CARRYBACK TABLE by CBt5G1

VIEWS: 12 PAGES: 32

									                                  Chapter 2

              Special Topics in Mergers and Acquisitions

            SUMMARY OF ASSIGNMENT MATERIAL

Item                     Topics Covered                      Level   Time
Q2.1    Definition of takeover.                              Low     5-10
Q2.2    Discuss how junk bonds facilitate takeovers.         Low     5-10
Q2.3    Explain why it is difficult to determine the present Low     5-10
        value of a junk bond.
Q2.4    Discuss the features which differentiate a           Low     5-10
        leveraged buyout from a conventional merger.
Q2.5    Differentiate among the three entities -- Target     Low     5-10
        Company, Buyout Company, and New Company.
Q2.6    Discuss why in an LBO stockholders equity           Mod     10-15
        which was positive before acquisition could
        become negative.
Q2.7    Discuss the reasons why the issue of change in       Mod     10-15
        control is important in accounting for a leveraged
        buyout.
Q2.8    Identify what circumstances should exist for         Mod     10-15
        shareholders who hold a smaller interest in New
        Company than they held in Target Company to be
        considered part of the new control group.
Q2.9    Discuss when the predecessor basis is used in        Mod     10-15
        valuing assets acquired in an LBO.
Q2.10   Discuss the reasons for a spinoff of a business      Mod     10-15
        unit.




                                     2-1
        SUMMARY OF ASSIGNMENT MATERIAL (contd.)


Item                     Topics Covered                       Level   Time
Q2.11   Discuss the reasons why companies reduce their        Mod     10-15
        scope of operations (refocus).
Q2.12   Discuss why companies employ takeover                 Mod     15-20
        defenses.
E2.1    Compute the valuation of a company's stock when Low           15-20
        the discount rate to be used to find the present
        value of the debt involved is varied.
E2.2    Determine whether a change of control occurs in       Mod     20-25
        four independent cases.
E2.3    Determine for five separate cases whether the         Mod     20-25
        party involved would be considered part of a new
        control group.
E2.4    Determine the residual interest of an individual in   Mod     20-25
        New Company and whether the individual would
        be considered a member of the new control group
        if he held an 18% residual interest.
E2.5    Determine whether the shareholders of Target          Mod     15-20
        Company will be considered members of the new
        control group.
E2.6    Given the facts in E2.5, determine whether a          Mod     10-15
        change in control has occurred.
E2.7    Assuming that a change in control did not occur,      Mod     15-20
        prepare the balance sheet following a merger of
        Buyout and Target.




                                   2-2
        SUMMARY OF ASSIGNMENT MATERIAL (contd.)


 Item                    Topics Covered                        Level   Time
E2.8    Using the same facts as E2.7, but assuming a           Mod     15-20
        change in control did take place and no
        shareholders of Target are involved in any way in
        Buyout, prepare a balance sheet following the
        merger.
E2.9    Record entry for spinoff of a business.                Low     10-15
E2.10   Analyze, from the stockholder perspective,the          High    20-25
        effects of a spinoff compared to a sale and cash
        distribution.
E2.11   Prepare the entry to record the purchase of a          Mod     10-15
        raider's stock at a price in excess of market price.
E2.12   Describe the role of poison pills as a takeover        Mod     10-15
        defense and how the poison pill might be
        designed.
P2.1    Prepare a post-merger balance sheet for a debt-        Mod     30-40
        financed acquisition assuming that the bonds are
        discounted at 20 percent, and assuming that an
        appropriate discount rate cannot be determined
        but that an all-cash offer exists.
P2.2    Prepare the acquirer's journal entry to record the     Mod     20-30
        acquisition of 90 percent of the stock of the
        acquired company in a debt-financed acquisition.
P2.3    Prepare the balance sheet of the buyout company Mod            30-40
        before and after the stock purchase and prepare a
        balance sheet after the acquirer is merged with the
        acquired company to form New Company.




                                    2-3
        SUMMARY OF ASSIGNMENT MATERIAL (contd.)

 Item                    Topics Covered                        Level   Time
P2.4    Assume the same facts as P2.3, and complete the        Mod     30-40
        same requirements except that management does
        not participate in the buyout.
P2.5    Prepare the balance sheet of the acquiring             Mod     35-45
        company before and after the stock purchase.
        Prepare the balance sheet of the new company
        following the merger.
P2.6    Assume the same facts as in P2.5,except that the       Mod     35-45
        assets received by the seller are different. Prepare
        the balance sheet of the acquirer before and after
        stock purchase and prepare the balance sheet of
        the new firm.
P2.7    Prepare two years journal entries for a spinoff.      High    30-35
P2.8    Prepare journal entries to reflect the adoption of     Mod     35-45
        various takeover defenses.




