Homework week 1 1-18-2013 Exercise 1-1

Dawna Berry

ACC401

Professor Peter McDanel

Part A Normal earnings for similar firms = ($15,000,000 - $8,800,000) x 15% = $930,000 Expected earnings of target: Pretax income of Condominiums, Inc., 2008 Subtract: Additional depreciation on building ($960,000 30%) Targets adjusted earnings, 2008 Pretax income of Condominiums, Inc., 2009 Subtract: Additional depreciation on building Targets adjusted earnings, 2009 Pretax income of Condominiums, Inc., 2010 Add: Extraordinary loss Subtract: Additional depreciation on building Targets adjusted earnings, 2010 Targets three year total adjusted earnings Targets three year average adjusted earnings ($3,086,000 3) $1,200,000 (288,000) 912,000 $1,500,000 (288,000) 1,212,000 $950,000 300,000 (288,000) 962,000 3,086,000 1,028,667

Excess earnings of target = $1,028,667 - $930,000 = $98,667 per year

$98,667 = $394,668 (Estimated Goodwill) 25% Implied offering price = $15,000,000 $8,800,000 + $394,668 = $6,594,668.

Present value of excess earnings (perpetuity) at 25%:

Part B Excess earnings of target (same as in Part A) = $98,667 Present value of excess earnings (ordinary annuity) for three years at 15%: $98,667 2.28323 = $225,279 Implied offering price = $15,000,000 $8,800,000 + $225,279 = $6,425,279. Note: The sales commissions and depreciation on equipment are expected to continue at the same rate, and thus do not necessitate adjustments.

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Exercise 1-2 Part A Cumulative 5 years net cash earnings Add nonrecurring losses Subtract extraordinary gains Five-years adjusted cash earnings $831,000 Average annual adjusted cash earnings 5 $850,000 48,000 (67,000) $831,000 $166,200

(a) Estimated purchase price = present value of ordinary annuity of $166,200 (n=5, rate= 15%) $166,200 3.35216 = $557,129 (b) Less: Market value of identifiable assets of Beta Less: Liabilities of Beta Market value of net identifiable assets Implied value of goodwill of Beta Part B Actual purchase price Market value of identifiable net assets Goodwill purchased $750,000 320,000 430,000 $127,129 $625,000 430,000 $195,000

Exercise 1-3 Part A Normal earnings for similar firms (based on tangible assets only) = $1,000,000 x 12% = $120,000 Excess earnings = $150,000 $120,000 = $30,000 (1) (2) Goodwill based on five years excess earnings undiscounted. Goodwill = ($30,000)(5 years) = $150,000 Goodwill based on five years discounted excess earnings Goodwill = ($30,000)(3.6048) = $108,144 (present value of an annuity factor for n=5, I=12% is 3.6048) Goodwill based on a perpetuity Goodwill = ($30,000)/.20 = $150,000

(3) Part B

The second alternative is the strongest theoretically if five years is a reasonable representation of the excess earnings duration. It considers the time value of money and assigns a finite life. Alternative three also considers the time value of money but fails to assess a duration period for the excess earnings. Alternative one fails to account for the time value of money. Interestingly, alternatives one and three yield the same goodwill estimation and it might be noted that the assumption of an infinite life is not as absurd as it might sound since the present value becomes quite small beyond some horizon. Part C Goodwill = [Cost less (fair value of assets less the fair value of liabilities)], 1-2

Or, Cost less fair value of net assets Goodwill = ($800,000 ($1,000,000 - $400,000)) = $200,000 Exercise 2-2 Cash Receivables Inventories Plant and Equipment (net) ($3,840,000 + $720,000) Goodwill Total Assets Liabilities Common Stock, $16 par ($3,440,000 + (.50 $800,000)) Other Contributed Capital ($400,000 + $800,000) Retained Earnings Total Equities $680,000 720,000 2,240,000 4,560,000 120,000 1,520,000 3,840,000 1,200,000 1,760,000

Entries on Petrello Companys books would be: Cash Receivables Inventory Plant and Equipment Goodwill * Liabilities Common Stock (25,000 $16) Other Contributed Capital ($48 - $16) 25,000 200,000 240,000 240,000 720,000 120,000 320,000 400,000 800,000

* ($48 25,000) [($1,480,000 ($800,000 $720,000) $320,000] = $1,200,000 [$1,480,000 $80,000 $320,000] = $1,200,000 $1,080,000 = $120,000 Exercise 2-3 Accounts Receivable Inventory Land Buildings and Equipment Goodwill Allowance for Uncollectible Accounts ($231,000 - $198,000) Current Liabilities Bonds Payable Premium on Bonds Payable ($495,000 - $450,000) Preferred Stock (15,000 $100) Common Stock (30,000 $10) Other Contributed Capital ($25 - $10) 30,000 Cash 1-3 231,000 330,000 550,000 1,144,000 848,000 33,000 275,000 450,000 45,000 1,500,000 300,000 450,000 50,000

Cost paid ($1,500,000 + $750,000 + $50,000) = $2,300,000 Fair value of net assets (198,000 + 330,000 + 550,000 + 1,144,000 275,000 495,000) = 1,452,000 Goodwill = $848,000

Exercise 2-4
Cash Receivables Inventory Land Plant and Equipment Goodwill* Accounts Payable Bonds Payable Premium on Bonds Payable** Cash ** Present value of maturity value, 12 periods @ 4%: Present value of interest annuity, 12 periods @ 4%: Total present value Par value Premium on bonds payable 0.6246 $480,000 = 9.38507 $24,000 = 96,000 55,200 126,000 198,000 466,800 137,450 44,400 480,000 45,050 510,000 $299,808 225,242 525,050 480,000 $ 45,050 $510,000 (373,200) 136,800

*Cash paid Less: Book value of net assets acquired ($897,600 $44,400 $480,000) Excess of cash paid over book value Increase in inventory to fair value (15,600) Increase in land to fair value (28,800) Increase in bond to fair value 45,050 Total increase in net assets to fair value Goodwill

650 $137,450

Exercise 2-6 The amount of the contingency is $500,000 (10,000 shares at $50 per share)

Part A

Goodwill Paid-in-Capital for Contingent Consideration

500,000 500,000 500,000 100,000 1-4

Part B

Paid-in-Capital for Contingent Consideration Common Stock ($10 par)

Paid-In-Capital in Excess of Par Platz Company does not adjust the original amount recorded as equity. Exercise 2-9 Case A Cost (Purchase Price) Less: Fair Value of Net Assets Goodwill Case B Cost (Purchase Price) Less: Fair Value of Net Assets Goodwill Case C Cost (Purchase Price) Less: Fair Value of Net Assets Gain Assets Current Assets $20,000 30,000 20,000 $130,000 120,000 $ 10,000 $110,000 90,000 $ 20,000 $15,000 20,000 ($ 5,000)

400,000

Goodwill Case A Case B Case C $10,000 20,000 0

Long-Lived Assets $130,000 80,000 40,000

Liabilities $30,000 20,000 40,000

Retained Earnings (Gain) 0 0 5,000

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