LBO: Continuing Ownership Increases Oldco is a publicly owned company having 10,000 shares of common stock outstanding. In November 2006, Oldco’s upper management, which owns 500 common shares (5%) of Oldco, approached an independent investment firm concerning a lever¬

aged buyout of Oldco. The investment company has strong relationships with lending institutions.

In December 2006, a new corporation (Newco) was formed as a holding company to acquire all of Oldco’s outstanding common stock. Newco issued 200 shares of common stock as follows:

1. 100 shares to the investment firm for $25,000 cash.

2. 100 shares to Oldco’s upper management in exchange for the 500 shares of Oldco common stock it held.

In December 2006, Newco borrowed $450,000 from a lending institution, a loan secured by Oldco’s assets. On 12/31/06, Newco acquired Oldco’s remaining 9,500 outstanding common shares by paying cash of $475,000 ($50 per share). Information concerning Oldco at 12/31/06 fol¬ lows:
Book Value Current Value Assets . $600,000 $850,000 Liabilities . $400,000 $400,000 Stockholders' equity . 200,000 450,000 $600,000 $850,000 Assume that management’s basis (collectively as individuals) totals $7,000. In solving this prob¬
lem, it may be helpful to use the following format:
_ . Book Value Undervaluation „ , ..i of Net Assets of Net Assets 1. At what amount should the 100 shares of Newco common stock issued to upper management be recorded?

a. At their personal basis of $7,000.

b. At 5% of the hook value of $200,000.

c. At the imputed fair market value of their 5% interest ($475,000 = 95%; thus 5% = $25,000).
2. Determine the extent to which Oldco’s assets are revalued upward.
3. Determine the amount of goodwill to be reported.
4. Would your answers to requirements 2 and 3 be different if the transaction had been structured as follows: Oldco

(a) borrowed $450,000 from the lending institution,

(b) issued 500 shares of its common stock to the investment firm for $25,000 cash, and

(c) acquired the 9,500 shares of its outstanding common stock held by the outside investors for $475,000 cash through a self- tender offer?