                                    2-4
                           CARRYBACK TABLE


The carryback table identifies the assignment items which are new in this
edition and those which are carried over from the seventh edition. For the
latter, the problem number in the seventh edition is shown.

    New                        New                        New
  Problem                    Problem                    Problem
  Number        Source       Number          Source     Number         Source
    Q2.1          new          E2.1           E2.1        P2.1          P2.1
    Q2.2          Q2.2         E2.2          E2.2         P2.2          P2.2
    Q2.3         Q2.3          E2.3          E2.3         P2.3          P2.3
    Q2.4         Q2.4          E2.4          E2.4         P2.4          P2.4
    Q2.5         Q2.5          E2.5          E2.5         P2.5          P2.5
    Q2.6         Q2.6          E2.6          E2.6         P2.6          P2.6
    Q2.7         Q2.7          E2.7          E2.7         P2.7          P2.7
    Q2.8         Q2.8          E2.8          E2.8         P2.8          P2.8
    Q2.9         Q2.9          E2.9          E2.9
    Q2.10        Q2.10         E2.10         E2.10
    Q2.11        Q2.11         E2.11         E2.11
    Q1.12        Q1.12         E1.12         E1.12

Carryforward tables for all chapters, identifying the disposition of seventh
edition assignment items, appear at the beginning of the solutions manual.




                                       2-5
                        ANSWERS TO QUESTIONS


Q2.1

A takeover is an acquisition of one public company by another. The
would-be acquirer makes a fixed-price offer, known as a tender offer, to buy
some or all the shares of the target company. Debt financing is usually
employed.

Q2.2

Junk bonds facilitate takeovers by providing a source of large amounts of
capital, with little direct risk to the acquirer. An extensive market for these
high-risk, high-yield debt securities has enabled acquirers to combine large
amounts of borrowed money with their own (often limited) capital to finance
large-scale takeovers.


Q2.3

It is difficult to determine the present value of a junk bond because the risk
characteristics are hard to estimate, and hence selection of an appropriate
discount rate cannot be done with confidence.

Q2.4

A leveraged buyout (LBO) is differentiated from a conventional merger by the
following features: (1) an LBO is usually heavily financed by debt, whereas a
conventional merger usually involves large amounts of cash and equity; (2) the
presence of substantial debt means that much of the purchase price in an LBO
will come from cash generated by the acquired company, either through its
operations or the sale of its assets, while most of the purchase price in a
conventional merger comes from the resources or equity of the acquirer; and
(3) the acquirers in an LBO are often investment firms and management
groups, while the acquirers in a conventional merger are usually other business
firms.


                                       2-6
Q2.5

Target Company is the company to be acquired. Buyout Company is a
company created to purchase Target Company. New Company results from
the post-acquisition merger of Buyout Company and Target Company.


Q2.6

Following the acquisition of a company with positive stockholders' equity in a
leveraged buyout, stockholders' equity of the new company may be negative
because the heavy debt of the buyout company may exceed the net assets of the
target company.

Q2.7

A change of control (that is, a change of controlling ownership) is deemed
necessary to justify the establishment of a new basis of accountability. If there
is no change of control--that is, the existing ownership interests are simply
restructured in some way--then existing accounting values are continued. If a
change of control occurs--that is, existing ownership interests are replaced by
new interests--then a transaction has occurred which justifies a new basis of
accounting based on the transaction price. This is essentially the same as the
logic of the pooling of interests method of accounting versus the purchase
method of accounting.


Q2.8

Stockholders who hold a smaller interest in New Company than they held in
Target Company are considered part of the new control group if they retain a
significant voting interest (as measured by the 20 percent voting-interest test)
or if they retain a significant economic interest (as measured by the 20-percent
capital-at-risk test).




                                       2-7
Q2.9

Predecessor basis is used in valuing all assets acquired in a leveraged buyout
when there is no change of control. Predecessor basis is also used, to a limited
extent, when there is a change of control (1) to the extent of the new control
group's residual interest in Target or in Buyout, whichever is less, and (2) for
continuing stockholders who are not members of the new control group, to the
extent of their residual interest in Buyout. The residual interest of these
shareholders in Buyout must be at least five percent individually and 20
percent in the aggregate.

