On 1/1/21, P acquires 100% of the stock of S by issuing 100,000 shares of stock when the market price is $90 per share and promising a contingent payment of $1,000,000 cash payable on 12/31/21 if S earns EPS of at least $1.25 for fiscal 2013. In addition, P agrees to pay additional shares of stock if the price per share is less than $90 on 12/31/21 such that the total value of the stock transferred remains at $9,000,000.

P estimates that there is a 40% probability that the cash payment will be required, a 95% probability that the stock price on 12/31/21 will be above $90 per share, and a 5% probability that the price is $85. P assumes a 4% annual rate of interest.

A) P’s entry at acquisition:

B) P’s entry on 12/31/21 if EPS is $1.50 and price is above $90:

C) P’s entry on 12/31/21 if contingency is not met and price is $88: