Seagram Company Ltd. is a Canadian corporation whose shares trade on the NYSE and on the majorCanadian exchanges. Seagram is principally engaged in the production and worldwide marketing ofdistilled spirits, wines, fruit juices, and other beverages.

E.I. du Pont de Nemours and Company (Du Pont), the largest U.S. chemical producer and one ofthe leading chemical producers worldwide, concentrates in industrial chemicals, fibers, and polymers,as well as various petroleum products.

In 1981 Seagram became involved in a bidding war with Du Pont for controlling interest inConoco, a major oil company. Du Pont eventually gained control of Conoco but had to swap slightlyover 20% of its own shares to get the Conoco shares Seagram had already accumulated at an invest-ment of nearly $3 billion. As part of the exchange agreement (subsequently amended in 1986), DuPont has the right to designate two nominees to the Seagrams board of directors, and Seagram has theright to designate 25% of the members of the Du Pont board. Other details about the agreementappear in footnote 1 of the Seagram 1988 Annual Report reproduced next.

Note 1: Equity in Du Pont

The Company owns 54.7 million shares (approximately 22.9%) of the outstanding common stock ofE.I. du Pont de Nemours and Company (Du Pont). The Company and Du Pont have entered into anagreement providing for mutual board representation and other matters concerning their future rela-tionship. Subject to certain conditions, the Company will not as a general matter exceed a 25% holdingof Du Pont voting stock, and Du Pont will have a right of first refusal if the Company offers its Du Pontshares for sale or transfer during the term of the agreement. The Company may terminate the agree-ment upon the occurrence of specified events, including dilution of the Companys stock position.

The Company accounts for its interest in Du Pont using the equity method whereby its pro-portionate share of Du Pont earnings is included in income. The $401 million excess at acquisitionof the Companys carrying value above the equity in Du Pont net assets was allocated primarily toDu Pont LIFO inventory. The portion allocated to property, plant, and equipment and long-termborrowings is being amortized over varying periods, none exceeding fifteen years.

Summarized financial information for Du Pont, based upon its publicly reported financialstatements, follows:

Years Ended December 31($ in millions) 1987 1986 1985

Sales $30,468 $27,148 $29,483Cost of goods sold and other expenses 27,132 24,436 26,670Net income $ 1,786 $ 1,538 $ 1,118

December 31,($ in millions) 1987 1986

Current assets $ 9,953 $ 8,960Noncurrent assets 18,256 17,773

$28,209 $26,733

Current liabilities $ 6,140 $ 5,636Noncurrent liabilities 7,825 7,723Stockholders equity 14,244 13,374

$28,209 $26,733

Information regarding dividends from Du Pont and the Companys accounting for unremittedDu Pont earnings follows:

Ended January 31($ in thousands) 1988 1987 1986

Dividends received from Du Pont $179,481 $165,511 $162,017Income tax provided 14,114 11,420 11,179

$165,367 $154,091 $150,838Interest expense allocated against

unremitted Du Pont earnings $ 11,192 $ 10,662 $ 11,557Income tax benefit 4,415 4,853 4,111

$ 6,777 $ 5,809 $ 7,446

CHAPTER 16 Intercorporate Equity Investments 16-1

C16 8

The Seagram Company Ltd.:Equity method

16-2 CHAPTER 16 Intercorporate Equity Investments

Cumulative unremitted Du Pont earnings of $778.8 million are included in consolidated retained

earnings at January 31, 1988; no provision for taxes has been made in view of available options for

realization.

The following financial statements for Seagram and Du Pont will be used to answer the questionsposed at the end of the case.

The Seagram Company Ltd.