Q2.10

While the company receives nothing in exchange in the case of a spinoff, the
company's stockholders may receive significant value. The combined value of
the shares of the original company and the spinoff company may be expected
to exceed the pre-spinoff value of the original company shares. The first
obligation of the Board of Directors, which makes decisions on matters such as
spinoffs, is to the stockholders of the company, not to the company itself or its
management. Thus, a spinoff may be chosen as a way of maximizing
shareholder value.




                                      2-8
Q2.11

Among the reasons why companies reduce the size and scope of their
operations, by restructuring or refocusing, are:

       To focus on core businesses. Companies may decide to dispose of
        noncore businesses for operating, managerial, marketing, or risk
        reasons, and to focus its activities in the areas of its primary (core)
        competencies.

       To enhance shareholder value. Companies may decide that the value of
        the business is higher if structured as several separate companies than as
        one big company. The separated entities may be sold to others, or spun
        off to shareholders.

       To meet cash needs. Especially after a debt-financed acquisition, a
        company may dispose of segments of the business to raise cash for debt
        service. For this purpose, the restructuring would result in sales rather
        than spinoffs.

       To meet legal or regulatory requirements. Dispositions may be required
        to meet antitrust requirements, or to separate regulated from unregulated
        businesses.
Q2.12

Companies enter into takeover defenses to attempt to prevent an undesirable
takeover, especially a hostile takeover. Motivation for takeover defenses may
include management's desire to protect its own position, and a board of
directors' attempt to extract the highest possible price from an acquirer, for the
benefit of stockholders.




                                         2-9
                       SOLUTIONS TO EXERCISES

E2.1 VALUATION OF BONDS IN ACQUISITION

Using a discount rate of 10 percent, the valuation of Dallas Industries' stock is:
 Cash price                                                        $ 1,000,000
 Present value of bonds:
    Principal $10,000,000 x.3855                                      3,855,000
    Interest $1,700,000 x 6.1446                                     10,445,820
                                                                   $15,300,820

Using a discount rate of 20 percent, the valuation of Dallas Industries' stock is:
 Cash price                                                         $ 1,000,000
 Present value of bonds:
    Principal $10,000,000 x .1615                                     1,615,000
    Interest $1,700,000 x 4.1925                                      7,127,250
                                                                    $ 9,742,250


E2.2 LEVERAGED BUYOUT: CHANGE OF CONTROL

Requirement 1:

Yes, a change of control occurs because a single shareholder, D, who did not
control Keys Corp., has control after the buyout.

Requirement 2:

No, a change of control does not occur, because the now sole-shareholder C
previously held a 70 percent interest.




                                      2-10
E2.2 (contd.)

Requirement 3:

Yes, a change of control occurs. While the new control group consists of A
and B who were prior shareholders, none of these, either individually or in
combination, controlled Keys Company before the buyout.

Requirement 4:

Yes, a change of control occurs, because the new control group consists
entirely of new stockholders.


E2.3 LEVERAGED BUYOUT: NEW CONTROL GROUP

(1)   Because the management group is actively promoting the LBO, it is
      considered part of the new control group.

(2)   This stockholder would not be considered part of the new control group,
      because the stockholder's residual interest in New Company is less than
      five percent.

(3)   This stockholder's residual interest increases and will equal or exceed
      five percent, qualifying the stockholder as a member of the new control
      group.

(4)   This stockholder would not be considered a member of the new control
      group. Residual interest will decrease, and neither the 20-percent
      voting-interest test nor the 20-percent capital-at-risk test will be met.

(5)   This stockholder qualifies as a member of the new control group.
      Residual interest will decrease, but at least one of the two tests (20-
      percent voting interest or 20-percent capital at risk) will be met.




                                      2-11
E2.4 LEVERAGED BUYOUT: RESIDUAL INTEREST

Requirement 1:

                                                            Total      Harmon
 Preferred stock A                                          10,000           --
 Preferred stock B                                                --         --
 Voting common stock                                        10,000       1,000
 Nonvoting common stock                                     50,000      15,000
                                                            70,000      16,000

Harmon's residual interest is 22.9% (= 16,000/70,000).

Requirement 2:

Yes, Harmon would be a member of the new control group because his
residual interest has increased, and it exceeds five percent.

E2.5 LEVERAGED BUYOUT: NEW CONTROL GROUP

Harris and Hill each have a lesser residual interest. They qualify as members
of the new control group only if they pass either the 20-percent voting-interest
test (which they obviously do not, as each holds only one percent of the voting
common stock) or the 20-percent capital-at-risk test.

