Merger Model Questions & Correct Answers - Advanced
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What's the difference between Purchase Accounting and Pooling Accounting in an M&A deal? In purchase accounting the seller's shareholder's equity number is wiped out and the premium paid over that value is recorded as Goodwill on the conbined balance sheet post-acquisition. In pooling account, you ...
walk me through a concrete example of how to calcu
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Merger Model Questions & Correct
Answers - Advanced
What's the difference between Purchase Accounting and Pooling Accounting in an M&A
deal? ✅In purchase accounting the seller's shareholder's equity number is wiped out
and the premium paid over that value is recorded as Goodwill on the conbined balance
sheet post-acquisition. In pooling account, you simply combine the 2 shareholder's
equity numbers rather than worrying about Goodwill and t he related items that get
created.
There are specific requirements for using pooling accounting, so in 99% of M&A deals
you will use purchase accounting.
Walk me through a concrete example of how to calculate revenue synergies. ✅Lets
say Microsoft is going to acquire Yahoo. Yahoo makes money from search advertising
online, and they make a certain amount of revenue per search (RPS). Let's say this
RPS is $0.10 right now. If Microsoft acquired it, we might assume that they could boost
this RPS by $0.01 or $0.02 because of their superior monetization. So to calculate the
additional revenue from this synergy, we would multiple this $0.01 or $0.02 by Yahoo's
total # of searches, get the total additional revenue, and then select a margin on it to
determine how much flows through the combined company's Operating Income.
Walk me through an example of how to calcualte expense synergies. ✅Lets say that
Microsoft still wants to acquire Yahoo. Microsoft has 5,000 SG$A-related exmployees,
whereas Yahoo has around 1,000. Microsoft calculates that post-transaction, it will only
need about 200 of Yahoo's SG&A employees, and its existing employees can take over
the rest of the work. To calculate the Operating Expenses the combined company would
save, we would multiply these 800 employees Microsoft is going to fire post-transaction
by their average salary.
How do you take into account NOLs in an M&A deal? ✅You apply Section 382 to
determine how much of the seller's NOLs are usable each year.
Allowable NOLs = Equity Purchase Price * Highest of Past 3 Month's Adjusted Long
Term Rates
So if our equity purchase price were $1 billion and the highest adjusted long-term rate
were 5%, then we could use $1 billion * 5% = $50 million of NOLs each year.
If the seller had $250 million in NOLs, then the combined company could use $50
million of them each year for 5 years to offset its taxable income.
Why do deferred tax liabilities (DTLs) and deferred tax assets (DTAs) get created in
M&A deals? ✅These get created when you write up assets - both tangible and
intangible - and when you write down assets in a transaction. An asset write-up creates
a deferred tax liability and an asset write-down creates a deferred tax asset.
, You write down and write up assets because there book value - what's on the balance
sheet - often differs substantially from their "fair market value."
An asset write-up creates deferred tax liabilitiy because you'll have a higher
depreciation expense on the new asset, which means you save on taxxes in the short-
term - but eventually you'll have to pay them back, hence the liability. The opposite
applies for an asset write-down and a deferred tax asset.
How do DTLs and DTAs affect Balance Sheet Adjustement in an M&A deal? ✅So let's
say you were buying a company for $1 billion with half-cash and half-debt, and you had
a $100 million asset write-up and a tax rate of 40%. In addition, the seller has total
assets of $200 million, total liabilities of $150 million, and shareholder's equity of $50
million.
Here's what would happen to the combined company's balance sheet (ignoring
transaction/financing fees):
- First, you simply add the seller's Assets and Liabilities (but NOT Shareholder's Equity -
it is wiped out) - to the buyer's to get your "initial" balance sheet. Assets are up by $200
million and Liabilities are up by $150 million.
-The, Cash on the Assets side goes down by $500 million.
-Debt on the Liabilities & Equity Side goes up by $500 million
-You get a new Deferred Tax Liability of $40 million ($100 million * 40%) on the
Liabilities & Equity side.
-Assets are down by $300 million total and Liabilities & Shareholders' Equity are up by
$690 million ($500 + $40 + $150).
-So you need Goodwill & Intangibles of $990 million on the Assets side to make both
sides balance.
Could you get DTLs and DTAs in an asset purchase? ✅No, because in an asset
purchase the book basis of assets always matches the tax basis. They get created in a
stock purchase because the book values of assets are written up or written down, but
the tax values are not.
How do you account for DTLs in forward projections in a merger model? ✅You create
a book vs. cash tax schedule and figure out what the company owes in taxes based on
the Pretax Income on its books, and then you determine what it actually pays in cash
taxes based on its NOLs and newly created amortization and depreciation expenses
(from any write-ups).
Anytime the "cash" tax expense exceeds the "book" tax expense you record this as a
decrease to the Deferred Tax Liability on the Balance Sheet; if the "book" expense is
higher, then you record that as an increase to the DTL.
Explain the complete formula for how to calculate Goodwill in an M&A deal. ✅Goodwill
= Equity Purchase Price - Seller Book Value + Seller's Existing Goodwill - Asset Write-
Ups - Seller's Existing Deferred Tax Liability + Write-Down of Seller's Existing Deferred
Tax Asset + Newly Created Deferred Tax Liability
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