When corporations have their annual meetings with stockholders, the managements often have to deal with difficult questions from stockholders. For example, at a recent stockholders' meeting of Tamerack, Inc., one of the stockholders made the following statements. "I have owned shares of Tamerack for several years, but am now questioning whether management is telling the truth in the annual financial statements. At the end of 1989 , you announced that Tamerack had just acquired a \(30 \%\) interest in the outstanding stock of Franklin Corporation. You also stated that the 105,000 shares had cost Tamerack about \(\$ 10.5\) million. In the financial statements for 1990 , you told us that the investments of Tamerack were proving to be very profitable, and reported that earnings from all investments had amounted to more than \(\$ 5.25\) million. In the financial statements for 1991 , you explained that Tamerack had sold the Franklin shares during the first week of the year, receiving \(\$ 11.7\) million cash proceeds from the sale. Nevertheless, the income statement for 1991 reports only a \(\$ 260,000\) gain on the sale (before taxes). I realize that Franklin did not pay any dividends during 1990, but it was very profitable. As I recall, it reported net income of \(\$ 3.3\) million for 1990 . Personally, I do not think you should have sold the shares. But, much more importantly, you reported to us that our company gained only \(\$ 260,000\) from the sale. How can that be true if the shares were purchased for \(\$ 10.5\) million and were sold for \(\$ 11.75\) million?"

Explain to this stockholder why the \(\$ 260,000\) gain is correctly reported.

Provocative Problem 15-2 American Motor Inns, Incorporated

(L.O. 4)