Calculation of Harris' capital at risk:
   Security               Percentage                Cumulative Percentage
 Voting         1.0%($1,000/$100,000)            1.0%($1,000/$100,000)
 common
 stock
 Preferred      30.0%($45,000/$150,000)          18.4%($46,000/$250,000)
 stock
 Debt           20.0%($400,000/$2,000,000)       19.8%($446,000/$2,250,000

Harris' cumulative percentage does not reach 20 percent at any stage of the
test, so Harris is not a member of the new control group.


                                      2-12
E2.5 (contd.)

Calculation of Hill's capital at risk:
   Security                Percentage              Cumulative Percentage
 Voting         1%($1,000/$100,000)              1%($1,000/$100,000)
 common
 stock
 Preferred      30%($45,000/$150,000)            18.4%($46,000/$250,000)
 stock
 Debt           45%($900,000/$2,000,000)          42%($946,000/$2,250,000)
 (including
 guarantee of
 $500,000)

Hill's cumulative percentage does reach the 20 percent level, so Hill is a
member of the new control group.

E2.6 LEVERAGED BUYOUT: CHANGE OF CONTROL

A change in control occurs when either (1) the new control group consists
entirely of new shareholders or (2) the new control group includes prior
shareholders but none of these, individually or in combination, controlled the
target company before the buyout.

From E2.5, Hill qualifies as a member of the new control group but Harris
does not. Hill owned 50 percent of HH Industries, which is not a controlling
interest. Thus test (2) above is met, and there has been a change in control.

If, however, it could be shown that Hill had the ability to implement major
operating and financial policies (e.g., Harris was a "silent partner" and Hill
managed the firm), then we would conclude that Hill had control prior to the
LBO. In this case, since Hill is a member of the new control group, there
would be no change in control.




                                      2-13
E2.7 LEVERAGED BUYOUT: POST-ACQUISITION BALANCE
     SHEET

                                New Company
                                Balance Sheet
                                After Merger

 Assets                      $700,000 Liabilities                     $900,000
                                      Stockholders' Equity           (200,000)
                                                                      $700,000

Because there was no change in control, there is no change in the valuation of
Target Company's assets in recording the merger.


E2.8 LEVERAGED BUYOUT: POST-ACQUISITION BALANCE
     SHEET

                                New Company
                                Balance Sheet
                                After Merger

 Assets                      $875,000 Liabilities                    $900,000
 Goodwill                      75,000 Stockholders' Equity             50,000
                             $950,000                                $950,000

Target's net assets are valued at fair value ($750,000) in the merger. Because
no stockholder of Target was involved in any way with Buyout, no use of
predecessor basis is required. The acquisition was for cash, and therefore the
monetary test is met.




                                     2-14
E2.9 RECORDING A SPINOFF

A spinoff is recorded at book value. Thus stockholders' equity will be reduced
by the book value of net assets of the entity spun off to the stockholders. The
entry is:

 Liabilities                                             850,000
 Additional Paid-in Capital                              550,000
                                  Assets                             1,400,000

E2.10    SALE vs SPINOFF

The sale and distribution of after-tax proceeds to the stockholders would net
them $5,330,000 after taxes, as follows:
 Jack's proceeds from sale of Jill                                 $10,000,000
 Less: tax on gain (= .3 x ($10,000,000-$4,000,000))                  1,800,000
 Cash available for distribution to stockholders                   $ 8,200,000
 Less: tax paid by stockholders on dividends(= .35 x
 $8,200,000)                                                          2,870,000
 After-tax benefit to stockholders                                  $ 5,330,000

The spinoff would provide the stockholders with 1,000,000 shares of Jill
Company stock, having an aggregate market value of $7,500,000. No tax
would be payable at the time of the stock distribution. The spinoff would
provide greater immediate wealth to the stockholders (stock worth $7,500,000
versus cash of $5,330,000).

Taxes would be due if and when the stockholders sell the Jill stock. While
income tax laws would provide that some of the basis of their Jack stock be
allocated to the Jill stock, no increase in total basis would occur. Thus we may
view the entire $7,500,000 as being subject to tax, part of it when Jill shares
are sold and the remainder when Jack shares are sold. If the same 35 percent
rate applies to the gains from the sale of stock, the income tax would
eventually be $2,625,000, for an ultimate net cash benefit of $4,875,000.




                                     2-15
E2.10 (contd.)

While this amount is lower than the immediate cash benefit, several factors
would need to be considered in deciding which is preferable. These factors
include:

        1.     The time value of money, as the tax would not be incurred until
               shares are sold, which may be many years in the future.
        2.     The possibility that no income tax will be due at all, because the
               stockholder holds the stock until death, when it passes at fair
               value to heirs, avoiding any income tax on appreciation.

