Concept explainers
EXCEL CASE 1
On January 1, 2018, Acme Co. is considering purchasing a 40 percent ownership interest in PHC Co., a privately held enterprise, for $700,000. PHC predicts its profit will be $185,000 in 2018, projects a 10 percent annual increase in profits in each of the next four years, and expects to pay a steady annual dividend of $30,000 for the foreseeable future. Because PHC has on its books a patent that is undervalued by $375,000, Acme realizes that it will have an additional amortization expense of $15,000 per year over the next 10 years—the patent’s estimated remaining useful life. All of PHC’s other assets and liabilities have book values that approximate market values. Acme uses the equity method for its investment in PHC.
Required
- 1. Using an Excel spreadsheet, set the following values in cells:
- Acme’s cost of investment in PHC.
- Percentage acquired.
- First-year PHC reported income.
- Projected growth rate in income.
- PHC annual dividends.
- Annual excess patent amortization.
- 2. Referring to the values in (1), prepare the following schedules using columns for the years 2018 through 2022.
- Acme’s equity in PHC earnings with rows showing these:
- Acme’s share of PHC reported income.
- Amortization expense.
- Acme’s equity in PHC earnings.
- Acme’s Investment in PHC balance with rows showing the following:
- Beginning balance.
- Equity earnings.
- Dividends.
- Ending balance.
- Return on beginning investment balance = Equity earnings/Beginning investment balance in each year.
- Acme’s equity in PHC earnings with rows showing these:
- 3. Given the preceding values, compute the average of the projected returns on beginning investment balances for the first five years of Acme’s investment in PHC. What is the maximum Acme can pay for PHC if it wishes to earn at least a 10 percent average return on beginning investment balance? (Hint: Under Excel’s Data tab, select What-If Analysis, and the Goal Seek capability to produce a 10 percent average return on beginning investment balance by changing the cell that contains Acme’s cost of investment in PHC. Excel’s Solver should produce an exact answer while Goal Seek should produce a close approximation. You may need to first add in the Solver capability under Excel’s Tools menu.)
1.
Using an Excel spreadsheet, set the following values in cells:
- Acme’s cost of investment in PHC.
- Percentage acquired.
- First-year PHC reported income.
- Projected growth rate in income.
- PHC annual dividends.
- Annual excess patent amortization.
Explanation of Solution
The required values are presented in excel sheet as follows:
Growth rate in income | 10% | ||||
Dividends | 30000 | ||||
Cost | 700000 | ||||
Annual amortization | $ 15,000 | ||||
1st year PHC income | $ 185,000 | ||||
Percentage owned | 40% | ||||
2018 | 2019 | 2020 | 2021 | 2022 | |
PHC reported income | $ 74,000 | $ 81,400 | $ 89,540 | $ 98,494 | $ 108,343 |
Amortization | $ 15,000 | $ 15,000 | $ 15,000 | $ 15,000 | $ 15,000 |
Equity earnings | $ 59,000 | $ 66,400 | $ 74,540 | $ 83,494 | $ 93,343 |
Beginning balance | $ 700,000 | $ 747,000 | $ 801,400 | $ 863,940 | $ 935,434 |
Equity earnings | $ 59,000 | $ 66,400 | $ 74,540 | $ 83,494 | $ 93,343 |
Dividends | $ (12,000) | $ (12,000) | $ (12,000) | $ (12,000) | $ (12,000) |
Ending balance | $ 747,000 | $ 801,400 | $ 863,940 | $ 935,434 | $ 1,016,777 |
ROI | 8.43% | 8.89% | 9.30% | 9.66% | 9.98% |
Average | 9.25% |
2.
Referring to the values in (1), prepare the following schedules using columns for the years 2018 through 2022.
Acme’s equity in PHC earnings with rows showing these:
- Acme’s share of PHC reported income.
- Amortization expense.
- Acme’s equity in PHC earnings.
Acme’s Investment in PHC balance with rows showing the following:
- Beginning balance.
- Equity earnings.
- Dividends.
- Ending balance.
Explanation of Solution
Growth rate in income | 10% | ||||
Dividends | 30000 | ||||
Cost | 700000 | ||||
Annual amortization | $ 15,000 | ||||
1st year PHC income | $ 185,000 | ||||
Percentage owned | 40% | ||||
2018 | 2019 | 2020 | 2021 | 2022 | |
PHC reported income | $ 74,000 | $ 81,400 | $ 89,540 | $ 98,494 | $ 108,343 |
Amortization | $ 15,000 | $ 15,000 | $ 15,000 | $ 15,000 | $ 15,000 |
Equity earnings | $ 59,000 | $ 66,400 | $ 74,540 | $ 83,494 | $ 93,343 |
Beginning balance | $ 700,000 | $ 747,000 | $ 801,400 | $ 863,940 | $ 935,434 |
Equity earnings | $ 59,000 | $ 66,400 | $ 74,540 | $ 83,494 | $ 93,343 |
Dividends | $ (12,000) | $ (12,000) | $ (12,000) | $ (12,000) | $ (12,000) |
Ending balance | $ 747,000 | $ 801,400 | $ 863,940 | $ 935,434 | $ 1,016,777 |
ROI | 8.43% | 8.89% | 9.30% | 9.66% | 9.98% |
Average | 9.25% |
3.
