Merger Model Advanced Exam
Questions and Answers
What's the purpose of Purchase Price Allocation in an M&A deal? Can you explain how
it works? ✅The ultimate purpose is to make the combined Balance Sheet balance
This harder than it sounds because many items get adjusted up or down (e.g. PP&E),
some items disappear altogether (e.g. the seller's Shareholders' Equity), and some new
items get created (e.g. Goodwill).
To complete the process, you look at every single item on the seller's Balance Sheet
and then assess the fair market values of all those items, adjusting them up or down as
necessary.
So if the buyer pays, say, $1 billion for the seller, you figure out how much of that $1
billion gets allocated to each Asset on the Balance Sheet.
Goodwill (and Other Intangible Assets) serves as the "plug" and ensures that both sides
balance you've made all the adjustments. Goodwill is roughly equal to the Equity
Purchase Price minus the seller's Shareholders' Equity and other adjustments.
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 + Intercompany Accounts Receivable - Intercompany Accounts Payable
Couple notes:
-Sellers Book value is just the Shareholders' Equity number (technically, the
Common Shareholders' Equity number).
-You add the Seller's Existing Goodwill because it is "reset" and written
down to $0 in an M&A deal.
-You subtract the Asset Write-Ups because these are additions to the
Assets side of the Balance Sheet - Goodwill is also an asset, so effectively
you need less Goodwill to "plug the hole."
-Normally you assume 100% of the Seller's existing DTL is written down.
-The seller's existing DTA may or may not be written down completely
-You add Intercompany Accounts Receivable because they go away, which
reduces the Assets side; the opposite applies for Intercompany AP.
Why do we adjust the values of Assets such as PP&E in an M&A deal? ✅Why do we
adjust the values of Assets such as PP&E in an M&A deal?
Investments, Inventory, and other Assets may have also "drifted" from their fair
, market values since the Balance Sheet is recorded at historical cost for companies
in most industries (exceptions, such as commercial banking, do exist).
What's the logic behind Deferred Tax Liabilities and Deferred Tax Assets? ✅The basic
idea is that you normally write down most of the seller's existing DTLs
and DTAs to "reset" its tax basis, since it's now part of another entity
And then you may create new DTLs or DTAs if there are Asset Write-Ups or
Write-Downs and the book and tax Depreciation and Amortization numbers
differ.
If there are write-ups, a Deferred Tax Liability will be created in most deals since
the Depreciation on the write-ups is not tax-deductible, which means that the
company will pay more in cash taxes; the opposite applies for write-downs and
there, a Deferred Tax Asset would be created.
How do you treat items like Preferred Stock, Noncontrolling Interests, Debt,
and so on, and how do they affect Purchase Price Allocation? ✅Normally you build in
the option to repay (or in the case of Noncontrolling
Interests, purchase the remainder of) these items or assume them in the Sources
& Uses schedule.
If you repay them, additional cash/debt/stock is required to purchase the seller.
However, that choice does not affect Purchase Price Allocation.
You always start with the Equity Purchase Price there, which excludes the
treatment of all these items.
Also, you only use the seller's Common Shareholders' Equity in the PPA schedule,
which excludes Preferred Stock and Noncontrolling Interests.
So do you use Equity Value or Enterprise Value for the Purchase Price in a merger
model? ✅This is a trick question because neither one is entirely accurate. The PPA
schedule is based on the Equity Purchase Price, but the actual amount of
cash/stock/debt used is based on that Equity Purchase Price plus the additional funds
needed to repay debt, pay for transaction-related fees, and so on.
That number is not exactly "Enterprise Value" - it's something in between Equity Value
and Enterprise Value, and it's normally labeled "Funds Required" in a model.
How do you reflect transaction costs, financing fees, and miscellaneous
expenses in a merger model? ✅You expense transaction and miscellaneous fees
(such as legal and accounting
services) upfront and capitalize the financing fees and amortize them over the
term of the debt.
