Parent, Inc. is contemplating a tender offer to acquire 80 percent of Subsidiary Corporation's common stock. Subsidiary's shares are currently quoted on the New York Stock Exchange at $85 per share. In order to have a reasonable chance of the tender offer attracting 80 percent of Subsidiary's stock, Parent believes it will have to offer at least $105 per share. If the tender offer is made and is successful, the purchase will be consummated on January 1, 2009. A typical part of the planning of a proposed business combination is the preparation of projected or pro forma consolidated financial statements. As a member of Parent's accounting group, you have been asked to prepare the pro forma 2009 consolidated financial statements for Parent and Subsidiary assuming that 80 percent of Subsidiary's stock is acquired at a price of $105 per share. To support your computations, Martha Franklin, the chairperson of Parent's acquisitions committee, has provided you with the projected 2009 financial statements for Subsidiary. (The projected financial statements for Subsidiary and several other companies were prepared earlier for the acquisition committee's use in targeting a company for acquisition.) The projected financial statements for Subsidiary for 2009 and Parent's actual 2008 financial statements are presented in table 1. Assumptions Ms. Franklin has asked you to use the following assumptions to project Parent's 2009 financial statements: ? Sales will increase by 10 percent in 2009. ? All sales will be on account. ? Accounts receivable will be 5 percent lower on December 31, 2009, than on December 31, 2008. ? Cost of goods sold will increase by 9 percent in 2009. ? All purchases of merchandise will be on account. ? Accounts payable are expected to be $50,500 on December 31, 2009. ? Inventory will be 3 percent higher on December 31, 2009, than on December 31, 2008. ? Straight-line depreciation is used for all fixed assets. ? No fixed assets will be disposed of during 2009. The annual depreciation on existing assets is $40,000 per year. ? Equipment will be purchased on January 1, 2009, for $48,000 cash. The equipment will have an estimated life of 10 years with no salvage value. ? Operating expenses, other than depreciation, will increase by 14 percent in 2009. ? All operating expenses, other than depreciation, will be paid in cash. ? Parent's income tax rate is 40 percent, and taxes are paid in cash in four equal payments. Payments will be made on the 15th of April, June, September, and December. For simplicity, assume taxable income equals financial reporting income before taxes. ? Parent will continue the $2.50 per share annual cash dividend on its common stock. ? If the tender offer is successful, Parent will finance the acquisition by issuing $170,000 of 6 percent non-convertible bonds at par on January 1, 2009. The bonds would first pay interest on July 1, 2009, and would pay interest semi-annually thereafter each January 1 and July 1 until maturity on January 1, 2019. ? The acquisition will be accounted for as a purchase and Parent will account for the investment using the equity method. Although most of the legal work related to the acquisition will be handled by Parent's staff attorney, direct costs to prepare and process the tender offer will total $2,000 and will be paid in cash by Parent in 2009. As of January 1, 2009, all of Subsidiary's assets and liabilities are fairly valued except for machinery with a book value of $8,000, an estimated fair value of $9,500, and a 5-year remaining useful life. Assume that straight-line depreciation is used to amortize any revaluation increment. No transactions between these companies occurred prior to 2009. Regardless of whether they combine, Parent plans to buy $50,000 of merchandise from Subsidiary in 2009 and will have $3,600 of these purchases remaining in inventory on December 31, 2009. In addition, Subsidiary is expected to buy $2,400 of merchandise from Parent in 2009 and to have $495 of these purchases in inventory on December 31, 2009. Parent and Subsidiary price their products to yield a 65 percent and 80 percent markup on cost, respectively. Parent intends to use three financial yardsticks to determine the financial attractiveness of the combination. First, Parent wishes to acquire Subsidiary Corporation only if 2009 consolidated earnings per share will be at least as high as the earnings per share Parent would report if no combination takes place. Second, Parent will consider the proposed combination unattractive if it will cause the consolidated current ratio to fall below 2 to 1. Third, return on average stockholders' equity must remain above 20 percent for the combined entity. If the financial yardsticks described above and the non-financial aspects of the combination are appealing, then the tender offer will be made. On the other hand, if these objectives are not met, the acquisition will either be restructured or abandoned. Milestones 1. Forecast the separate financial statements of Parent, Inc. Using Ms. Franklin's assumptions and Parent's 2008 financial statements, prepare pro forma 2009 financial statements for Parent, Inc., assuming that the acquisition is not attempted. Support your statements with appropriate work papers and journal entries. Pro forma financial statements include Statement of Operation; Statement of Retained Earnings, Balance Sheet and Cash Flow Statement. 