Firm a firm b working capital fixed assets total 4 16

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FIRM A FIRM B Working capital Fixed assets Total $ 4 16 $20 Equity Total $20 $20 Working capital Fixed assets Total $ 2 8 $10 Equity Total $10 $10 FIRM AB Working capital Fixed assets Goodwill Total $ 6 30 2 $38 Debt Equity Total $18 20 $38 The market value of the fixed assets of Firm B is $14 million. Firm A pays $18 million for Firm B by issuing debt. TABLE 21.1 Accounting for Acquisitions: Purchase (in millions) FIRM A FIRM B Working capital Fixed assets Total $ 4 16 $20 Equity Total $20 $20 Working capital Fixed assets Total $ 2 8 $10 Equity Total $10 $10 FIRM AB Working capital Fixed assets Total $ 6 24 $30 Equity Total $30 $30 TABLE 21.2 Accounting for Acquisitions: Pooling of Interests (in millions)
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7 More on Goodwill As we just discussed, the purchase method generally leads to the creation of an intangible asset called goodwill. Pre-2001 guidelines required fi rms to amortize this goodwill, meaning that a portion of it was deducted as an expense every year over some period of time. In essence, the goodwill, like any asset, had to be depreciated until it was completely written off. Despite the cash flow irrelevance of goodwill amortization, FASB’s decision to require purchase accounting caused a great deal of protest, much of it due to the treatment of goodwill and its impact on reported earnings. As a compromise, in 2001 FASB eliminated the requirement that goodwill be amortized and put in place a new rule. In essence, the new rule says that each year firms must assess the value of the goodwill on their balance sheets. If the value has gone down (or become “impaired” in accounting-speak), the firm must deduct the decrease; otherwise, no amortization is required. 2 1 . 4 G A I N S F R O M A C Q U I S I T I O N To determine the gains from an acquisition, we need to first identify the relevant incre- mental cash flows, or, more generally, the source of value. In the broadest sense, acquiring another firm makes sense only if there is some concrete reason to believe that the target firm will somehow be worth more in our hands than it is worth now. For example, in the ABN AMRO Holdings and Barclays merger we discussed at the beginning of the chapter, when the companies announced the merger, they issued a joint statement indicating that they expected synergies of 3.5 billion per year by 2010. As we will see, synergy is just one among a number of reasons why this might be so. Synergy Suppose Firm A is contemplating acquiring Firm B. The acquisition will be benefi cial if the combined fi rm will have value that is greater than the sum of the values of the separate fi rms. If we let V AB stand for the value of the merged firm, then the merger makes sense only if: V AB V A V B where V A and V B are the separate values of the two firms. A successful merger thus requires that the value of the whole exceed the sum of the parts.
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  • Spring '12
  • Scott
  • Firm, Firm B

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