E2.11        RECORDING A TAKEOVER DEFENSE

 Treasury Stock                                          5,600,000
 Expense of Takeover Defense                             4,000,000
                                     Cash                              9,600,000
To record repurchase of 8,000,000 shares at $12,
a price in excess of the current market value of $7.

E2.12        TAKEOVER DEFENSES

Poison pills are devices which become operable when a hostile takeover is
imminent. The purpose is to prevent the takeover by increasing its cost, or if
the takeover does occur, to increase the payoff to existing stockholders.

A poison pill might be designed as a stock rights plan, whereby existing
stockholders could buy additional shares at a very favorable price upon
occurrence of the triggering event. Another possible design would be
preferred stock that is redeemable for cash in the event of a takeover.




                                        2-16
                      SOLUTIONS TO PROBLEMS

P2.1 DEBT-FINANCED ACQUISITION

Requirement 1:

Present value of bonds, using 20 percent discount rate:
 Principal $8,000,000 x .1615                                    $1,292,000
 Interest $1,200,000 x 4.1925                                     5,031,000
Present value of bonds                                           $6,323,000
Cash                                                              1,000,000
Common stock 10,000 shares x $50                                    500,000
 Total purchase price                                            $7,823,000
Stockholders' equity acquired                                   (3,000,000)
 Purchase premium                                                $4,823,000
Attributed to:
 Current assets ($2,000,000 - $1,500,000)                       ( 500,000)
 Plant and equipment ($5,000,000 - $3,000,000)                  (2,000,000)
Goodwill                                                         $2,323,000

                                 Kelly, Inc.
                               Balance Sheet
                              January 2, 20X0
Current Assets                                                   $ 4,000,000
Plant and Equipment, Net                                          14,000,000
Goodwill                                                           2,323,000
                                                                $20,323,000
Current Liabilities                                              $ 1,500,000
Long-Term Liabilities                                              4,000,000
Bonds Payable                                     $8,000,000
Less: Discount                                   ( 1,677,000)     6,323,000
Common Stock, $10 Par                                             1,100,000
Additional Paid-In Capital                                        2,900,000
Retained Earnings                                                 4,500,000
                                                                $20,323,000


                                    2-17
P2.1 (contd.)

Requirement 2:

 Valuation of Jones' stock based on cash offer of $150 per
 share 50,000 x $150                                         $ 7,500,000
 Less:
  Cash                                                        (1,000,000)
  Value of stock                                                (500,000)
 Assumed value of bonds                                       $ 6,000,000
 Total purchase price                                         $ 7,500,000
 Stockholders' equity acquired                               ( 3,000,000)
  Purchase premium                                            $ 4,500,000
 Attributed to:
  Current assets                                             ( 500,000)
  Plant and equipment                                        ( 2,000,000)
                                                              $ 2,000,000


                                  Kelly, Inc.
                                Balance Sheet
                               January 2, 20X0
 Current Assets                                              $ 4,000,000
 Plant and Equipment, Net                                      14,000,000
 Goodwill                                                       2,000,000
                                                             $20,000,000
 Current Liabilities                                          $ 1,500,000
 Long-Term Liabilities                                         10,000,000
 Common Stock, $10 Par                                          1,100,000
 Additional Paid-In Capital                                     2,900,000
 Retained Earnings                                              4,500,000
                                                             $20,000,000




                                     2-18
P2.2 DEBT-FINANCED ACQUISITION

 Total purchase price
 Twenty-year notes
  Principal $10,000 x .0261                                           $    261,000
  Interest $1,800,000 x 4.8696                                           8,765,280
  Present value of notes                                               $ 9,026,280
 Cash                                                                    2,000,000
 One-year noninterest-bearing notes $3,000,000 x .8929                   2,678,700
 Total purchase price                                                 $13,704,980

 Investment in
 Underwood                                               13,704,980
                          Cash                                            2,000,000
                          Notes Payable (One Year)                        2,678,700
                          Notes Payable (20 Year)                         9,026,280
To record acquisition of 90 percent of stock of
Underwood, Inc.

Alternatively, Notes Payable (20 Year) could be credited for the face value of
$10,000,000 with a debit to Discount on Notes Payable of $973,720.

P2.3 LEVERAGED BUYOUT OF A PUBLIC COMPANY

Requirement 1:
                                   RM Associates
                                   Balance Sheet
                                    Prior to LBO
 Cash                                                                 $16,200,000
 Investment in Reynolds-Morris                                            960,000
                                                                      $17,160,000
 Bonds Payable, Net of $3,000,000 Discount                            $15,000,000
 Stockholders' Equity                                                   2,160,000
                                                                      $17,160,000
The conditions for a change in control are met. Both the management group
and the private investor group are members of the new control group. The
third test for a change of control is met.