Questions and Answers
What's the purpose of Purchase Price Allocation in an M&A deal? Can you explain how
it works? ✅The ultimate purpose is to make the combined Balance Sheet balance
This harder than it sounds because many items get adjusted up or down (e.g. PP&E),
some items disappear altogether (e.g. the seller's Shareholders' Equity), and some new
items get created (e.g. Goodwill).
To complete the process, you look at every single item on the seller's Balance Sheet
and then assess the fair market values of all those items, adjusting them up or down as
necessary.
So if the buyer pays, say, $1 billion for the seller, you figure out how much of that $1
billion gets allocated to each Asset on the Balance Sheet.
Goodwill (and Other Intangible Assets) serves as the "plug" and ensures that both sides
balance you've made all the adjustments. Goodwill is roughly equal to the Equity
Purchase Price minus the seller's Shareholders' Equity and other adjustments.
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 + Intercompany Accounts Receivable - Intercompany Accounts Payable
Couple notes:
-Sellers Book value is just the Shareholders' Equity number (technically, the
Common Shareholders' Equity number).
-You add the Seller's Existing Goodwill because it is "reset" and written
down to $0 in an M&A deal.
-You subtract the Asset Write-Ups because these are additions to the
Assets side of the Balance Sheet - Goodwill is also an asset, so effectively
you need less Goodwill to "plug the hole."
-Normally you assume 100% of the Seller's existing DTL is written down.
-The seller's existing DTA may or may not be written down completely
-You add Intercompany Accounts Receivable because they go away, which
reduces the Assets side; the opposite applies for Intercompany AP.
Why do we adjust the values of Assets such as PP&E in an M&A deal? ✅Why do we
adjust the values of Assets such as PP&E in an M&A deal?
Investments, Inventory, and other Assets may have also "drifted" from their fair
, market values since the Balance Sheet is recorded at historical cost for companies
in most industries (exceptions, such as commercial banking, do exist).
What's the logic behind Deferred Tax Liabilities and Deferred Tax Assets? ✅The basic
idea is that you normally write down most of the seller's existing DTLs
and DTAs to "reset" its tax basis, since it's now part of another entity
And then you may create new DTLs or DTAs if there are Asset Write-Ups or
Write-Downs and the book and tax Depreciation and Amortization numbers
differ.
If there are write-ups, a Deferred Tax Liability will be created in most deals since
the Depreciation on the write-ups is not tax-deductible, which means that the
company will pay more in cash taxes; the opposite applies for write-downs and
there, a Deferred Tax Asset would be created.
How do you treat items like Preferred Stock, Noncontrolling Interests, Debt,
and so on, and how do they affect Purchase Price Allocation? ✅Normally you build in
the option to repay (or in the case of Noncontrolling
Interests, purchase the remainder of) these items or assume them in the Sources
& Uses schedule.
If you repay them, additional cash/debt/stock is required to purchase the seller.
However, that choice does not affect Purchase Price Allocation.
You always start with the Equity Purchase Price there, which excludes the
treatment of all these items.
Also, you only use the seller's Common Shareholders' Equity in the PPA schedule,
which excludes Preferred Stock and Noncontrolling Interests.
So do you use Equity Value or Enterprise Value for the Purchase Price in a merger
model? ✅This is a trick question because neither one is entirely accurate. The PPA
schedule is based on the Equity Purchase Price, but the actual amount of
cash/stock/debt used is based on that Equity Purchase Price plus the additional funds
needed to repay debt, pay for transaction-related fees, and so on.
That number is not exactly "Enterprise Value" - it's something in between Equity Value
and Enterprise Value, and it's normally labeled "Funds Required" in a model.
How do you reflect transaction costs, financing fees, and miscellaneous
expenses in a merger model? ✅You expense transaction and miscellaneous fees
(such as legal and accounting
services) upfront and capitalize the financing fees and amortize them over the
term of the debt.