2. Adjust the separate financial statements of Parent, Inc. to reflect the proposed acquisition. Adjust Parent's pro forma 2009 financial statements prepared in #1 to reflect the proposed acquisition (i.e., adjust Parent's forecasted financial statements for bond issuance, stock purchase, income from subsidiary, etc.). Support your statements with appropriate work papers and journal entries. Pro forma financial statements include Statement of Operation; Statement of Retained Earnings, Balance Sheet and Cash Flow Statement. 3. Prepare pro forma consolidated worksheet. Prepare a pro forma consolidation worksheet for Parent, Inc. and its proposed subsidiary as of December 31, 2009. To ensure you are starting with the right numbers, use the solution provided to Milestone 1 for the adjusted pro forma 2009 financial statements of Parent, Inc., and the projected 2009 financial statements of Subsidiary Corporation in table 1. Show all consolidation adjusting entries including minority interest entries. 4. Perform ratio analysis. Compute earnings per share for (1) the separate financial statements of Parent, Inc. prepared in #1 and (2) the consolidated financial statements contained in the solution for the pro forma consolidation worksheet prepared in #3. Also, calculate current ratio and return on average stockholders' equity for the separate company and consolidated financial statements. 5 Write a memorandum (as a Word document) to Ms. Franklin summarizing the results of your analysis, including a summary of the financial ratios you computed and your recommendation. Attach copies of both sets of pro forma financial statements of Parent, Inc. and the pro forma consolidation worksheet. Table 1 Parent , Inc Actual Financial Statements for 2008 and Subsidiary Corporation Projected Financial Statements for 2009 Parent 2008 Actual Subsidiary 2009 Projected Sales $ 800,000 $ 100,000 Cost of Goods Sold (485,000) (55,000) Operating Expenses (219,000) (10,000) Income before Taxes 96,000 35,000 Income Tax Expense (38,400) (14,000) Net Income $ 57,600 $ 21,000 Retained Earnings January 1 $ 23,000 $ 14,500 Add Net Income 57,600 21,000 Deduct Dividends (38,000) (7,000) Retained Earnings December 31 $ 42,600 $ 28,500 Cash $ 36,200 $ 19,500 Accounts Receivable 39,000 13,000 Inventory 26,000 12,000 Property, Plant and Equipment 673,000 213,000 Accumulated Depreciation (490,000) (28,000) Total Assets 284,200 229,500 Accounts Payable 44,600 21,000 Common Stock* 190,000 150,000 Paid-in Capital in Excess of Par 7,000 30,000 Retained Earnings 42,600 28,500 Total Liabilities & Equities $ 284,200 $ 229,500 *Parent: $12.50 par value. Subsidiary: $75 par value Course Project Check Figures ? Req #1 Net Income ?...$61,494 Cash...........?...$63,564 Total Assets....$313,594 Ret. Earnings....$66,094 Req #2 Net Income ???????....$63,225 Cash.........???????......$62,910 Investment in Subsidiary??.$177,485 Total Assets???????..$490,425 Ret. Earnings???????..$67,825 " 
AC559 - Course Project Corporate Takeover Situation Parent, Inc. is contemplating a tender offer to acquire 80 percent of Subsidiary Corporation's common stock. Subsidiary's shares are currently quoted on the New York Stock Exchange at $100 per share. Parent is going to offer $105 per share to execute the tender offer. If the tender offer is made and is successful, the purchase will be consummated on January 1, 2009. A typical part of the planning of a proposed business combination is the preparation of projected or pro forma consolidated financial statements. As a member of Parent's accounting group, you have been asked to prepare the pro forma 2009 consolidated financial statements for Parent and Subsidiary assuming that 80 percent of Subsidiary's stock is acquired at a price of $105 per share. To support your computations, Martha Franklin, the chairperson of Parent's acquisitions committee, has provided you with the projected 2009 financial statements for Subsidiary. (The projected financial statements for Subsidiary and several other companies were prepared earlier for the acquisition committee's use in targeting a company for acquisition.) The projected financial statements for Subsidiary for 2009 and Parent's actual 2008 financial statements are presented in table 1. Assumptions Ms. Franklin has asked you to use the following assumptions to project Parent's 2008 financial statements: - Sales will increase by 10 percent in 2009 and all sales will be on account. - Accounts receivable will be 5 percent lower on December 31, 2009, than on December 31, 2008. - Cost of goods sold will increase by 9 percent in 2009. - All purchases of merchandise will be on account. - Accounts payable are expected to be $50,500 on December 31, 2009. - Inventory will be 3 percent higher on December 31, 2009, than on December 31, 2008. - Straight-line depreciation is used for all fixed assets. - No fixed assets will be disposed of during 2009. The annual depreciation expense on existing assets is $40,000 per year. - Equipment will be purchased on January 1, 2009, for $48,000 cash. The equipment will have an estimated life of 10 years with no salvage value. - Other operating expenses (depreciation is discussed above) will increase by 14 percent in 2009 and all will be paid in cash. - Parent's income tax rate is 40 percent, and taxes are paid in cash in four equal payments. Payments will be made on the 15th of April, June, September, and December. For simplicity, assume taxable income equals financial reporting income before taxes. - Parent will continue the $2.50 per share annual cash dividend on its common stock. - If the tender offer is successful, Parent will finance the acquisition by issuing $170,000 of 6 percent non-convertible