                                         2-19
P2.3 (contd.)

Valuation is based on predecessor basis to the extent of management's 4
percent interest in Reynolds-Morris, with the remaining 96 percent based on
fair value (the 80-percent monetary test is met). Thus the valuation of the
investment is:
 Predecessor basis $8,500,000 x .04                                $ 340,000
 Fair Value $24,000,000 x .96                                       23,040,000
                                                                   $23,380,000

Payment to the remaining stockholders consisted of:
 Cash 1,920,000 shares x $8                                      $15,360,000
 Notes 1,920,000 shares x $4                                       7,680,000
                                                                 $23,040,000

The resulting balance sheet is as follows:

                                RM Associates
                                Balance Sheet
                                 After LBO
 Cash                                                            $    840,000
 Investment in Reynolds-Morris                                     23,380,000
                                                                 $24,220,000
 Notes Payable                                                    $ 7,680,000
 Bonds Payable, Net                                                15,000,000
 Stockholders' Equity                                               1,540,000
                                                                 $24,220,000




                                      2-20
P2.3 (contd.)

Requirement 2:

 Current assets:
  Fair value ($7,300,000 x .96)                  $ 7,008,000
  Predecessor basis ($6,000,000 x.04)                240,000   $ 7,248,000
 Plant and equipment:
  Fair value ($19,000,000 x .96)                 $18,240,000
  Predecessor basis ($15,500,000 x .04)              620,000    18,860,000
 Liabilities (fair value equals predecessor
 basis)                                                        (13,000,000)
   Subtotal                                                     $13,108,000
 Total valuation to be accounted for                             23,380,000
  Balance - to be recorded as goodwill                          $10,272,000


                         Reynolds-Morris-Stevens Corp.
                                Balance Sheet
                                 After Merger
 Current Assets                                                $ 8,088,000
 Plant and Equipment                                            18,860,000
 Goodwill                                                       10,272,000
                                                               $37,220,000
 Current Liabilities                                           $10,680,000
 Long-Term Liabilities                                          25,000,000
 Stockholders' Equity                                            1,540,000
                                                               $37,220,000




                                      2-21
P2.4 LEVERAGED BUYOUT OF A PUBLIC COMPANY

Requirement 1:
                                RM Associates
                                Balance Sheet
                                 Prior to LBO
 Cash                                                             $16,200,000
                                                                  $16,200,000
 Bonds Payable, Net of $3,000,000 discount                        $15,000,000
 Stockholders' Equity                                               1,200,000
                                                                  $16,200,000

The conditions for a change in control are met, since the private investor group
has full ownership and had no previous ownership. Valuation is based on fair
value (the 80-percent monetary test is met). Thus the valuation of the
investment is $24,000,000 (2,000,000 shares x $12).

Payment to the stockholders consisted of:
 Cash 2,000,000 shares x $8                                       $16,000,000
 Notes 2,000,000 shares x $4                                        8,000,000
                                                                  $24,000,000

The resulting balance sheet is as follows:
                                 RM Associates
                                  Balance Sheet
                                   After LBO
 Cash                                                             $    200,000
 Investment in Reynolds-Morris                                      24,000,000
                                                                  $24,200,000
 Notes Payable                                                     $ 8,000,000
 Bonds Payable, Net                                                 15,000,000
 Stockholders' Equity                                                1,200,000
                                                                  $24,200,000




                                     2-22
P2.4 (contd.)

Requirement 2:

The calculation of goodwill is as follows:

 Current assets                                           $ 7,300,000
 Plant and equipment                                       19,000,000
 Liabilities                                             (13,000,000)
 Subtotal                                                 $13,300,000
 Total valuation to be accounted for                       24,000,000
 Balance-to be recorded as goodwill                       $10,700,000


                         Reynolds-Morris-Stevens Corp.
                                Balance Sheet
                                 After Merger
 Current Assets                                          $ 7,500,000
 Plant and Equipment                                      19,000,000
 Goodwill                                                 10,700,000
                                                         $37,200,000
 Current Liabilities                                     $11,000,000
 Long-Term Liabilities                                    25,000,000
 Stockholders' Equity                                      1,200,000
                                                         $37,200,000




                                       2-23
P2.5 LEVERAGED BUYOUT OF A PRIVATE COMPANY

Requirement 1:
                               Mayes-Docker Inc.
                                Balance Sheet
                                 Prior to LBO
 Cash                                                                $1,600,000
 Bank Loan Payable                                                   $ 500,000
 Redeemable Preferred Stock                                           1,000,000
 Common Stock                                                           100,000
                                                                     $1,600,000

Management, which held no equity interest in Lehigh Products, is clearly a
member of the new control group. Because the industrial development agency
holds redeemable preferred stock, its residual interest is zero and it is thus not
part of the new control group. Management therefore constitutes the new
control group. The first test for a change in control is met.

