CH1&2 Homework Answers
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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 $1,200,000Subtract: Additional depreciation on building ($960,000 30%) (288,000)Target’s adjusted earnings, 2008 912,000
Pretax income of Condominiums, Inc., 2009 $1,500,000Subtract: Additional depreciation on building (288,000)Target’s adjusted earnings, 2009 1,212,000
Pretax income of Condominiums, Inc., 2010 $950,000Add: Extraordinary loss 300,000Subtract: Additional depreciation on building (288,000)Target’s adjusted earnings, 2010 962,000Target’s three year total adjusted earnings 3,086,000Target’s three year average adjusted earnings ($3,086,000 3) 1,028,667
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 850,000
Less: Extraordinary gains (67,000)
Add: Nonrecurring cash losses 48,000
Five-year cash earnings 831,000Period/years covered 5
Annual Cash Earnings $ 166,200
PVF of Ordinary Annuity (n=5, i=15%) 3.35216
a. PV of Cash Flows (Implied Value) / Offer Price $ 557,129
Expected purchase price (implied value of Beta) 557,129
Beta's Identifiable assets 750,000
Beta's Liabilities 320,000
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Beta's Net Assets at fair market value: 430,000
b. Goodwill $ 127,129
Requirement 2:
Actual purchase price 625,000
Fair value of Beta's net assets 430,000
Goodwill recorded $ 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) Goodwill based on five years excess earnings undiscounted.Goodwill = ($30,000)(5 years) = $150,000
(2) Goodwill based on five years discounted excess earningsGoodwill = ($30,000)(3.6048) = $108,144
(present value of an annuity factor for n=5, I=12% is 3.6048)
(3) Goodwill based on a perpetuityGoodwill = ($30,000)/.20 = $150,000
Part BThe second alternative is the strongest theoretically if five years is a reasonable representation of the excessearnings 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 thetime value of money. Interestingly, alternatives one and three yield the same goodwill estimation and itmight be noted that the assumption of an infinite life is not as absurd as it might sound since the presentvalue 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 theacquisition date, Pretzel Company stock had the following characteristics:
Pretzel CompanyStock Par Value Fair ValueCommon $ 10 $ 25Preferred 100 100
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Immediately prior to the acquisition, Salt Company's balance sheet reported the following book values andfair values:
SALT COMPANYBalance SheetJanuary 2, 2005
Book Value Fair ValueCash $ 165,000 $ 165,000Accounts receivable (net of $11,000 allowance) 220,000 198,000Inventory - LIFO cost 275,000 330,000Land 396,000 550,000Buildings and equipment (net) 1,144,000 1,144,000Total assets $ 2,200,000$ 2,387,000
Current liabilities $ 275,000 $ 275,000Bonds Payable, 10% 450,000 495,000Common stock, $5 par value 770,000
Other contributed capital 396,000Retained earnings 219,000Total 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 andassumption of the liabilities of Salt Company.
Step 1: Calculation of fair value of net assets acquired of Salt company
Accounts receivables $198,000
Inventory $330,000
Land $550,000
Buildings and equipment (net) $1,144,000
Fair value of gross assets $2,222,000
Less: Liabilities
Current liabilities ($275,000)
Bonds payable ($495,000)
Fair value of net assets $1,452,000
Calculation of goodwill, if any
Acquisition price:
30,000 common shares @ $25 fair value $750,000
15,000 preferred shares @ $100 fair value $1,500,000Cash payment $50,000
Total purchase price $2,300,000
Less: Fair value of net assets of Salt Co. $1,452,000
Goodwill $848,000
Journal entry
Date Account titles Debit Cred
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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 $11,
Current liabilities $275,
Bonds payable $495,
Common stock (30000 x $10 par) $300,
Additional paid in capital - Common (30000 x (25-10)) $450,
Preferred stock (15000 x $100 par) $1,500,
Cash $50,
Problem 2-2
Cash $680,000Receivables 720,000
Inventories 2,240,000Plant and Equipment (net) ($3,840,000 + $720,000) 4,560,000Goodwill 120,000
Total Assets $8,320,000
Liabilities 1,520,000
Common Stock, $16 par ($3,440,000 + (.50 × $800,000)) 3,840,000
Other Contributed Capital ($400,000 + $800,000) 1,200,000Retained Earnings 1,760,000
Total Equities $8,320,000
Entries on Petrello Company’s books would be:
Cash 200,000Receivables 240,000Inventory 240,000Plant and Equipment 720,000Goodwill * 120,000
Liabilities 320,000
Common Stock (25,000 × $16) 400,000
Other Contributed Capital ($48 - $16) × 25,000 800,000
Problem 2-9
Case A
Cost (Purchase Price) $130,000Less: Fair Value of Net Assets 120,000Goodwill $ 10,000
Case B
Cost (Purchase Price) $110,000
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Less: Fair Value of Net Assets 90,000Goodwill $ 20,000
Case C
Cost (Purchase Price) $15,000Less: Fair Value of Net Assets 20,000Gain ($ 5,000)
AssetsLiabilities Retained E
(GainGoodwill Current Assets Long-Lived Assets
Case A $10,000 $20,000 $130,000 $30,000Case B 20,000 30,000 80,000 20,000Case C 0 20,000 40,000 40,000 5,00
Exercise 2-6
The amount of the contingency is $500,000 (10,000 shares at $50 per share)
Part A Goodwill 500,000Paid-in-Capital for Contingent Consideration 500,0
Part B Paid-in-Capital for Contingent Consideration 500,000Common Stock ($10 par) 100,0
Paid-In-Capital in Excess of Par 400,0
Platz Company does not adjust the original amount recorded as equity.