Explain why the target's historical equity accounts are eliminated on the pro forma balance sheet rather than combined with the acquirer's.
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The answer
The target's entire historical equity section is eliminated because it represents the claims of the former shareholders, who are being bought out in the deal. I do not combine it with the acquirer's equity because an acquisition resets the basis of the target's net assets at fair value.
The acquirer pays consideration to acquire those net assets, and that consideration, whether cash, debt, or new shares, becomes the new source of funding on the pro forma balance sheet. The target's retained earnings, APIC, and common stock all belong to the sellers; they do not survive the transaction.
Instead, the acquirer's equity stays intact, and any new shares issued to target shareholders get added to the acquirer's common stock and APIC at deal close value. Leaving the target's historical equity on the combined balance sheet would double-count the cost of the acquisition and overstate equity.
So I wipe it out completely, letting the purchase price, fair-value write-ups, and new goodwill capture the economic value paid. Goodwill is solved last as the residual that balances the sheet after all other adjustments, and it replaces any target goodwill that existed. That way, the pro forma balance sheet reflects only the acquirer's post-deal capital structure.
Accretion / dilution
| Acquirer standalone net income | 300 |
| + Target net income | 80 |
| + After-tax synergies | 15 |
| − After-tax incremental interest | (10) |
| Pro forma combined net income | 385 |
| Acquirer standalone EPS | $3.00 |
| Pro forma share count | 125 |
| Pro forma EPS | $3.08 |
| Accretion | 2.7% |
Also asked as
- Starting from an acquirer's and a target's standalone balance sheets, list in order the adjustments needed to build the pro forma combined balance sheet for a deal.
- Acquirer has $200M cash and $600M other assets, no debt, $700M equity. Target has $40M cash, $260M other assets (fair value = book), $300M equity. Acquirer pays $300M cash for the target (no premium). Build the combined balance sheet and confirm it balances.
- Distinguish how advisory/legal fees versus new-debt financing fees are treated on the pro forma balance sheet, and explain the accounting rationale for the difference.
- Explain the difference between a fixed-exchange-ratio stock deal and a fixed-value stock deal in terms of which party bears the risk of the acquirer's share price moving between signing and close.
- What is the ASC 805 'measurement period,' and how does a fair-value revision discovered within that period get reflected on the balance sheet differently than one discovered after it closes?
- Acquirer pays $700M for a target: $400M new debt, $200M new stock issued at fair value, $100M cash. Target's book equity is $280M including $30M of old goodwill. PPA: PP&E write-up $40M, new intangibles $110M, tax rate 25% (stock deal). A $12M advisory fee is expensed in cash and a $6M financing fee is capitalized. Build the full pro forma balance sheet adjustments (goodwill, DTL, cash, equity) and confirm the balance sheet balances.
- A fixed-value stock deal promises target shareholders $600M of stock. At signing the acquirer trades at $30/share; at close it trades at $24/share. Compute the number of shares issued at close, explain the dilution consequence for the acquirer's existing shareholders relative to the signing-date expectation, and explain how a collar could have limited this outcome.
- A deal includes a $40M net working capital peg. Actual closing NWC comes in $15M above the peg, increasing the purchase price by $15M paid in cash at close. Separately, nine months later (within the measurement period), an appraisal revises a PP&E write-up down by $10M. Walk through both adjustments' effects on goodwill, explaining why they are mechanically distinct even though both ultimately move the same line.
- An acquirer sizes new acquisition debt as 4.0x pro forma EBITDA, where pro forma EBITDA includes run-rate cost synergies that are themselves an assumption in the model, and the resulting debt quantum feeds into the purchase price the target will accept. Explain why this creates circularity in the pro forma balance sheet build and describe how you would resolve it in a live Excel model.
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The rest of this topic
Purchase accounting: goodwill, write-ups and the tax basis