Chapter 15 Business Combinations (Part 3)
Multiple Choice Theory
1. D
2. B
3. A
4. A
Multiple Choice Computational
Answers at a glance:
1. D
6. B
2. A
7. A
3. A
8. D
4. C
9. D
5. C
10. B
11.
12.
13.
14.
A
D
B
A
Solution:
1. D
Solution:
Total earnings for the last 5 years
Less: Expropriation gain
Normalized earnings for the last 5 years
Divide by:
(a) Average annual earnings
27,600,000
(1,600,000)
26,000,000
5
Fair value of acquiree's net assets
Multiply by: Normal rate of return
(b) Normal earnings
40,000,000
12%
5,200,000
4,800,000
Excess earnings (a) (b)
Multiply by: Probable duration of excess
earnings
Goodwill
400,000
5
2,000,000
2. A
Solution:
Average earnings (27.6M 1.6M expropriation gain) 5 yrs. 5,200,000
Normal earnings in the industry (40M x 12%)
(4,800,000)
Excess earnings
400,000
Divide by: Capitalization rate
25%
Goodwill
1,600,000
3. A
Solution:
Average earnings (27.6M 1.6M expropriation gain) 5 yrs.
31
5,200,000
Divide by: Capitalization rate
Estimated purchase price
Fair value of XYZs net assets
Goodwill
12.5%
41,600,000
(40,000,000)
1,600,000
4. C
Solution:
Average earnings (27.6M 1.6M expropriation gain) 5 yrs. 5,200,000
Normal earnings in the industry (40M x 12%)
(4,800,000)
Excess earnings
400,000
Multiply by: PV of an ordinary annuity @10%, n=5
3.79079
Goodwill
1,516,316
5. C
Solution:
Average earnings (2,600,000 5 years)
Normal earnings on average net assets [10% x (11M 5)]
Excess earnings
Divide by: Capitalization rate
Goodwill
Add: Fair value of net identifiable assets acquired
Estimated purchase price
6. B
Solution:
Average earnings (2,600,000 5 years)
Divide by: Capitalization rate
Estimated purchase price
Fair value of net identifiable assets acquired
Goodwill
520,000
(220,000)
300,000
30%
1,000,000
2,360,000
3,360,000
520,000
16%
3,250,000
(2,360,000)
890,000
7. A (See solution above)
8. D
Solution:
Average earnings
Normal earnings (12% x 40M*)
Excess earnings
Multiply by: PV of an ordinary annuity @10%, n=5
Goodwill
5,200,000
(4,800,000)
400,000
3.79079
1,516,316
*The fair value of XYZs net assets is computed as follows:
Carrying amount of equity
36,000,000
Excess of fair value of one asset over its carrying amount 4,000,000
Fair value of XYZs net assets
40,000,000
32
Purchase price (squeeze)
Fair value of net assets acquired
Goodwill
41,516,316
(40,000,000)
1,516,316
9. D
Solution:
Average earnings (squeeze)
5,200,000
Normal earnings on net assets [12% x 40M*] (4,800,000)
Excess earnings
400,000
Divide by: Capitalization rate
25%
Goodwill (given)
1,600,000
*The net assets of XYZ is computed as follows:
Purchase price (given)
Fair value of net assets acquired (squeeze)
Goodwill (given)
(squeeze)
(start)
41,600,000
(40,000,000)
1,600,000
10. B
Solution:
Goodwill is computed as follows:
DREARY
320,000
(160,000)
160,000
20%
800,000
Average annual earnings
Normal earnings on net assets
Excess earnings
Divide by: Capitalization rate
Goodwill
Total contributions are computed as follows:
DREARY
DISMAL
Total contributions
(squeeze)
Fair value of net assets
Goodwill
2,400,000
(1,600,000)
800,000
3,600,000
(2,400,000)
1,200,000
DISMAL
480,000
(240,000)
240,000
20%
1,200,000
Totals
6,000,000
(4,000,000)
2,000,000
11. A (See solution above)
12. D
Solution:
Net asset contributions
Divide by: Par value per share of PS
Number of preference shares issued
Total contributions
Net asset contributions
Excess of total contributions
DREARY
,1600,000
400
4,000
DISMAL
2,400,000
400
6,000
Totals
4,000,000
400
10,000
2,400,000 3,600,000
(1,600,000) (2,400,000)
800,000 1,200,000
6,000,000
(4,000,000)
2,000,000
33
Divide by: Par value per share of OS
Number of ordinary shares issued
200
4,000
200
6,000
200
10,000
Total PS and OS issued
8,000
12,000
20,000
Ratio of shares issued
40%
60%
100%
13. B
Solution:
Analyses:
ZYX, Inc. lets itself be acquired (legal form) for it to gain control
over the legal acquirer (substance).
