Mergers

Question 1

When is a deal accretive/dilutive (broadly)

Answer 1

An accretive deal is when the purchase increases the EPS and a dilutive deal is when it decreases the EPS

Question 2

How to calculate EPS?

Answer 2

Net Income / Outstanding Shares

Question 3

How do you combine income statements?

Answer 3

You add together everything on the income statement down to pre-tax income

Multiple the combined pre-tax income by the buyers tax rate

Add new shares issued (not sellers shares outstanding) to shares outstanding and then divide net income by the new share count

Question 4

How to calculate goodwill?

Answer 4

It should be difference between combined assets (minus however much buyer paid in cash) and combined liabilities (add any new shares/debt from deal)

*can also be called other outstanding assets (but you need to amortize other intangible assets)

Question 5

What happens to goodwill on the sellers balance sheet?

Answer 5

You write it down to zero

Question 6

What are key items to be adjusted on the income statement?

Answer 6

1) Synergies

2) Depreciation & Amortization

3) Foregone interest on cash (cash used * interest rate)

4) Interest paid on new debt

5) Shares outstanding

Question 7

When is a deal dilutive (generally)

Answer 7

When the amount of Pre-Tax Income the seller contributes is less than the foregone interest on cash, the cash paid on debt, and the new shares issued

Question 8

General rules of thumb for accretion / dilution

Answer 8

1) Buyers almost always prefer to use 100% cash because it is cheaper than debt

2) In 100% stock deal, if the buyer has a higher P / E than the seller, the deal will be accretive. You can flip the P / E to find the % value for each share

3) You can calculate the weighted average cost of each form that you bought it from and if it is greater than the Yield of Seller then it is dilutive

Question 9

How to calculate P / E?

Answer 9

Equity Value / Net Income

Question 10

How to calculate cost of cash?

Answer 10

Foregone Interest Rate on Cash * (1-Buyer Tax Rate)

Question 11

How to calculate cost of debt?

Answer 11

Interest Rate on Debt * (1-Buyer Tax Rate)

Question 12

How to calculate cost of stock?

Answer 12

Reciprocal of the Buyer’s P / E (Net Income / Equity Value)

Question 13

How to calculate yield of seller?

Answer 13

Reciprocal of Seller’s P / E (Net Income / Equity Value)

Question 14

Some problems with calculating weighted average cost?

Answer 14

1) Doesn’t account for synergies

2) Doesn’t account for new D&A

3) Doesn’t account for the premium paid for the seller (you can fix this by Net Income / Price Paid for Company)

Question 15

What is foregone interest on cash?

Answer 15

This is what the buyer loses by paying cash (e.g., the money they could have collected from the interest on the cash they used to buy the company)

Question 16

What is additional interest on debt?

Answer 16

The additional interest expense the buyer pays for debt

Question 17

What is additional shares outstanding?

Answer 17

If the buyer pays with stock, it will reduce its EPS because there are more shares

Question 18

What happens to PP&E in a merger?

Answer 18

You can sometimes write up the values of assets in an acquisition if you think the market values exceed the book values

Question 19

How to combine deferred tax liabilities?

Answer 19

You write off the seller’s existing DTL and then create a new one based on the buyers tax rate

Question 20

What do you do with legal and advisory fees in a deal?

Answer 20

You expense these fees and deduct them from cash and retained earnings at the time of the transaction

Question 21

What do you do with financing fees?

Answer 21

You capitalize financing fees and then amortize them

Question 22

How do you model revenue synergies?

Answer 22

Assuming a price increase on units sold or assume additional volume sold

Question 23

How do you model expense synergies?

Answer 23

1) If you’re firing people, you can multiple the cost of each employee by how many you can let go

2) If you’re consolidating buildings you can just write off the expense of the building