure balance

Question 8

More advanced acquisition effects

Answer 8

• PP&E and fixed asset write-ups
• deferred tax liabilities
• deferred tax assets
• transactions and financing fees
• inter-company accounts receivable and payable
• deferred revenue write-down

Question 9

PP&E and fixed asset write-ups

Answer 9

May write up the values of these assets in an acquisition, under the assumption that the market values exceed the book values

Question 10

Deferred tax liabilities

Answer 10

Normally write off, then create new ones based on buyer’s tax rate

Question 11

Deferred tax assets

Answer 11

In most deals, write these off completely, depending on seller’s tax situation

Question 12

Transaction and financing fees

Answer 12

Expense legal and advisory fees and deduct them from cash and retained earnings at the time of the transaction. But, capitalise financing fees and then amortise them however long newly issued debt remains on the balance sheet

Question 13

Inter-company accounts receivable and payable

Answer 13

May eliminate some of the combined AR and AP as buyer may owe seller money, and vice. Once they’re the same company, no longer makes sense.

Question 14

Deferred revenue write down

Answer 14

Accounting rules state that you can only recognise the profit portion of the seller’s deferred revenue post acquisition, so write down expense portion over several years in a merger model

Question 15

Revenue and expense synergies

Answer 15

By combining, 2 companies may earn more revenue than if they simply added together their separate revenues, or may pay less expenses

Question 16

Revenue synergies are rarely taken seriously in practise why?

Answer 16

Because it is impossible to predict how successful these types of up-sell/ cross-sell efforts will be

Question 17

Expense synergies are much more grounded in reality, two most common types:

Answer 17

• reduction in force - cost synergies in employees force
• building consolidation, rather than two mid buildings, one big building