Legal form of the agreement: (ZYX lets itself be acquired)
CBA Co. issues 40,000 ordinary shares to ZYX, Inc.s shareholders in
exchange for all of ZYX, Inc.s 8,000 shares outstanding.
Substance of the agreement: (ZYX gains control over legal acquirer)
After the combination, ZYX, Inc. gains control because it now owns
80% of CBA Co.
Accounting acquiree (CBA Co.) issues shares Actual:
CBA's currently issued shares
10,000
Shares to be issued to ZYX (5 sh. x 8,000 sh.)
40,000
Total shares of CBA Co. after the combination
50,000
20%
80%
Accounting acquirer (ZYX, Inc.) issues shares Reverse:
ZYX's currently issued shares
8,000
80%
Shares to be issued to CBA's shareholders to enable
them to have the same interest in ZYX, Inc.
[(8,000 80%) x 20%]
20%
Total
The consideration transferred is computed as follows:
Shares of ZYX effectively transferred to CBA
Multiply by: Fair value per share of ZYXs shares
Fair value of consideration effectively transferred
2,000
10,000
2,000
800
1,600,000
Goodwill (gain on bargain purchase) is computed as follows:
Consideration transferred
1,600,000
Non-controlling interest in the acquiree
Previously held equity interest in the acquiree
Total
1,600,000
Fair value of net identifiable assets acquired (6.4M
(1,200,000)
5.2M)
34
Goodwill
400,000
14. A
Solution:
Consideration transferred
Non-controlling interest in the acquiree
Previously held equity interest in the acquiree
Total
Fair value of net identifiable assets acquired
Goodwill
4,000,000
4,000,000
(3,200,000)
800,000
Exercises
1. Solutions:
Method #1: Multiples of average excess earnings
Average earnings (13.8M .8M expropriation gain) 5 years 2,600,000
Normal earnings in the industry (20M x 12%)
(2,400,000)
Excess earnings
200,000
Multiply by: Probable duration of excess earnings
5
Goodwill
1,000,000
Method #2: Capitalization of average excess earnings
Average earnings (13.8M .8M expropriation gain) 5 years 2,600,000
Normal earnings in the industry (20M x 12%)
(2,400,000)
Excess earnings
200,000
Divide by: Capitalization rate
25%
Goodwill
800,000
Method #3: Capitalization of average earnings
Average earnings (13.8M .8M expropriation gain) 5 years 2,600,000
Divide by: Capitalization rate
12.5%
Estimated purchase price
20,800,000
Fair value of acquirees net assets
(20,000,000)
Goodwill
800,000
Method #4: Present value of average excess earnings
Average earnings (13.8M .8M expropriation gain) 5 years 2,600,000
Normal earnings in the industry (20M x 12%)
(2,400,000)
Excess earnings
200,000
Multiply by: PV of an ordinary annuity @10%, n=5
3.79079
Goodwill
758,158
35
2. Solutions:
Case #1: Excess earnings
Average earnings (1,300,000 5 years)
Normal earnings on average net assets [10% x (5.5M 5)]
Excess earnings
Divide by: Capitalization rate
Goodwill
Add: Fair value of net identifiable assets acquired
Estimated purchase price
260,000
(110,000)
150,000
30%
500,000
1,180,000
1,680,000
Case #2: Average earnings
Average earnings (1,300,000 5 years)
Divide by: Capitalization rate
Estimated purchase price
Fair value of net identifiable assets acquired
Goodwill
260,000
16%
1,625,000
(1,800,000)
445,000
3. Solution:
Average earnings
Normal earnings (12% x 20M*)
