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



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



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



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



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.

CH1&2 Homework Answers

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