Profitable Growth by Acquisition 583stockholders on the other hand, have seen the postmerger value of the
Daimler-Benz shares they received fall by 60%.- Overvaluation:An increase in the acquirer ’s stock price, especially for
technology firms, may leave its shares overvalued historically and even in
the opinion of management. In this case, the acquirer can get more value
using shares for the acquisition rather than cash. However, investors may
anticipate this and view the stock acquisition as a signal that the ac-
quirer ’s shares are overpriced. - Taxes: In a cash deal, the target firm’s shareholders will owe capital gains
taxes on the proceeds. By exchanging shares, the transaction is tax-free (at
least until the target firm stockholders choose to sell their newly acquired
shares of the bidder). Taxes may be an important consideration in deals
where the target is private or has a few large shareholders, as Example 6
makes clear.
Often firms will make offers using a combination of stock and cash. In a study
of large mergers between 1992 and 1998, only 22% of the deals were cash-only.
Stock only (60%) and combination cash and stock (18%) accounted for the vast
majority of the deals.^15 This contrasts with the 1980s when many deals were
cash offers financed by the issuance of junk bonds. The acquirer ’s financial ad-
visor or investment banker can help sort through these factors to maximize the
gains to shareholders.
Example 6 Sarni Inc. began operations 10 years ago as an excavating com-
pany. Jack Sarni, the principal and sole shareholder, purchased equipment (a
truck and bulldozer) at that time for $40,000. The equipment had a six-year
useful life and has been depreciated to a book value of zero. However, the ma-
chinery has been well maintained and because of inf lation, has a current mar-
ket value of $90,000. The business has no other assets and no debt.
Pave-Rite Inc. makes an offer to acquire Sarni for $90,000. If the deal is
a cash deal, Jack Sarni will immediately owe tax on $50,000, the difference be-
tween the $90,000 he receives and his initial investment of $40,000. If he in-
stead accepts shares of Pave-Rite Inc. worth $90,000 in a tax-free acquisition,
there is no immediate tax liability. He will only owe tax if and when he sells the
Pave-Rite shares. Of course in this latter case, Sarni assumes the risk that
Pave-Rite’s shares may fall in value.
Purchase versus Pooling Accounting
The purchase methodrequires the acquiring corporation to allocate the pur-
chase price to the assets and liabilities it acquires. All identifiable assets and
liabilities are assigned a value equal to their fair market value at the date of ac-
quisition. The difference between the sum of these fair market values and the
purchase price paid is called goodwill.Goodwill appears on the acquirer ’s
books as an intangible asset and is amortized,or written off as a noncash