Gabriel Aaron Dionne Week 1 homework assignment 4/11/2013 Chapter 1: Exercise 1-1, 1-2, and 1-3 Chapter 2: Exercises

2-3 and 2-9; Problems 2-2 and 2-6 EXERCISE 1-1 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 $1,200,000 Subtract: Additional depreciation on building ($960,000 30%) Targets adjusted earnings, 2008 912,000 Pretax income of Condominiums, Inc., 2009 $1,500,000 Subtract: Additional depreciation on building (288,000) Targets adjusted earnings, 2009 1,212,000 Pretax income of Condominiums, Inc., 2010 $950,000 Add: Extraordinary loss 300,000 Subtract: Additional depreciation on building (288,000) Targets adjusted earnings, 2010 962,000 Targets three year total adjusted earnings 3,086,000 Targets three year average adjusted earnings ($3,086,000 3) Excess earnings of target = $1,028,667 - $930,000 = $98,667 per year Present value of excess earnings (perpetuity) at 25%: = $394,668 (Estimated Goodwill) Implied offering price = $15,000,000 $8,800,000 + $394,668 = $6,594,668. 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. Requirement 1: Total net cash earnings for 5 years Less: Extraordinary gains Add: Nonrecurring cash losses Five-year cash earnings Period/years covered Annual Cash Earnings PVF of Ordinary Annuity (n=5, i=15%) a. PV of Cash Flows (Implied Value) / Offer Price Expected purchase price (implied value of Beta) Beta's Identifiable assets Beta's Liabilities (288,000)

1,028,667

$ $

850,000 (67,000) 48,000 831,000 5 166,200 3.35216 557,129 557,129 750,000 320,000

Beta's Net Assets at fair market value: b. Goodwill Requirement 2: Actual purchase price Fair value of Beta's net assets Goodwill recorded

430,000 127,129

625,000 430,000 195,000

EXERCISE 1-3 Part A Normal earnings for similar firms = $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. 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)], Or, Cost less fair value of net assets Goodwill = ($800,000 ($1,000,000 - $400,000)) = $200,000

Exercise 2-3: Pretzel Company acquired the assets (except for cash) and assumed the liabilities of Salt Company on January 2, 2005. As compensation, Pretzel Company gave 30,000 shares of its common stock, 15,000 shares of its 10% preferred stock, and cash of $50,000 to the stockholders of Salt Company. On the acquisition date, Pretzel Company stock had the following characteristics: Pretzel Company Stock Par Value Fair Value Common $ 10 $ 25 Preferred 100 100

Immediately prior to the acquisition, Salt Company's balance sheet reported the following book values and fair values: SALT COMPANY Balance Sheet January 2, 2005 Book Value Fair Value Cash $ 165,000 $ 165,000 Accounts receivable (net of $11,000 allowance) 220,000 198,000 Inventory - LIFO cost 275,000 330,000 Land 396,000 550,000 Buildings and equipment (net) 1,144,000 1,144,000 Total assets $ 2,200,000 $ 2,387,000 Current liabilities $ 275,000 $ 275,000 Bonds Payable, 10% 450,000 495,000 Common stock, $5 par value 770,000 Other contributed capital 396,000 Retained earnings 219,000 Total liabilities and stockholders' equity $ 2,110,000 Required: Prepare the journal entry on the books of Pretzel Company to record the acquisition of the assets and assumption of the liabilities of Salt Company. Step 1: Calculation of fair value of net assets acquired of Salt company Accounts receivables Inventory Land Buildings and equipment (net) Fair value of gross assets Less: Liabilities Current liabilities Bonds payable Fair value of net assets Calculation of goodwill, if any Acquisition price: 30,000 common shares @ $25 fair value 15,000 preferred shares @ $100 fair value Cash payment Total purchase price Less: Fair value of net assets of Salt Co. Goodwill Journal entry Date Account titles Debit Credit $198,000 $330,000 $550,000 $1,144,000 $2,222,000 ($275,000) ($495,000) $1,452,000

$750,000 $1,500,000 $50,000 $2,300,000 $1,452,000 $848,000

January 2, 2005

Accounts receivable (198000+11000) $209,000 Inventory $330,000 Land $550,000 Buildings & equipment (net) $1,144,000 Goodwill $848,000 Allowance for doubtful debts Current liabilities Bonds payable Common stock (30000 x $10 par) Additional paid in capital - Common (30000 x (25-10)) Preferred stock (15000 x $100 par) Cash

$11,000 $275,000 $495,000 $300,000 $450,000 $1,500,000 $50,000

Problem 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 $8,320,000 1,520,000 3,840,000 1,200,000 1,760,000 $8,320,000

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

Problem 2-9 Case A Cost (Purchase Price) Less: Fair Value of Net Assets Goodwill Case B Cost (Purchase Price)

$130,000 120,000 $ 10,000 $110,000

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

90,000 $ 20,000 $15,000 20,000 ($ 5,000)

Goodwill Case A Case B Case C Exercise 2-6 $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

The amount of the contingency is $500,000 (10,000 shares at $50 per share) Part A Part B Goodwill Paid-in-Capital for Contingent Consideration Paid-in-Capital for Contingent Consideration Common Stock ($10 par) Paid-In-Capital in Excess of Par 500,000 500,000 500,000 100,000 400,000

Platz Company does not adjust the original amount recorded as equity.