Compute the average of the projected returns on beginning investment balances for the first five years of Acme’s investment in PHC. Find the maximum amount which Acme can pay for PHC if it wishes to earn at least a 10 percent average return on beginning investment balance.
Explanation of Solution
The average of the projected returns on beginning investment balances for the first five years of Acme’s investment in PHC is as follows:
Growth rate in income | 10% | ||||
Dividends | 30000 | ||||
Cost | 639794 | ||||
Annual amortization | $ 15,000 | ||||
1st year PHC income | $ 185,000 | ||||
Percentage owned | 40% | ||||
2018 | 2019 | 2020 | 2021 | 2022 | |
PHC reported income | $ 74,000 | $ 81,400 | $ 89,540 | $ 98,494 | $ 108,343 |
Amortization | $ 15,000 | $ 15,000 | $ 15,000 | $ 15,000 | $ 15,000 |
Equity earnings | $ 59,000 | $ 66,400 | $ 74,540 | $ 83,494 | $ 93,343 |
Beginning balance | $ 639,794 | $ 686,794 | $ 741,194 | $ 803,734 | $ 875,228 |
Equity earnings | $ 59,000 | $ 66,400 | $ 74,540 | $ 83,494 | $ 93,343 |
Dividends | $ (12,000) | $ (12,000) | $ (12,000) | $ (12,000) | $ (12,000) |
Ending balance | $ 686,794 | $ 741,194 | $ 803,734 | $ 875,228 | $ 956,571 |
ROI | 9.22% | 9.67% | 10.06% | 10.39% | 10.67% |
Average | 10.00% |
Want to see more full solutions like this?
Chapter 1 Solutions
ADVANCED ACCOUNTING
- Begin with the partial model in the file Ch02 P21 Build a Model.xlsx on the textbooks Web site. a. Using the financial statements shown here for Lan Chen Technologies, calculate net operating working capital, total net operating capital, net operating profit after taxes, free cash flow, and return on invested capital for 2020. The federal-plus-state tax rate is 25%. b. Assume there were 15 million shares outstanding at the end of 2019, the year-end closing stock price was 65 per share, and the after-tax cost of capital was 10%. Calculate EVA and MVA for 2020. Lan Chen Technologies: Income Statements for Year Ending December 31 (Millions of Dollars) Lan Chen Technologies: December 31 Balance Sheets (Thousands of Dollars)arrow_forwardAcme Co is considering an acquisition of Pinder Co at the end of the current year. Acme expects to generate $5 million in cash flows next year, after which the cash flows will grow by 2% per year in perpetuity. Pinder expects to generate $2 million in cash flows next year, after which the cash flows will grow by 3% per year in perpetuity. After the acquisition, Acme expects to be able increase its cash flows by $300,000 per year in perpetuity. This increase in cash flows is attributable to the assets owned by Pinder. Acme's beta is 1.2 and has 4,000,000 shares outstanding. Pinder's beta is 0.8 and has 2,000,000 shares outstanding. The risk-free rate is 2% and the market risk premium is 8%. Both Acme and Pinder have no debt. The share prices for Acme and Pinder are equal to the discounted present value of future cash flows. All cash flows occur at the end of the year. (a) If Acme pays $20 per share acquire Pinder, what is the value of the net benefit to Acme shareholders from the…arrow_forwardA firm after -tax operating income ( after-tax EBIT)$90,000 in 2018. The value of depreciation is $8000 in 2018. Operating working capital increased by $20,000, and the firm purchased $30,000 of assets. The firm's free cash flow is Given the rate information in the table belowCan you calculate the maturity risk premium? 3 month T-bill = 2.5% (risk-free rate), 30 years Bonds-5.0%, 30year corporate bonds 7.0% Inflation Rate- 3.6% and the liquidity risk premium is 0.03%arrow_forward
- Double B Industry Corporation has reached its maturity stage, and its net sales are expected to grow at a 6 percent compound rate for the foreseeable future. Management believes that, as a mature venture, the appropriate equity discount rate for Double B is 18 percent. Double B Industry CORPORATION 2019 2020Cash $50,000 $40,000Accounts receivables 200,000 260,000Inventories 450,000 500,000 Total current assets 700,000 800,000Fixed assets, net 400,000 500,000 Total assets $1,100,000 $1,300,000Accounts payable 130,000 $170,000Accruals 50,000 70,000Bank loan…arrow_forwardTop management of Crane company is considering two alternative capital structures for 2027. The first (the "no debt" structure) would be to have $1,020,000 in assets and $1,020,000 in stockholders' equity, with 39,000 shares outstanding the entire year. This is the structure the company had on December 31, 2026. Alternatively, on January 1, 2027, the company could issue $370,000 in debt at 6% interest (the "with debt" structure) and immediately use the proceeds to repurchase 19,500 shares of stock for $390,000. The expected amount of net income (ignoring taxes), prior to any interest costs, is $102,000 for 2027. Assume the company pays dividends on common stock equal to its net income each year. Also, assume the accrued interest on the debt was paid at December 31, 2027, and the company has no other debt outstanding at year-end. Also, assume the company has $1,020,000 in assets at both the beginning and the end of 2027. (a) Your answer is correct. Compute the company's net income and…arrow_forwardNet profit of Lily Fashion House Ltd in the current year is $2,575, 000. The company is planningto launch a project that will requires an investment of $745 000 next year. Today the company’sstock has market value of $22/share. Lily Fashion House has the current capital structure of 60%in equity and 40% in debt. Required: b. How much dividend Lily Fashion House can pay its shareholders this year and what isdividend payout ratio of the company. Assume the Residual Dividend Payout Policyapplies?arrow_forward
