Summary And Conclusions

This chapter has introduced you to the extensive literature on mergers and acquisitions.

We touched on a number of issues, including:

1. Forms of merger. One firm can acquire another in several different ways. The three legal forms of acquisition are merger or consolidation, acquisition of stock, and acquisition of assets.

2. Tax issues. Mergers and acquisitions can be taxable or tax-free transactions. The primary issue is whether the target firm's stockholders sell or exchange their shares. Generally, a cash purchase will be a taxable merger, whereas a stock exchange will not be taxable. In a taxable merger, there are capital gains effects and asset write-up effects to consider. In a stock exchange, the target firm's shareholders become shareholders in the merged firm.

3. Accounting issues. Accounting for mergers and acquisitions traditionally involved either the purchase method or the pooling of interests method. In 2001, pooling was eliminated as an option. As a result, a merger or acquisition will generally result in the creation of goodwill, but, under the new guidelines, goodwill does not have to be amortized.

4. Merger valuation. If Firm A is acquiring Firm B, the benefits (AV) from the acquisition are defined as the value of the combined firm (VAB) less the value of the firms as separate entities (VA and VB), or:

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VIII. Topics in Corporate Finance

25. Mergers and Acquisitions

© The McGraw-Hill Companies, 2002

PART EIGHT Topics in Corporate Finance

The gain to Firm A from acquiring Firm B is the increased value of the acquired firm, A V, plus the value of B as a separate firm, VB. The total value of Firm B to Firm A, VB, is thus:

An acquisition will benefit the shareholders of the acquiring firm if this value is greater than the cost of the acquisition.

The cost of an acquisition can be defined in general terms as the price paid to the shareholders of the acquired firm. The cost frequently includes a merger premium paid to the shareholders of the acquired firm. Moreover, the cost depends on the form of payment, that is, the choice between paying with cash or paying with common stock.

5. Benefits. The possible benefits of an acquisition come from several sources, including the following:

a. Revenue enhancement b. Cost reductions c. Lower taxes d. Reductions in capital needs

6. Defensive tactics. Some of the most colorful language of finance comes from defensive tactics used in acquisition battles. Poison pills, golden parachutes, crown jewels, and greenmail are terms that describe various antitakeover tactics.

7. Effect on shareholders. Mergers and acquisitions have been extensively studied. The basic conclusions are that, on average, the shareholders of target firms do very well, whereas the shareholders of bidding firms do not appear to gain very much.

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