bonds at par on January 1, 2009. The bonds would first pay interest on July 1, 2009, and would pay interest semiannually thereafter each January 1 and July 1 until maturity on January 1, 2019. - The acquisition will be properly accounted for as an acquisition (SFAS 141R) and Parent will account for the investment using the equity method. Although most of the legal work related to the acquisition will be handled by Parent's staff attorney, direct costs to prepare and process the tender offer will total $2,000 and will be paid in cash by Parent in 2009. Additional Information As of January 1, 2009, all of Subsidiary's assets and liabilities are fairly valued except for machinery with a book value of $8,000, an estimated fair value of $9,500, and a 5-year remaining useful life. Assume that straight-line depreciation is used to amortize any revaluation increment. No transactions between these companies occurred prior to 2009. Regardless of whether they combine, Parent plans to buy $50,000 of merchandise from Subsidiary in 2009 and will have $3,600 of these purchases remaining in inventory on December 31, 2009. In addition, Subsidiary is expected to buy $2,400 of merchandise from Parent in 2009 and to have $495 of these purchases in inventory on December 31, 2009. Parent and Subsidiary price their products to yield a 65 percent and 80 percent markup on cost, respectively. Parent intends to use three financial yardsticks to determine the financial attractiveness of the acquisition. First, Parent wishes to acquire Subsidiary Corporation only if 2009 consolidated earnings per share will be at least as high as the earnings per share Parent would report if no acquisition takes place. Second, Parent will consider the proposed acquisition unattractive if it will cause the consolidated current ratio to fall below 2 to 1. Third, return on average stockholders' equity must remain above 20 percent for the consolidated entity. If the financial yardsticks described above and the non-financial aspects of the acquisition are appealing, then the tender offer will be made. On the other hand, if these objectives are not met, the acquisition will either be restructured or abandoned. Course Project Team The project is to be done in teams to be assigned by the instructor during week 1 of the course. The team will work together in private threaded discussion assigned by the instructor. The private threads are located in Letter designated (A. B. ...) areas included in the Team Caf link just below Week 8. There are three threads in each letter group that correspond to the three required milestones. Milestone 1 - Required 1. & 2. Milestone 2 - Required 3. Milestone 3 - Required 4. & 5. The team will choose a leader to be responsible for posting their document(s) to that person's Dropbox for the appropriate week. In addition to the private threaded discussion areas, teams have private Doc Sharing to facilitate project activities. Required 1. Forecast the separate financial statements of Parent, Inc. Using Ms. Franklin's assumptions and Parent's 2008 financial statements, prepare pro forma 2009 financial statements for Parent, Inc., assuming that the acquisition is not attempted. Support your statements with appropriate work papers and journal entries. Pro forma financial statements include Statement of Operation; Statement of Retained Earnings, Balance Sheet and Cash Flow Statement. 2. Adjust the separate financial statements of Parent, Inc. to reflect the proposed acquisition. Adjust Parent's pro forma 2009 financial statements prepared in #1 to reflect the proposed acquisition (i.e., adjust Parent's forecasted financial statements for bond issuance, stock purchase, income from subsidiary, etc.). Support your statements with appropriate work papers and journal entries. Pro forma financial statements include Statement of Operation; Statement of Retained Earnings, Balance Sheet and Cash Flow Statement. 3. Prepare pro forma consolidation worksheet. Prepare a pro forma consolidation worksheet for Parent, Inc. and it's proposed subsidiary as of December 31, 2009. Use the adjusted pro forma 2009 financial statements of Parent, Inc. prepared in #2 and the projected 2009 financial statements of Subsidiary Corporation in table 1. Show all consolidation adjusting entries including non controlling interest (NCI) entries. 4. Perform ratio analysis. Compute earnings per share for (1) the separate financial statements of Parent, Inc. prepared in #1 and (2) the consolidated financial statements contained in the pro forma consolidation worksheet prepared in #3. Also, calculate current ratio and return on average stockholders' equity for the separate company (parent) and consolidated financial statements. 5. Write a memorandum to Ms. Franklin summarizing the results of your analysis, including a summary of the financial ratios you computed and your recommendation. Attach copies of both sets of pro forma financial statements of Parent, Inc. and the pro forma consolidation worksheet. Table 1 Parent , Inc Actual Financial Statements for 2008 and Subsidiary Corporation Projected Financial Statements for 2009 Parent 2008 Actual Sales Cost of Goods Sold Operating Expenses Income before Taxes Income Tax Expense Net Income Subsidiary 2009 Projected $800,000 $100,000 (485,000) (55,000) (219,000) (10,000) 96,000 35,000 (38,400) (14,000) $57,600 $21,000 Retained Earnings January 1 Add Net Income Deduct Dividends Retained Earnings December 31 $23,000 57,600 (38,000) $42,600 $14,500 21,000 (7,000) $28,500 Cash Accounts Receivable Inventory