Under business consolidation accounting, a merger or acquisition brings net assets of the target firm onto the balance sheet of the acquirer. Though the acquisition typically increases earnings, it reduces RNOA because of the increased NOA in the denominator. That’s in chapter 6 but with a much-expanded demonstration in chapter 11.
Again, here is the short-form valuation formula:
Adding a target’s NOA to the balance sheet reduces RNOA1. And it reduces  because NOA0 increases as well.
Here a typical path of RNOA for a mature pharmaceutical firm that had invested in R&D:
| 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | |
|---|---|---|---|---|---|---|
| RNOA | 25.0% | 27.4% | 29.1% | 14.2% | 15.7% | 16.4% |
| NOA | $50.7b | $52.4b | $53.0b | $76.8b | $77.1b | $81.1b |
With R&D investment missing from NOA in the balance sheet, RNOA is high from 2020-2022. But at the end of 2022, the firm acquired another pharmaceutical firm That reduces the RNOA because NOA increases.
The mistake is to see the decline in RNOA as a loss of value. No: Carry the Balance Sheet with You. In the valuation formula, the increase in NOA0 offsets the decline in RNOA and residual income. See the Procter and Gamble acquisition of Gillette in chapter 6 and chapter 11.