Because management had no prior equity interest, there is no use of
predecessor basis. To use fair value fully, the 80-percent monetary test must
be met. It is not. Monetary consideration includes the $1,500,000 cash and the
$700,000 notes. Because the preferred is redeemable at the company's option
(rather than the holder's option), it is not monetary consideration. Thus
monetary consideration is 73.33 percent (= $2,200,000/$3,000,000) of total
compensation, and fair value may therefore be used only to the extent of 73.33
percent of net assets.

The valuation of the acquisition is (rounded):
 Fair value ($3,000,000 x. .7333)                                    $2,200,000
 Predecessor basis ($2,100,000 x .2667)                                 560,000
                                                                     $2,760,000




                                      2-24
P2.5 (contd.)

The balance sheet after the stock purchase is as follows:

                              Mayes-Docker Inc.
                               Balance Sheet
                                 After LBO
 Cash                                                               $ 100,000
 Investment in Lehigh Products                                       2,760,000
                                                                    $2,860,000
 Bank Loan Payable                                                  $ 500,000
 Notes Payable                                                         700,000
 Redeemable Preferred Stock                                          1,000,000
 Preferred Stock                                                       560,000
 Common Stock                                                          100,000
                                                                    $2,860,000

Requirement 2:

Fair values of Lehigh Products' assets and liabilities equal their book values.
The calculation of goodwill is as follows:
 Current assets                                                       $1,850,000
 Plant and equipment                                                     650,000
 Current liabilities                                                   (400,000)
 Subtotal                                                             $2,100,000
 Total valuation                                                       2,760,000
 Goodwill                                                             $ 660,000




                                      2-25
P2.5 (contd.)

                          Lehigh, Mayes & Company
                                Balance Sheet
                                After Merger
 Current Assets                                                      $1,950,000
 Plant and Equipment                                                    650,000
 Goodwill                                                               660,000
                                                                     $3,260,000
 Current Liabilities                                                 $ 400,000
 Bank Loan Payable                                                      500,000
 Notes Payable                                                          700,000
 Redeemable Preferred Stock                                           1,000,000
 Preferred Stock                                                        560,000
 Common Stock                                                           100,000
                                                                     $3,260,000

P2.6 LEVERAGED BUYOUT OF A PRIVATE COMPANY

Requirement 1:

                               Mayes-Docker Inc.
                                Balance Sheet
                                 Prior to LBO
 Cash                                                                $1,600,000
 Bank Loan Payable                                                   $ 500,000
 Redeemable Preferred Stock                                           1,000,000
 Common Stock                                                           100,000
                                                                     $1,600,000

Management, which held no equity interest in Lehigh Products, is clearly a
member of the new control group. Because the industrial development agency
holds redeemable preferred stock, its residual interest is zero and it is thus not
part of the new control group. Management therefore constitutes the new
control group.



                                      2-26
P2.6 (contd.)

Susan Leland also qualifies as a member of the new control group. She has a
decreased residual interest, but with 25 percent of the voting common stock
she passes the 20-percent voting interest test (as only one test need be passed,
it is not necessary to compute the capital at risk).

Because Leland qualifies as a member of the new control group, none of the
tests for a change in control are met. Thus, a change in control has not
occurred.

Because no change in control has occurred, there can be no change in the
valuation of the assets acquired. The valuation remains at $2,100,000, the
existing net asset amount.

The balance sheet after the stock purchase is as follows:

                               Mayes-Docker Inc.
                                Balance Sheet
                                  After LBO
 Cash                                                                $   50,000
 Investment in Lehigh Products                                        2,100,000
                                                                     $2,150,000
 Bank Loan Payable                                                   $ 500,000
 Notes Payable                                                          700,000
 Redeemable Preferred Stock                                           1,000,000
 Other Stockholders' Equity                                            (50,000)
                                                                     $2,150,000




                                      2-27
P2.6 (contd.)