- URGENT Consider the following information for two all- equity firms, Firm Attrex and Firm Maliwan: Attrex Maliwan Shares 4800000 175000 outstanding Marketprice 30.83 371.43 per share Attrex estimates that the value of the synergistic benefit from acquiring Maliwan is yearly positive Cash Flow of $1,085,000 in perpetuity. Maliwan has indicated that it would accept a cash purchase offer of $525.715 per share. Attrex is thinking about offering 38% of their shares in exchange. How should Attrex proceed?arrow_forwardABC Sdn Bhd has a gross sales of RM 12000000 for year 2021. This company needs to pay 10% for annual fixed capital, 15% for operation capital and 10% for business taxes. Based on the net profit, they plan to invest 50% of the amount into a stock market. Estimate the amount of his money after THREE (3) years for the following cases:(i) Profit forecast is based on fixed interest rate of 10% per annum.(ii) The profit forecast is 10% per annum compounded every SIX (6) month.arrow_forwardNet profit of Lily Fashion House Ltd in the current year is $2,575, 000. The company is planning to launch a project that will requires an investment of $745 000 next year. Today the company's stock has market value of $22/share. Lily Fashion House has the current capital structure of 60% in equity and 409% in debt. Required: a. The company is paying a cash dividend of $4.50/share plus an extra-cash dividend of $1.5/share. Tomorrow the stock will go ex-dividend. Explain why there is ex-dividend date and ex-dividend price? Calculate the ex-dividend price tomorrow morning. Assuming the tax on dividend is 25%? b. How much dividend Lily Fashion House can pay its shareholders this year and what is dividend payout ratio of the company. Assume the Residual Dividend Payout Policy applies? c. Floral Textile Ltd. is a daughter company of the Lily Fashion House Group and currently under a liquidation plan due to severe business contraction caused by the COVID 19 pandemic. The company plans to pay…arrow_forward
- Net profit of Lily Fashion House Ltd in the current year is $2,575, 000. The company is planning to launch a project that will requires an investment of $745 000 next year. Today the company’s stock has market value of $22/share. Lily Fashion House has the current capital structure of 60% in equity and 40% in debt. Required:a. The company is paying a cash dividend of $4.50/share plus an extra-cash dividend of $1.5/share. Tomorrow the stock will go ex-dividend. Explain why there is ex-dividend date and ex-dividend price? Calculate the ex-dividend price tomorrow morning. Assuming the tax on dividend is 25%? b. How much dividend Lily Fashion House can pay its shareholders this year and what is dividend payout ratio of the company. Assume the Residual Dividend Payout Policy applies? c. Floral Textile Ltd. is a daughter company of the Lily Fashion House Group and currently under a liquidation plan due to severe business contraction caused by the COVID 19 pandemic. The company plans to pay…arrow_forwardNet profit of Lily Fashion House Ltd in the current year is $2,575, 000. The company is planning to launch a project that will requires an investment of $745 000 next year. Todaythe company’s stockhas market value of $22/share.Lily Fashion House has thecurrent capital structure of 60% in equity and 40% in debt. Required: a.The company is paying a cash dividend of $4.50/share plus an extra-cash dividend of $1.5/share. Tomorrow the stock will go ex-dividend. Explain why there is ex-dividend date and ex-dividend price? Calculate the ex-dividend price tomorrow morning. Assuming the tax on dividend is 25%? b.How much dividend Lily Fashion House can pay its shareholders this year and what is dividend payout ratio of the company.Assumethe Residual Dividend Payout Policy applies? c.Floral Textile Ltd. is a daughter company of the Lily Fashion HouseGroup and currently under a liquidation plan due to severe business contraction caused by the COVID19 pandemic. The company plans to pay total…arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENTCornerstones of Financial AccountingAccountingISBN:9781337690881Author:Jay Rich, Jeff JonesPublisher:Cengage Learning
- Financial Reporting, Financial Statement Analysis...FinanceISBN:9781285190907Author:James M. Wahlen, Stephen P. Baginski, Mark BradshawPublisher:Cengage Learning