Property, Plant and Equipment Accumulated Depreciation Total Assets $36,200 39,000 26,000 673,000 (490,000) 284,200 $19,500 13,000 12,000 213,000 (28,000) 229,500 Accounts Payable Common Stock* Paid-in Capital in Excess of Par Retained Earnings Total Liabilities & Equities *Parent: $12.50 par value. Subsidiary: $75 par value 44,600 21,000 190,000 150,000 7,000 30,000 42,600 28,500 $284,200 $229,500 Requiremennt #1 Requirement #2 Parent, Inc. 2009 Pro Forma Income Statement 2009 Projected w/o Acquisition Sales (800,000 x 110%) $880,000 Cost of Goods Sold (485,000 x 109%) (528,650) Operating Expenses [(219000-40,000) x 114%] + [40,000 + 4,800 dpr]+2000 legal fees (248,860) Interest Expense - Equity in Subsidiary income - Income Before Taxes (102,490 x 40%) 102,490 Income Tax Expense (40,996) Net Income $61,494 2009 Projected w/Acquisition $880,000 (528,650) (250,860) (10,200) 15,085 105,375 (42,150) $63,225 Parent, Inc. 2009 Pro Forma Statement of Retained Earnings Retained Earnings, January 1 Add: Net Income Less: Dividends Retained Earnings, December 31 $42,600 61,494 (38,000) $66,094 $42,600 63,225 (38,000) $67,825 Parent, Inc. 2009 Pro Forma Balance Sheet Cash (below) Accounts Receivable (39,000 x 95%) Inventory (26,000 x 103%) Property, Plant, & Equipment (673,000 + 48,000) Less: Accumulated Depreciation (490,000 + 44,800) Investment in Subsiidiary T otal Assets $63,564 37,050 26,780 721,000 (534,800) - $313,594 $62,910 37,050 26,780 721,000 (534,800) 177,485 $490,425 Accounts Payable (given) Interest Payable Bonds Payable Common Stock Paid-In Capital in Excess of Par Retained Earnings T otal Liabilities & Equities $50,500 - - 190,000 7,000 66,094 $313,594 $50,500 5,100 170,000 190,000 7,000 67,825 $490,425 Parent, Inc. 2009 Pro Forma Cash Flow Cash flows from operating activities Net Income Adjustments Depreciation Change in accounts receivable Inventory Change in accounts and interest payable Net cash from operating activities $61,494 $63,225 44,800 1,950 (780) 5,900 113,364 44,800 1,950 (780) 11,000 120,195 Cash flows from investing activities Investment in Subsidiary Dividend received Equip Purchase Net cash provided (used) by investing activities - - (48,000) (48,000) (183,085) 5,600 (48,000) (225,485) Cash flows from financing activities Bond issuance Dividend paid Net cash provided (used) by financing activities - (38,000) (38,000) 170,000 (38,000) 132,000 Change in cash Cash at beginning of year Cash at end of year 27,364 36,200 $63,564 Working Papers - Requirement #1 w/out acquisition Beginning Inventory Add: Purchases Less: Ending Inventory C ost of Goods Sold Cash Account Beginning Balance Sales Decrease in Accounts Receivable Cash paid for purchases ** Cash operating exp. (248,860-44,800dpr) Dividends Taxes Equipment purchase Balance 12/31/09 ** Cash paid for purchases Cost of Goods Sold Plus increase in Inventory Purchases Less increase in Accounts Payable Cash paid for purchases 26,000 529,430 26,780 528,650 Dr 36,200 880,000 1,950 Cr 523,530 204,060 38,000 40,996 48,000 63,564 528,650 780 529,430 (5,900) 523,530 26,710 36,200 $62,910 Added Journal Entries for acquisition Dr. Cr. Cash 170,000 Bonds Payable 170,000 (Issue bonds to finance acquisition) Investment in Subsidiary Cash (1,600 sh. X $105) 168,000 168,000 Investment in Subsidiary 16,800 Equity in Subsidiary Income (To recognize investee income $21,000 x 80%) 16,800 Equity in Subsidiary Income 240 Investment in Subsidiary 240 (To record annual amortization on excess payment - below) Cash 5,600 Investment in Subsidiary 5,600 (To record dividend from investee $7,000 x 80%) Equity in Subsidiary Income 1,280 Investment in Subsidiary (To defer 80% of gain on upstream sales) [3,600 - (3,600/1.80)] Equity in Subsidiary Income 195 Investment in Subsidiary (To defer 100% of gain on downstream sales) [495 - (495/1.65)] Interest Expense Cash Interest Payable (To Record Bond Interest Expense) 1,280 195 10,200 5,100 5,100 Income Tax Expense 1,154 Cash 1,154 (To record additional Income Tax Expense $2,885 x 40%) Legal Fees 2,000 Cash 2,000 (To record expense of legal costs associated with acquisition) Computation of Revaluation Increment and Goodwill Fair value paid (1,600 sh. X $105) Less Fair Value of Identifiable Assets Acquired see below Excess fair value transferred - Goodwill 168,000 Investment in Subsidiary balance Beginning balance Equity in Subsidiary Subsidiary Dividend Unrealized gain in upstream sale Unrealized gain in downstream sale Balance 12/31/09 (156,800) 11,200 Excess fair value allocated to machinery (included in fair value above) 1,200 Annual Amortization 5yr 240 168,000 16,560 (5,600) (1,280) (195) 177,485 To Defer Realized Gain On Intercompany Sales Parent $1,600 80% $1,280 Subsidiary $195 100% $195 $1,475 Fair value acquired Cash A/R Inventory PP&E A/D A/P Change in RE** Total fair value 1 2/31 balance 19,500 13,000 12,000 214,500 (28,000) (21,000) (14,000) 196,000 80% 156,800 **Note: 1/1/09 individual asset fair values were not given, however by adjusting for change in RE you can calculate total fair value at 1/1/09 of all assets Requiremennt #1 Requirement #2 Parent, Inc. 2009 Pro Forma Income Statement 2009 Projected w/o Acquisition Sales (800,000 x 110%) $880,000 Cost of Goods Sold (485,000 x 109%) (528,650) Operating Expenses [(219000-40,000) x 114%] + [40,000 + 4,800 dpr]+2000 legal fees (248,860) Interest Expense Equity in Subsidiary income Income Before Taxes (102,490 x 40%) 102,490 Income Tax Expense (40,996) Net Income $61,494 2009 Projected w/Acquisition $880,000 (528,650) (250,860) (10,200) 