Excess earnings
Multiply by: PV of an ordinary annuity @10%, n=5
Goodwill
2,600,000
(2,400,000)
200,000
3.79079
758,158
*The fair value of THICKENs net assets is computed as follows:
Carrying amount of equity
18,000,000
Excess of fair value of one asset over its carrying amount 2,000,000
Fair value of THICKENs net assets
20,000,000
Purchase price (squeeze)
Fair value of net assets acquired
Goodwill
20,758,158
(20,000,000)
758,158
4. Solution:
Average earnings (squeeze)
Normal earnings on net assets [12% x (20M)
Excess earnings
Divide by: Capitalization rate
Goodwill (given)
2,600,000
(2,400,000)
200,000
25%
800,000
*The net assets of HISS is computed as follows:
Purchase price (given)
Fair value of net assets acquired (squeeze)
Goodwill (given)
36
(squeeze)
(start)
20,800,000
(20,000,000)
800,000
5. Solutions:
Requirement (a):
Goodwill is computed as follows:
DREARY
Co.
160,000
(80,000)
80,000
20%
400,000
Average annual earnings
Normal earnings on net assets
Excess earnings
Divide by: Capitalization rate
Goodwill
DISMAL,
Inc.
240,000
(120,000)
120,000
20%
600,000
Total contributions are computed as follows:
Total contributions
(squeeze)
Fair value of net
assets
Goodwill
DREARY
Co.
DISMAL,
Inc.
Totals
1,200,000
1,800,000
3,000,000
(800,000)
(1,200,000)
(2,000,000)
400,000
600,000
1,000,000
Requirement (b):
The number of preference shares to be issued to each of the
combining constituents is computed as follows:
Net asset contributions
Divide by: Par value per share
of PS
Number of preference shares
issued
DREARY
Co.
800,000
DISMAL,
Inc.
1,200,000
Totals
2,000,000
200
200
200
4,000
6,000
10,000
Total contributions
1,200,000
1,800,000
3,000,000
Net asset contributions
Excess of total contributions
Divide by: Par value per share
of OS
Number of ordinary shares
issued
(800,000)
400,000
(1,200,000)
600,000
(2,000,000)
1,000,000
100
100
100
4,000
6,000
10,000
Total PS and OS issued
8,000
12,000
20,000
Ratio of shares issued
40%
60%
100%
37
6. Solution:
Accounting acquiree (CBA Co.) issues shares Legal form:
CBA's currently issued shares
Shares to be issued to ZYX (5 sh. x 8,000 sh.)
Actual
10,000
40,000
Total shares of CBA Co. after the combination
50,000
%
20%
80%
Accounting acquirer (ZYX, Inc.) issues shares Substance:
ZYX's currently issued shares
Shares to be issued to CBA's shareholders to enable
them to have the same interest in ZYX, Inc.
[(8,000 80%) x 20%]
Total
Reverse
8,000
%
80%
2,000
20%
10,000
As a result, the fair value of the consideration effectively transferred
by ZYX and the groups interest in CBA is P800,000 (2,000 shares of
ZYX, Inc. with a fair value per share of P400).
Goodwill (gain on bargain purchase) is computed as follows:
(1) Consideration transferred (2,000 x P400)
800,000
(2) Non-controlling interest in the acquiree
(3) Previously held equity interest in the acquiree
Total
800,000
Fair value of net identifiable assets acquired
(600,000)
Goodwill
200,000
7. Solution:
(1) Consideration transferred
(2) Non-controlling interest in the acquiree
(3) Previously held equity interest in the acquiree
Total
Fair value of net identifiable assets acquired
Goodwill
38
2,000,000
2,000,000
(1,600,000)
400,000
