Question

Hi Elizabeth. I appreciate you sharing those research findings with the class! When dealing with mergers and acquisitions, valuation becomes especially important as the company in the acquiring role wants to be sure to pay a fair price for the other company. Now, with that being said, the perceived fair value will often exceed the value of a company’s net assets thus creating goodwill on the books of the acquiring company. Class, when a company is making an acquisition, what are some reasons why they might be willing to pay more than the value of a company’s net assets?

Answer 1

Goodwill is excess of Purchase Consideration paid to the target company for the Net value of their asset. Hence goodwill is an intangible asset which can not be touched, seen, used in business but is in-identifiable from other assets. The question arises that why then the company making acqusition is ready to pay for such goodwill.

1.Market Base -  The company acquired have its own Customer Base in the market, Customer entrust their products as they had made a special recognition in its own market. For example, Vodafone acquired Hutch, Hutch then had already its customer base and hence vodafone does not need to bring customers to them as they already had hutch's customers. Hence Companies pay extra money for their Customer Market base..

2. Growth - The company acquired in an acqusition may have long term benefits. It may be profitable in future or the acquiring company thinks that with their involvement and their expertise, they can turn such business into more profitable business. Eg Walmart Inc(USA) recently acquired Flipkart Ltd(India) as they see growth potential in Flipkart and they expect to earn huge profits from such company as Flipkart is a leading e-commerce website in India after Amazon.

3. Brand Recognition - Extra amount is shelled out from pockets to acquire a recognised brand. As brand enjoys higher reputation in market and considered best amongst all, hence giving benefits to the acquring company. Eg Google Purchased Motorola in 2012 for $12.1 Billions and Facebook acquired whatspp for whopping $19 Billions as they were recognised brand at that time.

4. Greater Fair Value - Asset is carried at Book values or cost price in Books of accounts but it is quite possible that revaluation was not done previously. At time of acqusition, Price of Assets such as Lands, or Investments held by such company increases and hence fair values were used instead of book values which will result in Goodwill.