15,085 105,375 (42,150) $63,225 Parent, Inc. 2009 Pro Forma Statement of Retained Earnings Retained Earnings, January 1 Add: Net Income Less: Dividends Retained Earnings, December 31 $42,600 61,494 (38,000) $66,094 $42,600 63,225 (38,000) $67,825 Parent, Inc. 2009 Pro Forma Balance Sheet Cash (below) Accounts Receivable (39,000 x 95%) Inventory (26,000 x 103%) Property, Plant, & Equipment (673,000 + 48,000) Less: Accumulated Depreciation (490,000 + 44,800) Investment in Subsiidiary T otal Assets $63,564 37,050 26,780 721,000 (534,800) $313,594 $62,910 37,050 26,780 721,000 (534,800) 177,485 $490,425 Accounts Payable (given) Interest Payable Bonds Payable Common Stock Paid-In Capital in Excess of Par Retained Earnings T otal Liabilities & Equities $50,500 190,000 7,000 66,094 $313,594 $50,500 5,100 170,000 190,000 7,000 67,825 $490,425 $61,494 $63,225 44,800 1,950 (780) 5,900 113,364 44,800 1,950 (780) 11,000 120,195 Cash flows from investing activities Investment in Subsidiary Dividend received Equip Purchase Net cash provided (used) by investing activities (48,000) (48,000) (183,085) 5,600 (48,000) (225,485) Cash flows from financing activities Bond issuance Dividend paid Net cash provided (used) by financing activities (38,000) (38,000) 170,000 (38,000) 132,000 Change in cash Cash at beginning of year Cash at end of year 27,364 36,200 $63,564 26,710 36,200 $62,910 Parent, Inc. 2009 Pro Forma Cash Flow Cash flows from operating activities Net Income Adjustments Depreciation Change in accounts receivable Inventory Change in accounts and interest payable Net cash from operating activities Working Papers - Requirement #1 w/out acquisition Beginning Inventory Add: Purchases Less: Ending Inventory Cost of Goods Sold Cash Account Beginning Balance Sales Decrease in Accounts Receivable Cash paid for purchases ** Cash operating exp. (248,860-44,800dpr) Dividends Taxes Equipment purchase Balance 12/31/09 ** Cash paid for purchases Cost of Goods Sold Plus increase in Inventory Purchases Less increase in Accounts Payable Cash paid for purchases 26,000 529,430 26,780 528,650 Dr 36,200 880,000 1,950 Cr 523,530 204,060 38,000 40,996 48,000 63,564 528,650 780 529,430 (5,900) 523,530 Added Journal Entries for acquisition Dr. Cash 170,000 Bonds Payable (Issue bonds to finance acquisition) Investment in Subsidiary Cash (1,600 sh. X $105) Cr. 170,000 168,000 168,000 Investment in Subsidiary 16,800 Equity in Subsidiary Income (To recognize investee income $21,000 x 80%) 16,800 Equity in Subsidiary Income 240 Investment in Subsidiary 240 (To record annual amortization on excess payment - below) Cash 5,600 Investment in Subsidiary (To record dividend from investee $7,000 x 80%) Equity in Subsidiary Income 1,280 Investment in Subsidiary (To defer 80% of gain on upstream sales) [3,600 - (3,600/1.80)] 5,600 1,280 Equity in Subsidiary Income 195 Investment in Subsidiary (To defer 100% of gain on downstream sales) [495 - (495/1.65)] Interest Expense Cash Interest Payable (To Record Bond Interest Expense) 195 10,200 5,100 5,100 Income Tax Expense 1,154 Cash 1,154 (To record additional Income Tax Expense $2,885 x 40%) Legal Fees 2,000 Cash 2,000 (To record expense of legal costs associated with acquisition) Computation of Revaluation Increment and Goodwill Fair value paid (1,600 sh. X $105) Less Fair Value of Identifiable Assets Acquired see below Excess fair value transferred - Goodwill 168,000 (156,800) 11,200 Excess fair value allocated to machinery (included in fair value above),200 1 Investment in Subsidiary balance Beginning balance Equity in Subsidiary Subsidiary Dividend Unrealized gain in upstream sale Unrealized gain in downstream sale Balance 12/31/09 Annual Amortization 5yr 240 168,000 16,560 (5,600) (1,280) (195) 177,485 T o Defer Realized Gain On Intercompany Sales Parent $1,600 80% $1,280 Subsidiary $195 100% $195 $1,475 Fair value acquired Cash A/R Inventory PP&E A/D A/P Change in RE** Total fair value 12/31 balance 19,500 13,000 12,000 214,500 (28,000) (21,000) (14,000) 196,000 80% 156,800 **Note: 1/1/09 individual asset fair values were not given, however by adjusting for change in RE you can calculate total fair value at 1/1/09 of all assets AC559 - Course Project Corporate Takeover Situation Parent, Inc. is contemplating a tender offer to acquire 80 percent of Subsidiary Corporation's common stock. Subsidiary's shares are currently quoted on the New York Stock Exchange at $100 per share. Parent is going to offer $105 per share to execute the tender offer. If the tender offer is made and is successful, the purchase will be consummated on January 1, 2009. A typical part of the planning of a proposed business combination is the preparation of projected or pro forma consolidated financial statements. As a member of Parent's accounting group, you have been asked to prepare the pro forma 2009 consolidated financial statements for Parent and Subsidiary assuming that 80 percent of Subsidiary's stock is acquired at a price of $105 per share. To support your computations, Martha Franklin, the chairperson of Parent's acquisitions committee, has provided you with the projected 2009 financial statements for Subsidiary. (The projected financial statements for Subsidiary and several other companies were prepared earlier for the acquisition committee's use in targeting a company for acquisition.) The projected financial statements for Subsidiary for 2009 and Parent's actual 2008 financial statements are presented in table 1. Assumptions Ms. Franklin has asked you to use the following assumptions to project