(Incorporated under the Canada Business Corporations Act) and Subsidiary Companies Consolidated Statement of Income

Twelve Months Ended January 31(U.S. $ in thousands) 1988 1987 1986

Sales and other income $3,815,480 $3,344,820 $2,970,669Cost of goods 2,436,640 2,189,628 1,940,993

1,378,840 1,155,192 1,029,676Selling, general, and administrative expenses 1,093,127 927,360 815,021Restructuring costs 35,000Operating income 285,713 192,832 214,655Interest expense 80,397 84,294 82,013Income before income taxes 205,316 108,538 132,642Provision for income taxes 60,801 5,715 33,417Income from spirits and wine operations 144,515 102,823 99,225Interest expense related to share repurchase,

after income taxes (2,513) (6,683)Dividend income from E.I. du Pont de Nemours

and Company, after income taxes 165,367 154,091 150,838Equity in unremitted earnings of E.I. du Pont de

Nemours and Company 211,206 169,057 75,694Net income $ 521,088 $ 423,458 $ 319,074

The Seagram Company LTD. and Subsidiaries Consolidated Balance Sheet

January 31(U.S. $ in thousands) 1988 1987

AssetsCurrent assetsCash and short-term investments at cost, which

approximates market $ 633,748 $ 593,590Receivables 713,917 590,155Inventories 1,535,464 1,250,029Prepaid expenses 67,226 48,110Wine company assets held for sale 220,000

Total current assets 2,950,355 2,701,884Common stock of E.I. du Pont de Nemours and Company 3,587,455 3,329,727Note receivable from Sun Company, Inc. 20,250 51,000Property, plant, and equipment, at cost 1,006,673 842,593Accumulated depreciation (404,305) (343,634)

602,368 498,959Investments and advancesspirits and wine companies 155,610 76,686Sundry assets, including excess of cost over net assets of

companies acquired 227,427 228,206Total assets $7,543,465 $6,886,462

CHAPTER 16 Intercorporate Equity Investments 16-3

January 31(U.S. $ in thousands) 1988 1987

Liabilities and shareholders equityCurrent liabilitiesShort-term borrowings $ 522,310 $ 460,410United States excise taxes 62,558 61,047Payables and accrued liabilities 587,915 450,780Income and other taxes 154,127 57,637Indebtedness payable within one year 66,774 72,420

Total current liabilities 1,393,684 1,102,294Long-term indebtedness 1,057,981 911,764Deferred income taxes and other credits 601,775 882,040

Minority interest 32,510 34,804

Shareholders equityShares without par value 198894,786,225 shares;

198795,494,856 shares 276,417 257,368Share purchase warrants 27,275 27,679Cumulative currency translation adjustments (105,922) (228,456)Retained earnings 4,259,745 3,898,969

Total shareholders equity 4,457,515 3,955,560Total liabilities and shareholders equity $7,543,465 $6,886,462

E.I. Du Pont

Consolidated Income Statement($ in millions, except per share) 1987 1986 1985

Sales $30,468 $27,148 $29,483Other income 324 273 382Total 30,792 27,421 29,865Cost of goods sold and other operating charges 17,150 15,129 17,898Selling, general and administrative expenses 2,716 2,350 2,077Depreciation, depletion, and amortization 2,225 2,119 1,796Exploration expenses, including dry hole costs and

impairment of unproved properties 459 550 561Research and development expense 1,223 1,156 1,144Interest and debt expense 435 438 513Taxes other than on income 3,085 2,656 2,282Gains from sales of businesses (161) (140) (27)Loss on restructuring of investments 178 226Early retirement program expense 200

Total 27,132 24,436 26,670

Earnings before income taxes 3,660 2,985 3,195Provision for income taxes 1,874 1,447 2,077Net income $ 1,786 $ 1,538 $ 1,118

Required:1. Explain the basis or rationale for Seagrams use of the equity method to account for its investment

in Du Pont.2. Given that Seagram uses the equity method to account for its investment in Du Pont, how do you

explain the dividend income from Du Pont shown on Seagrams income statement? Is this consis-tent with the way Seagram recorded its share of Du Pont earnings? Explain.

3. Note 1 indicates that Seagram effectively paid $401 million in excess of net book value of the DuPont shares at the time of acquisition. How much of this excess was amortized to earnings by Sea-gram in 1988? (Show the details.)

4. Reconcile the beginning and ending balances of Seagrams investment in Du Pont that appears onSeagrams balance sheet (i.e., explain the change in this account balance) for 1988.

5. Evaluate the return on assets that Seagram is earning on its own wine and spirits operationagainst the return on its investment in Du Pont. Which appears most profitable?

