1-1

ANSWERS TO WEEK 1 HOMEWORK

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%) (288,000)
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) 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.

Note: The sales commissions and depreciation on equipment are expected to continue at the
same rate, and thus do not necessitate adjustments.
%
, $
25
667 98
1-2
Exercise 1-2

Part A Cumulative 5 years net cash earnings $850,000
Add nonrecurring losses 48,000
Subtract extraordinary gains (67,000)
Five-years adjusted cash earnings $831,000
Average annual adjusted cash earnings $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 $750,000
Less: Liabilities of Beta 320,000
Market value of net identifiable assets 430,000
Implied value of goodwill of Beta $127,129

Part B Actual purchase price $625,000
Market value of identifiable net assets 430,000
Goodwill purchased $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) Goodwill based on five years excess earnings undiscounted.
Goodwill = ($30,000)(5 years) = $150,000

(2) 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)

(3) Goodwill based on a perpetuity
Goodwill = ($30,000)/.20 = $150,000
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)],
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000 831, $
1-3
Or, Cost less fair value of net assets
Goodwill = ($800,000 ($1,000,000 - $400,000)) = $200,000

Exercise 2-3

Accounts Receivable 231,000
Inventory 330,000
Land 550,000
Buildings and Equipment 1,144,000
Goodwill 848,000
Allowance for Uncollectible Accounts ($231,000 - $198,000) 33,000
Current Liabilities 275,000
Bonds Payable 450,000
Premium on Bonds Payable ($495,000 - $450,000) 45,000
Preferred Stock (15,000 $100) 1,500,000
Common Stock (30,000 $10) 300,000
Other Contributed Capital ($25 - $10) 30,000 450,000
Cash 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 2-9
Case A
Cost (Purchase Price) $130,000
Less: Fair Value of Net Assets 120,000
Goodwill $ 10,000
Case B
Cost (Purchase Price) $110,000
Less: Fair Value of Net Assets 90,000
Goodwill $ 20,000
Case C
Cost (Purchase Price) $15,000
Less: Fair Value of Net Assets 20,000
Gain ($ 5,000)


Assets
Liabilities Retained
Earnings (Gain)
Goodwill Current Assets Long-Lived Assets
Case A $10,000 $20,000 $130,000 $30,000 0
Case B 20,000 30,000 80,000 20,000 0
Case C 0 20,000 40,000 40,000 5,000





1-4
Problem 2-2 Acme Company
Balance Sheet
October 1, 2011
(000)
Part A.
Assets (except goodwill) ($3,900 + $9,000 + $1,300) $14,200
Goodwill (1) 1,160
Total Assets $15,360

Liabilities ($2,030 + $2,200 + $260) $4,490
Common Stock (180 $20) + $2,000 5,600
Other Contributed Capital (180 ($50 $20)) 5,400
Retained Earnings (130)
Total Liabilities and Equity $15,360

(1) Cost (180 $50) $9,000
Fair value of net assets acquired:
Fair value of assets of Baltic and Colt $10,300
Less liabilities assumed 2,460 7,840
Goodwill $1,160



1-5
Problem 2-2 (continued)

Part B.

Baltic
2012: Step1: Fair value of the reporting unit $6,500,000
Carrying value of unit:
Carrying value of identifiable net assets 6,340,000
Carrying value of goodwill 200,000*
Total carrying value 6,540,000
*[(140,000 x $50) ($9,000,000 $2,200,000)]
The excess of carrying value over fair value means that step 2 is required.

Step 2: Fair value of the reporting unit $6,500,000
Fair value of identifiable net assets 6,350,000
Implied value of goodwill 150,000
Recorded value of goodwill 200,000
Impairment loss $ 50,000

(because $150,000 < $200,000)

Colt
2012: Step1: Fair value of the reporting unit $1,900,000
Carrying value of unit:
Carrying value of identifiable net assets $1,200,000
Carrying value of goodwill 960,000*
Total carrying value 2,160,000
*[(40,000 x $50) ($1,300,000 $260,000)]
The excess of carrying value over fair value means that step 2 is required.

Step 2: Fair value of the reporting unit $1,900,000
Fair value of identifiable net assets 1,000,000
Implied value of goodwill 900,000
Recorded value of goodwill 960,000
Impairment loss $ 60,000

(because $900,000 < $960,000)

Total impairment loss is $110,000.

Journal entry:
Impairment Loss $110,000
Goodwill $110,000







1-6
Problem 2-6 Ping Company
Pro Forma Income Statement for the Year 2011
Assuming a Merger of Ping Company and Spalding Company

Sales (1) $6,345,972
Cost of goods sold:
Fixed Costs (2) $824,706
Variable Costs (3) 2,464,095 3,288,801
Gross Margin 3,057,171

Selling Expenses (4) $785,910
Other Expenses (5) 319,310 1,105,220

Net Income $1,951,951

$1,951,951 ($952,640 + $499,900) = = $2,497,055
0.20
Since $2,497,055 is greater than $1,800,000 Ping should buy Spalding.

(1) $3,510,100 + $2,365,800 = $5,875,900 1.2 .9 = $6,345,972

(2) ($1,752,360 .30) + ($1,423,800 .30 .70) = $824,706

(3) $1,752,360 .70 = $2,464,095

(4) ($632,500 + $292,100) .85 = $785,910

(5) $172,600 1.85 = $319,310

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