Parent's 2008 financial statements: - Sales will increase by 10 percent in 2009 and all sales will be on account. - Accounts receivable will be 5 percent lower on December 31, 2009, than on December 31, 2008. - Cost of goods sold will increase by 9 percent in 2009. - All purchases of merchandise will be on account. - Accounts payable are expected to be $50,500 on December 31, 2009. - Inventory will be 3 percent higher on December 31, 2009, than on December 31, 2008. - Straight-line depreciation is used for all fixed assets. - No fixed assets will be disposed of during 2009. The annual depreciation expense on existing assets is $40,000 per year. - Equipment will be purchased on January 1, 2009, for $48,000 cash. The equipment will have an estimated life of 10 years with no salvage value. - Other operating expenses (depreciation is discussed above) will increase by 14 percent in 2009 and all will be paid in cash. - Parent's income tax rate is 40 percent, and taxes are paid in cash in four equal payments. Payments will be made on the 15th of April, June, September, and December. For simplicity, assume taxable income equals financial reporting income before taxes. - Parent will continue the $2.50 per share annual cash dividend on its common stock. - If the tender offer is successful, Parent will finance the acquisition by issuing $170,000 of 6 percent non-convertible bonds at par on January 1, 2009. The bonds would first pay interest on July 1, 2009, and would pay interest semiannually thereafter each January 1 and July 1 until maturity on January 1, 2019. - The acquisition will be properly accounted for as an acquisition (SFAS 141R) and Parent will account for the investment using the equity method. Although most of the legal work related to the acquisition will be handled by Parent's staff attorney, direct costs to prepare and process the tender offer will total $2,000 and will be paid in cash by Parent in 2009. Additional Information As of January 1, 2009, all of Subsidiary's assets and liabilities are fairly valued except for machinery with a book value of $8,000, an estimated fair value of $9,500, and a 5-year remaining useful life. Assume that straight-line depreciation is used to amortize any revaluation increment. No transactions between these companies occurred prior to 2009. Regardless of whether they combine, Parent plans to buy $50,000 of merchandise from Subsidiary in 2009 and will have $3,600 of these purchases remaining in inventory on December 31, 2009. In addition, Subsidiary is expected to buy $2,400 of merchandise from Parent in 2009 and to have $495 of these purchases in inventory on December 31, 2009. Parent and Subsidiary price their products to yield a 65 percent and 80 percent markup on cost, respectively. Parent intends to use three financial yardsticks to determine the financial attractiveness of the acquisition. First, Parent wishes to acquire Subsidiary Corporation only if 2009 consolidated earnings per share will be at least as high as the earnings per share Parent would report if no acquisition takes place. Second, Parent will consider the proposed acquisition unattractive if it will cause the consolidated current ratio to fall below 2 to 1. Third, return on average stockholders' equity must remain above 20 percent for the consolidated entity. If the financial yardsticks described above and the non-financial aspects of the acquisition are appealing, then the tender offer will be made. On the other hand, if these objectives are not met, the acquisition will either be restructured or abandoned. Course Project Team The project is to be done in teams to be assigned by the instructor during week 1 of the course. The team will work together in private threaded discussion assigned by the instructor. The private threads are located in Letter designated (A. B. ...) areas included in the Team Caf link just below Week 8. There are three threads in each letter group that correspond to the three required milestones. Milestone 1 - Required 1. & 2. Milestone 2 - Required 3. Milestone 3 - Required 4. & 5. The team will choose a leader to be responsible for posting their document(s) to that person's Dropbox for the appropriate week. In addition to the private threaded discussion areas, teams have private Doc Sharing to facilitate project activities. Required 1. Forecast the separate financial statements of Parent, Inc. Using Ms. Franklin's assumptions and Parent's 2008 financial statements, prepare pro forma 2009 financial statements for Parent, Inc., assuming that the acquisition is not attempted. Support your statements with appropriate work papers and journal entries. Pro forma financial statements include Statement of Operation; Statement of Retained Earnings, Balance Sheet and Cash Flow Statement. 2. Adjust the separate financial statements of Parent, Inc. to reflect the proposed acquisition. Adjust Parent's pro forma 2009 financial statements prepared in #1 to reflect the proposed acquisition (i.e., adjust Parent's forecasted financial statements for bond issuance, stock purchase, income from subsidiary, etc.). Support your statements with appropriate work papers and journal entries. Pro forma financial statements include Statement of Operation; Statement of Retained Earnings, Balance Sheet and Cash Flow Statement. 3. Prepare pro forma consolidation worksheet. Prepare a pro forma consolidation worksheet for Parent, Inc. and it's proposed subsidiary as of December 31, 2009. Use the adjusted pro forma 2009 financial statements of Parent, Inc. prepared in #2 and the projected 2009 financial statements of Subsidiary Corporation in table 1. Show all consolidation adjusting entries including non controlling interest (NCI) entries. 