Evaluation of potential acquisition: Martin & Sons has $4.2 million in net working capital. The firm has total assets with a book value of $48.6 million and a market value of $53.4 million. They currently carry no debt on their balance sheet, sales are expected to be $45 million next year, and their tax rate is similar to ACME at 40%. Through a mixture of synergistic savings and increased market share this acquisition should add $2 million in net profit per year for the next 10 years. Acme Iron is considering buying the company for $60 million in cash. The acquisition will be recorded using the purchase accounting method.

**What is the amount of goodwill that Acme will record on its balance sheet as a result of this acquisition?

**How do you recommend the firm finance this transaction?

**Is there a danger that ACME could damage their finances to the point that bankruptcy is a potential?

Concept Check:

5-factor model of the Altman Z-score (a for private manufacturing firms):

Z-score = 0.717T₁+ 0.847T₂+ 3.107T₃+ 0.42T₄+ 0.998T₅

where,

T₁= Working Capital / Total Assets T₂= Retained Earnings / Total Assets T₃= Earnings Before Interest and Taxes / Total Assets T₄= Equity / Total Liabilities T₅= Sales / Total Assets

Zones of Discrimination:

23 or less Distress Zone

from 1.23 to 2.9 Grey Zone

9 or more Safe Zone

Interpretation of Altman Z-Score

The Z-Scores are helpful in predicting corporate defaults as well as an easy-to-calculate measure of control for financial distress status of companies in academic studies. A Z-Score above 2.6 (2.9) indicates a company to be healthy. Besides, such a company is also not likely to enter bankruptcy. However, Z-Scores ranging from 1.1-2.6 (1.23-2.9) are taken to lie in the grey area.