16-4 CHAPTER 16 Intercorporate Equity Investments

C16 9

Tyler Corporation (1):Business acquisitions andanalysis of sales growth

The narrative portions of corporate annual financial reports (including footnote explanations andother qualitative disclosures) represent an important source of information for understanding the pastoperations and for evaluating the future prospects of publicly held companies. Corporate managersconsider these disclosures to be an important vehicle for informing present and prospective investorsabout managerial performance, strategies, and plans.

This emphasis is typified in the 1979 Annual Report of Tyler Corporation, then a Fortune 500company headquartered in Dallas. In the presidents letter included in the 1979 report, Joseph P. McK-inney made the following observations on the companys performance in that year:

For Tyler Corporation, 1979 was another year of growth, markingon a historically reportedbasisthe ninth consecutive year of record sales, net income, and earnings per share.

At the close of 1979, Tylers operations encompassed four separate divisions: (1) Tyler Pipe, aleading manufacturer of pipe, fittings, and related applications in commercial, industrial, and residen-tial construction; (2) C&H Transportation, the nations largest carrier of heavy and cumbersomeitems; (3) Atlas Powder, ranked second in sales among domestic manufacturers of commercial andindustrial explosives; and (4) Thurston Motor Lines, a leading general commodity carrier that wasacquired in April of 1979 for a cash payment of $45.5 million.

The acquisition of Thurston was accounted for using the purchase method of accounting. Cer-tain data relating to the acquisition were reported in the following note to the consolidated financialstatements.

Acquisition of General Commodity Carrier

On April 6, 1979 the Company acquired all the business and assets of Thurston, Inc. for approxi-mately $45,500,000 cash. The acquisition is being accounted for by the purchase method ofaccounting. The consolidated statement of income includes sales of $74,234,000 and incomebefore taxes of $2,438,000 of the general commodity carrier since April 6, 1979. Since acquisition,the operating results of the general commodity carrier, after deduction for interest expense onfunds borrowed at the prime rate and invested in the operation, reduced earnings per share by$0.10. The excess of the purchase price over the fair value of the assets acquired was approximately$9,300,000 and is being amortized by the straight-line method over 40 years.

The following information summarizes the combined operating results of the acquired busi-ness and the Company for the years ended December 31, 1978 and 1979 on a pro forma basis asthough the business was acquired January 1, 1978.

1978 1979

Net sales $480,048,000 $540,327,000Net income 25,069,000 23,012,000Earnings per common share $2.33 $2.29

Sales growth received heavy attention in three separate sections of the narrative in Tylers annualreport. First, the third paragraph of the presidents letter included the following information:

Net income gained 2% to $23.5 million and total sales were 33% higher at $519.2 million.

Second, the Highlights section of the report prominently emphasized the 33% sales increase over1978 as follows:

Among the significant events and achievements of 1979 were:

ninth consecutive year of record sales and profits; increase of 33% in net sales, which for the first time exceeded one-half billion dollars.

CHAPTER 16 Intercorporate Equity Investments 16-5

Third, the Operations review included the following comments:

Sales jumped 33% in 1979, of which $74 million was contributed by the addition of Thurston andthe remaining $54 million by the other three operations. Over the last nine years, sales haveincreased at a compounded annual rate of 17% and operating profits at a compounded rate of19%.

Tylers consolidated statements of income for 1978 and 1979 follow:

Tyler Corporation

Consolidated Statements of IncomeYears Ended December 31

1978 1979

Net sales $390,873,000 $519,242,000Costs and expenses

Cost of sales 308,164,000 423,946,000Selling, administrative, and

general expenses 35,412,000 41,754,000Interest expense 4,986,000 11,212,000

348,562,000 476,912,000Income before income tax 42,311,000 42,330,000Income tax 19,252,000 18,873,000Net income $ 23,059,000 $ 23,457,000

Earnings per common share $2.14 $2.34Average shares outstanding 10,764,000 10,040,000

Required:1. As a lending officer at Gotham National Bank, you have been asked to prepare a cash flow forecast

for Tyler Corporation for 1980. You begin with a sales forecast, believing that this is one of the keydrivers of cash flow forecast accuracy. Given available data, what is your best estimate of the sus-tainable growth in sales between 1978 and 1979?

2. If Tyler had acquired Thurston in a stock-for-stock exchange, would the comparative incomestatement sales and other numbers be different from those shown earlier? Explain how.

3. Comment on Tylers repeated reference to 33% sales growth.