4. Perform ratio analysis. Compute earnings per share for (1) the separate financial statements of Parent, Inc. prepared in #1 and (2) the consolidated financial statements contained in the pro forma consolidation worksheet prepared in #3. Also, calculate current ratio and return on average stockholders' equity for the separate company (parent) and consolidated financial statements. 5. Write a memorandum to Ms. Franklin summarizing the results of your analysis, including a summary of the financial ratios you computed and your recommendation. Attach copies of both sets of pro forma financial statements of Parent, Inc. and the pro forma consolidation worksheet. Table 1 Parent , Inc Actual Financial Statements for 2008 and Subsidiary Corporation Projected Financial Statements for 2009 Parent 2008 Actual Sales Cost of Goods Sold Operating Expenses Income before Taxes Income Tax Expense Net Income Subsidiary 2009 Projected $800,000 $100,000 (485,000) (55,000) (219,000) (10,000) 96,000 35,000 (38,400) (14,000) $57,600 $21,000 Retained Earnings January 1 Add Net Income Deduct Dividends Retained Earnings December 31 $23,000 57,600 (38,000) $42,600 $14,500 21,000 (7,000) $28,500 Cash Accounts Receivable Inventory Property, Plant and Equipment Accumulated Depreciation Total Assets $36,200 39,000 26,000 673,000 (490,000) 284,200 $19,500 13,000 12,000 213,000 (28,000) 229,500 Accounts Payable Common Stock* Paid-in Capital in Excess of Par Retained Earnings Total Liabilities & Equities *Parent: $12.50 par value. Subsidiary: $75 par value 44,600 21,000 190,000 150,000 7,000 30,000 42,600 28,500 $284,200 $229,500 Requiremennt #1 Requirement #2 Parent, Inc. 2009 Pro Forma Income Statement 2009 Projected w/o Acquisition Sales (800,000 x 110%) $880,000 Cost of Goods Sold (485,000 x 109%) (528,650) Operating Expenses [(219000-40,000) x 114%] + [40,000 + 4,800 dpr]+2000 legal fees (248,860) Interest Expense - Equity in Subsidiary income - Income Before Taxes (102,490 x 40%) 102,490 Income Tax Expense (40,996) Net Income $61,494 2009 Projected w/Acquisition $880,000 (528,650) (250,860) (10,200) 15,085 105,375 (42,150) $63,225 Parent, Inc. 2009 Pro Forma Statement of Retained Earnings Retained Earnings, January 1 Add: Net Income Less: Dividends Retained Earnings, December 31 $42,600 61,494 (38,000) $66,094 $42,600 63,225 (38,000) $67,825 Parent, Inc. 2009 Pro Forma Balance Sheet Cash (below) Accounts Receivable (39,000 x 95%) Inventory (26,000 x 103%) Property, Plant, & Equipment (673,000 + 48,000) Less: Accumulated Depreciation (490,000 + 44,800) Investment in Subsiidiary T otal Assets $63,564 37,050 26,780 721,000 (534,800) - $313,594 $62,910 37,050 26,780 721,000 (534,800) 177,485 $490,425 Accounts Payable (given) Interest Payable Bonds Payable Common Stock Paid-In Capital in Excess of Par Retained Earnings T otal Liabilities & Equities $50,500 - - 190,000 7,000 66,094 $313,594 $50,500 5,100 170,000 190,000 7,000 67,825 $490,425 Parent, Inc. 2009 Pro Forma Cash Flow Cash flows from operating activities Net Income Adjustments Depreciation Change in accounts receivable Inventory Change in accounts and interest payable Net cash from operating activities $61,494 $63,225 44,800 1,950 (780) 5,900 113,364 44,800 1,950 (780) 11,000 120,195 Cash flows from investing activities Investment in Subsidiary Dividend received Equip Purchase Net cash provided (used) by investing activities - - (48,000) (48,000) (183,085) 5,600 (48,000) (225,485) Cash flows from financing activities Bond issuance Dividend paid Net cash provided (used) by financing activities - (38,000) (38,000) 170,000 (38,000) 132,000 Change in cash Cash at beginning of year Cash at end of year 27,364 36,200 $63,564 Working Papers - Requirement #1 w/out acquisition Beginning Inventory Add: Purchases Less: Ending Inventory C ost of Goods Sold Cash Account Beginning Balance Sales Decrease in Accounts Receivable Cash paid for purchases ** Cash operating exp. (248,860-44,800dpr) Dividends Taxes Equipment purchase Balance 12/31/09 ** Cash paid for purchases Cost of Goods Sold Plus increase in Inventory Purchases Less increase in Accounts Payable Cash paid for purchases 26,000 529,430 26,780 528,650 Dr 36,200 880,000 1,950 Cr 523,530 204,060 38,000 40,996 48,000 63,564 528,650 780 529,430 (5,900) 523,530 26,710 36,200 $62,910 Added Journal Entries for acquisition Dr. Cr. Cash 170,000 Bonds Payable 170,000 (Issue bonds to finance acquisition) Investment in Subsidiary Cash (1,600 sh. X $105) 168,000 168,000 Investment in Subsidiary 16,800 Equity in Subsidiary Income (To recognize investee income $21,000 x 80%) 16,800 Equity in Subsidiary Income 240 Investment in Subsidiary 240 (To record annual amortization on excess payment - below) Cash 5,600 Investment in Subsidiary 5,600 (To record dividend from investee $7,000 x 80%) Equity in Subsidiary Income 1,280 Investment in Subsidiary (To defer 80% of gain on upstream sales) [3,600 - (3,600/1.80)] Equity in Subsidiary Income 195 Investment in Subsidiary (To defer 100% of gain on downstream sales) [495 - (495/1.65)] Interest Expense Cash Interest Payable (To Record Bond Interest Expense) 1,280 195 10,200 5,100 5,100 Income Tax Expense 1,154 Cash 1,154 (To record additional Income Tax Expense $2,885 x 40%) Legal Fees 2,000 Cash 2,000 (To record expense of legal costs associated with acquisition) Computation of Revaluation Increment and Goodwill Fair value paid (1,600 