Requirement 2:
                       Lehigh, Mayes & Company
                             Balance Sheet
                             After Merger
 Current Assets                                  $1,900,000
 Plant and Equipment                                 650,000
                                                 $2,550,000
 Current Liabilities                              $ 400,000
 Bank Loan Payable                                   500,000
 Notes Payable                                       700,000
 Redeemable Preferred Stock                        1,000,000
 Other Stockholders' Equity                         (50,000)
                                                 $2,550,000




                                2-28
P2.7 ACCOUNTING FOR SPINOFF: AMERICAN BRANDS

The spinoff was announced in October 1996, which becomes the measurement
date for purposes of classifying Gallaher Tobacco as a discontinued operation.
 Accordingly, American Brands (Fortune Brands) would reclassify the assets
and liabilities of Gallaher into a Net Assets of Discontinued Operations
account. The following entry would be made (amounts in millions):
 Net Assets of Discontinued
 Operations                                                    915.0
 Notes Payable to Banks                                        445.8
 Accounts Payable                                              233.9
 Accrued Excise and Other
 Taxes                                                         412.5
 Accrued Expenses and
 Other Liabilities                                             303.3
 Deferred Income Taxes                                         100.2
 Postretirement and Other
 Liabilities                                                    39.5
                                  Cash and Cash Equivalents               84.8
                                  Accounts Receivable, net               232.6
                                  Inventories                          1,218.3
                                  Other Current Assets                   178.9
                                  Property, Plant and
                                  Equipment, net                         258.3
                                  Intangibles Resulting from
                                  Business Acquisition                   205.7
                                  Other Assets                           271.6
To reclassify assets and liabilities of Gallaher Tobacco.

 Commercial Paper                                              231.7
                       Net Assets of Discontinued Operations
                                                                       231.7
To allocate a portion of short-term debt to Gallaher.




                                      2-29
P2.7 (contd.)

In 1997, when the actual spinoff transactions occurs, Fortune Brands would
reflect the spinoff at book value, and also record the receipt of $1,250 million
from Gallaher. While this payment is explained as being made in lieu of an
allocation of long-term debt, it would constitute an increase in equity for
Fortune Brands, more than offsetting the book value of the net assets spun off.
 Based on the equity changes shown in the pro forma balance sheet, the entries
would be:
 Additional Paid-in                                                683.3
 Capital
                           Net Assets of Discontinued                       683.3
                           Operations
To record spinoff of Gallaher Tobacco to stockholders.

 Cash                                                             1,250.0
                           Additional Paid-in Capital                       683.3
                           Foreign Currency Adjustments                     238.0
                           Retained Earnings                                328.7
To record cash payment received from Gallaher Tobacco
in lieu of allocation of long-term debt in spinoff transaction.

In may be noted that American Brands' pre-spinoff long-term debt amounted to
approximately $1,600 million. The share attributed to Gallaher Tobacco
(about 78%) far exceeds Gallaher's share of pre-spinoff assets (about 26%).
While this transaction was structured as a spinoff, in effect American (Fortune)
Brands sold Gallaher Tobacco to its shareholders for $1.25 billion minus
Gallaher's equitable share of long-term debt.




                                       2-30
P2.8 ACCOUNTING FOR TAKEOVER DEFENSES

Journal entries for takeover defenses:

(1)
 Treasury Stock                                          9,000,000
 Expense of Takeover Defense                             3,000,000
                                  Cash                               12,000,000
To record repurchase of 300,000 shares at $40,
current market price, $30.

(2)     No entry required. Existence and terms of the rights would be disclosed
        in the notes to the financial statements.

(3)
 Property Dividend                                      35,000,000
                       Investment in Subsidiaries                16,000,000
                       Gain on Disposition                       19,000,000
To record distribution of stock of Fort Wayne Materials to Midwestern
Industries stockholders.

(4)
 Cash                                                   70,000,000
                            Bonds Payable                            70,000,000
To record issuance of bonds at par.

 Cash Dividend                                          28,500,000
 Treasury Stock                                         32,000,000
 Marketable Securities                                   9,500,000
                            Cash                                     70,000,000
To record use of bond proceeds. The cash dividend
is based on 5,700,000 shares, which is the original
6,000,000 shares less the 300,000 repurchased in (1).

(5)     No entry required. Existence and terms of the contracts would be
        disclosed in the notes to the financial statements.


                                         2-31
P2.8 (contd.)

                              Midwestern Industries
                                 Balance Sheet

 Current Assets                                       $ 32,500,000
 Investment in Subsidiaries                                4,000,000
 Plant and Equipment                                      95,000,000
 Total                                                 $131,500,000
 Current Liabilities                                   $ 15,00,000
 Long-Term Liabilities                                    95,000,000
 Common Stock, $10 par                                    60,000,000
 Retained Earnings                                         2,500,000
 Treasury Stock                                         (41,000,000)
 Total                                                 $131,500,000




                                      2-32

								
To top