Merger Model Advanced Correct Questions & Answers(GRADED A+)
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Merger Model Advanced
Institution
Merger Model Advanced
What's the purpose of Purchase Price Allocation in an M&A deal? Can you explain how it works? - ANSWER The ultimate purpose is to make the combined Balance Sheet balance
This harder than it sounds because many items get adjusted up or down (e.g. PP&E), some items disappear altogether (e.g. the ...
Merger Model Advanced Correct
Questions & Answers(GRADED A+)
What's the purpose of Purchase Price Allocation in an M&A deal? Can you explain how it works? -
ANSWER The ultimate purpose is to make the combined Balance Sheet balance
This harder than it sounds because many items get adjusted up or down (e.g. PP&E), some items
disappear altogether (e.g. the seller's Shareholders' Equity), and some new items get created (e.g.
Goodwill).
To complete the process, you look at every single item on the seller's Balance Sheet and then assess
the fair market values of all those items, adjusting them up or down as necessary.
So if the buyer pays, say, $1 billion for the seller, you figure out how much of that $1 billion gets
allocated to each Asset on the Balance Sheet.
Goodwill (and Other Intangible Assets) serves as the "plug" and ensures that both sides balance
you've made all the adjustments. Goodwill is roughly equal to the Equity Purchase Price minus the
seller's Shareholders' Equity and other adjustments.
Explain the complete formula for how to calculate Goodwill in an M&A deal. - ANSWER Goodwill =
Equity Purchase Price - Seller Book Value + Seller's Existing
-Sellers Book value is just the Shareholders' Equity number (technically, the
,Common Shareholders' Equity number).
-You add the Seller's Existing Goodwill because it is "reset" and written
down to $0 in an M&A deal.
-You subtract the Asset Write-Ups because these are additions to the
Assets side of the Balance Sheet - Goodwill is also an asset, so effectively
you need less Goodwill to "plug the hole."
-Normally you assume 100% of the Seller's existing DTL is written down.
-The seller's existing DTA may or may not be written down completely
-You add Intercompany Accounts Receivable because they go away, which
reduces the Assets side; the opposite applies for Intercompany AP.
Why do we adjust the values of Assets such as PP&E in an M&A deal? - ANSWER Why do we adjust
the values of Assets such as PP&E in an M&A deal?
Investments, Inventory, and other Assets may have also "drifted" from their fair
market values since the Balance Sheet is recorded at historical cost for companies
in most industries (exceptions, such as commercial banking, do exist).
What's the logic behind Deferred Tax Liabilities and Deferred Tax Assets? - ANSWER The basic idea is
that you normally write down most of the seller's existing DTLs
and DTAs to "reset" its tax basis, since it's now part of another entity
And then you may create new DTLs or DTAs if there are Asset Write-Ups or
Write-Downs and the book and tax Depreciation and Amortization numbers
differ.
If there are write-ups, a Deferred Tax Liability will be created in most deals since
the Depreciation on the write-ups is not tax-deductible, which means that the
company will pay more in cash taxes; the opposite applies for write-downs and
there, a Deferred Tax Asset would be created.
How do you treat items like Preferred Stock, Noncontrolling Interests, Debt,
, and so on, and how do they affect Purchase Price Allocation? - ANSWER Normally you build in the
option to repay (or in the case of Noncontrolling
Interests, purchase the remainder of) these items or assume them in the Sources
& Uses schedule.
If you repay them, additional cash/debt/stock is required to purchase the seller.
However, that choice does not affect Purchase Price Allocation.
You always start with the Equity Purchase Price there, which excludes the
treatment of all these items.
Also, you only use the seller's Common Shareholders' Equity in the PPA schedule,
which excludes Preferred Stock and Noncontrolling Interests.
So do you use Equity Value or Enterprise Value for the Purchase Price in a merger model? - ANSWER
This is a trick question because neither one is entirely accurate. The PPA schedule is based on the
Equity Purchase Price, but the actual amount of cash/stock/debt used is based on that Equity
Purchase Price plus the additional funds needed to repay debt, pay for transaction-related fees, and
so on.
That number is not exactly "Enterprise Value" - it's something in between Equity Value and
Enterprise Value, and it's normally labeled "Funds Required" in a model.
How do you reflect transaction costs, financing fees, and miscellaneous
expenses in a merger model? - ANSWER You expense transaction and miscellaneous fees (such as
legal and accounting
services) upfront and capitalize the financing fees and amortize them over the
term of the debt.
Expensed transaction fees come out of Retained Earnings when you adjust the
Balance Sheet (and Cash on the other side), while Capitalized Financing Fees
appear as a new Asset on the Balance Sheet (and reduce Cash immediately) and
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