sh. X $105) Less Fair Value of Identifiable Assets Acquired see below Excess fair value transferred - Goodwill 168,000 Investment in Subsidiary balance Beginning balance Equity in Subsidiary Subsidiary Dividend Unrealized gain in upstream sale Unrealized gain in downstream sale Balance 12/31/09 (156,800) 11,200 Excess fair value allocated to machinery (included in fair value above) 1,200 Annual Amortization 5yr 240 168,000 16,560 (5,600) (1,280) (195) 177,485 To Defer Realized Gain On Intercompany Sales Parent $1,600 80% $1,280 Subsidiary $195 100% $195 $1,475 Fair value acquired Cash A/R Inventory PP&E A/D A/P Change in RE** Total fair value 1 2/31 balance 19,500 13,000 12,000 214,500 (28,000) (21,000) (14,000) 196,000 80% 156,800 **Note: 1/1/09 individual asset fair values were not given, however by adjusting for change in RE you can calculate total fair value at 1/1/09 of all assets Requiremennt #1 Requirement #2 Parent, Inc. 2009 Pro Forma Income Statement 2009 Projected w/o Acquisition Sales (800,000 x 110%) $880,000 Cost of Goods Sold (485,000 x 109%) (528,650) Operating Expenses [(219000-40,000) x 114%] + [40,000 + 4,800 dpr]+2000 legal fees (248,860) Interest Expense Equity in Subsidiary income Income Before Taxes (102,490 x 40%) 102,490 Income Tax Expense (40,996) Net Income $61,494 2009 Projected w/Acquisition $880,000 (528,650) (250,860) (10,200) 15,085 105,375 (42,150) $63,225 Parent, Inc. 2009 Pro Forma Statement of Retained Earnings Retained Earnings, January 1 Add: Net Income Less: Dividends Retained Earnings, December 31 $42,600 61,494 (38,000) $66,094 $42,600 63,225 (38,000) $67,825 Parent, Inc. 2009 Pro Forma Balance Sheet Cash (below) Accounts Receivable (39,000 x 95%) Inventory (26,000 x 103%) Property, Plant, & Equipment (673,000 + 48,000) Less: Accumulated Depreciation (490,000 + 44,800) Investment in Subsiidiary T otal Assets $63,564 37,050 26,780 721,000 (534,800) $313,594 $62,910 37,050 26,780 721,000 (534,800) 177,485 $490,425 Accounts Payable (given) Interest Payable Bonds Payable Common Stock Paid-In Capital in Excess of Par Retained Earnings T otal Liabilities & Equities $50,500 190,000 7,000 66,094 $313,594 $50,500 5,100 170,000 190,000 7,000 67,825 $490,425 $61,494 $63,225 44,800 1,950 (780) 5,900 113,364 44,800 1,950 (780) 11,000 120,195 Cash flows from investing activities Investment in Subsidiary Dividend received Equip Purchase Net cash provided (used) by investing activities (48,000) (48,000) (183,085) 5,600 (48,000) (225,485) Cash flows from financing activities Bond issuance Dividend paid Net cash provided (used) by financing activities (38,000) (38,000) 170,000 (38,000) 132,000 Change in cash Cash at beginning of year Cash at end of year 27,364 36,200 $63,564 26,710 36,200 $62,910 Parent, Inc. 2009 Pro Forma Cash Flow Cash flows from operating activities Net Income Adjustments Depreciation Change in accounts receivable Inventory Change in accounts and interest payable Net cash from operating activities Working Papers - Requirement #1 w/out acquisition Beginning Inventory Add: Purchases Less: Ending Inventory Cost of Goods Sold Cash Account Beginning Balance Sales Decrease in Accounts Receivable Cash paid for purchases ** Cash operating exp. (248,860-44,800dpr) Dividends Taxes Equipment purchase Balance 12/31/09 ** Cash paid for purchases Cost of Goods Sold Plus increase in Inventory Purchases Less increase in Accounts Payable Cash paid for purchases 26,000 529,430 26,780 528,650 Dr 36,200 880,000 1,950 Cr 523,530 204,060 38,000 40,996 48,000 63,564 528,650 780 529,430 (5,900) 523,530 Added Journal Entries for acquisition Dr. Cash 170,000 Bonds Payable (Issue bonds to finance acquisition) Investment in Subsidiary Cash (1,600 sh. X $105) Cr. 170,000 168,000 168,000 Investment in Subsidiary 16,800 Equity in Subsidiary Income (To recognize investee income $21,000 x 80%) 16,800 Equity in Subsidiary Income 240 Investment in Subsidiary 240 (To record annual amortization on excess payment - below) Cash 5,600 Investment in Subsidiary (To record dividend from investee $7,000 x 80%) Equity in Subsidiary Income 1,280 Investment in Subsidiary (To defer 80% of gain on upstream sales) [3,600 - (3,600/1.80)] 5,600 1,280 Equity in Subsidiary Income 195 Investment in Subsidiary (To defer 100% of gain on downstream sales) [495 - (495/1.65)] Interest Expense Cash Interest Payable (To Record Bond Interest Expense) 195 10,200 5,100 5,100 Income Tax Expense 1,154 Cash 1,154 (To record additional Income Tax Expense $2,885 x 40%) Legal Fees 2,000 Cash 2,000 (To record expense of legal costs associated with acquisition) Computation of Revaluation Increment and Goodwill Fair value paid (1,600 sh. X $105) Less Fair Value of Identifiable Assets Acquired see below Excess fair value transferred - Goodwill 168,000 (156,800) 11,200 Excess fair value allocated to machinery (included in fair value above),200 1 Investment in Subsidiary balance Beginning balance Equity in Subsidiary Subsidiary Dividend Unrealized gain in upstream sale Unrealized gain in downstream sale Balance 12/31/09 Annual Amortization 5yr 240 168,000 16,560 (5,600) (1,280) (195) 177,485 T o Defer Realized Gain On Intercompany Sales Parent $1,600 80% $1,280 Subsidiary $195 100% $195 $1,475 Fair value acquired Cash A/R Inventory PP&E A/D A/P Change in RE** Total fair value 12/31 balance 19,500 13,000 12,000 214,500 (28,000) (21,000) (14,000) 196,000 80% 156,800 **Note: 1/1/09 individual asset fair values were not given, however by adjusting for change in RE you can calculate total fair value at 1/1/09 of all assets
