Parent Inc. is contemplating a tender offer to acquire 80% of Subsidiary Corpora
ID: 2509061 • Letter: P
Question
Parent Inc. is contemplating a tender offer to acquire 80% 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% 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, 2017.
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 2017 consolidated financial statements for Parent and Subsidiary assuming that 80% 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 2017 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 2017 and Parent's actual 2016 financial statements are presented in Table 1.
Explanation / Answer
Answer:
Assumption
Ms. Franklin has asked you to use the assumptions below to project Parent's 2013 financial statements.
As of January 1, 2017, 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 2017. Regardless of whether they combine, Parent plans to buy $50,000 of merchandise from Subsidiary in 2017 and will have $3,600 of these purchases remaining in inventory on December 31, 2017. In addition, Subsidiary is expected to buy $2,400 of merchandise from Parent in 2013 and to have $495 of these purchases in inventory on December 31, 2017. Parent and Subsidiary price their products to yield a 65% and 80% 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 2017 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 two to one. Third, return on average stockholders' equity must remain above 20% for the combined entity.
If the financial yardsticks described above and the nonfinancial 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.
Table 1
Parent Inc. Actual Financial Statements for 2016 and
Subsidiary Corporation Projected Financial Statements for 2017
Parent 2016 Actual
Subsidiary 2017 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
Less: 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
Parent 2016 Actual
Subsidiary 2017 Projected
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 and stockholders' equity
284,200
229,500
* Parent: $12.50 par; Subsidiary: $75 par
Parent 2016 Actual
Subsidiary 2017 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
Less: 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
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