PROBLEM 1    

Vanhorn Company sells tennis racquets; variable costs for each are $75, and each is sold for $105. Vanhorn incurs $ 270,000 of fixed operating expenses annually.  

1. Determine the sales volume in units and dollars required to attain a $ 120,000 profit. Verify your answer by preparing the income statement using the contribution margin format  

2. Vanhorn is considering establishing a quality improvement process that will require a $ 10 increase in the variable cost per unit. To inform its customers of the quality improvements, the company plan to spend an additional $ 60,000 for advertising. Assuming that the improvement programme will increase sales to a level that is 5,000 above the amount computed in question 1, should Vanhorn proceeds with plans to improve product quality? Support your answer by preparing a budgeted income statement   

3. Determine the new break-even point (units and $ sales) assuming Vanhorn adopts the quality improvement programme  

4. At the end of the year, the actual results are : a. Units sales are 15,000, with a selling price per unit of $ 104  b. The variable costs per unit are $ 72 and the fixed operating expenses amount to $ 270,000 

Prepare the actual income statement and compare it to the one prepared in question 1. Compute the sales variance and its components, the profit variance and its components.

 

 

Bingle Systems earned $780 million last year and paid out 20 percent of earnings in dividends.

a.   By how much did the company's retained earnings increase?

b.   With 100 million shares outstanding and stock price of $80, what was the dividend yield? (Hint: First compute dividends per share.) 

Baymont Enterprises is considering a cash acquisition of Bull, Inc. for $20,000,000. Bull, Inc. will provide the following pattern of cash inflows and synergistic benefits for the next 15 years. There is no tax loss carryforward.

 

Years

 

        1–5                    6–15     

Cash inflow (aftertax)........................       $2,740,000          $3,400,000 

Synergistic benefits (aftertax)............            250,000               360,000     

The cost of capital for the acquiring firm is 12 percent. Should the merger be undertaken?
(If you have difficulty with deferred time value of money problems, consult Chapter 9.)

 The Bright Corporation is considering acquiring the Lincoln Corporation. The data for two companies are as follows:

 

	Lincoln Corp.	Bright Corp.
Total earnings.................................................	$500,000	$2,000,000
Number of shares of stock outstanding.........	200,000	1,000,000
Earnings per share..........................................	$2.50	$2.00
Price-earnings ratio (P/E)...............................	16	20
Market price per share....................................	$40	$40

a.   The Bright Corp. is going to give Lincoln Corp. a 50 percent premium over Lincoln Corp.'s current market value. What price will it pay?

b.   At the price computed in part a, what is the total market value of Lincoln Corp.?

c.   How many shares must Bright Corp. issue to buy the Lincoln Corp. at the total value computed in part b? (Keep in mind Bright Corp.'s price per share is $40.)

d.   Given the answer to part d, how many shares will Bright Corp. have after the merger?

e.   Add together the total earnings of both corporations and divide by the total shares computed in part e. What are the new post-merger earnings per share?

g.   Why has Bright Corp.'s earnings per share gone down?

h.   How can Bright Corp. hope to overcome this dilution?

 

 

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COST OF CAPITAL FOR HUBBARD COMPUTER LTD

You have recently been hired by Hubbard Computer Ltd (HCL), in its relatively new treasury management department. HCL was founded eight years ago by Bob Hubbard and currently operates 14 stores in the South Island of New Zealand. HCL is privately owned by Bob and his family, and had sales of $9.7 million last year.

HCL primarily sells to in-store customers who come to the store and talk with a sales representative. The sales representative assists the customer in determining the type of computer and peripherals that are necessary for the individual customer's computing needs. After the order is taken, the customer pays for the order immediately, and the computer is made to fill the order. Delivery of the computer averages 15 days, and it is guaranteed in 30 days.

HCL's growth to date has been financed by its profits. When the company had sufficient capital, it would open a new store. Other than scouting locations, relatively little formal analysis has been used in its capital budgeting process. Bob has just read about capital budgeting techniques and has come to you for help. For starters, the company has never attempted to determine its cost of capital, and Bob would like you to perform the analysis. Since the company is privately owned, it is difficult to determine the cost of equity for the company. Bob wants you to use the pure play approach to estimating the cost of capital for HCL, and he has chosen Harvey Norman as a representative company. The following steps will allow you to calculate this estimate.

QUESTIONS

1. Most publicly traded corporations are required to submit half-yearly and annual reports to the ASX detailing the financial operations of the company over the past half-year or year, respectively. These reports are available on the ASX website at www.asx.com.au or in the investor section of the company's own website. Go to the ASX website and search for announcements made by Harvey Norman. Find the most recent annual report or half-year report and download the report. Look on the balance sheet to find the book value of debt and the book value of equity. If you look in the report, you should find a section titled 'Interest Rate Risk Management', which will provide a breakdown of Harvey Norman's long-term debt.

2. To estimate the cost of equity for Harvey Norman, go to http://au.finance.yahoo.com plus the business section of www.smh.com.au and enter the ASX code for Harvey Norman, HVN. Follow the various links to answer the following questions—What is the most recent stock price listed for Harvey Norman? What is the market value of equity, or market capitalisation? How many shares does Harvey Norman have outstanding? What is the most recent annual dividend? Can you use the dividend discount model in this case? What is the beta for Harvey Norman? Now go back to http://au.finance.yahoo.com and find the 'Bonds' link. What is the yield on government debt? Using the historical market risk premium, what is the cost of equity for Harvey Norman using the CAPM?

3. You now need to calculate the cost of debt for Harvey Norman. Go to www.westpac.com.au and find the current business loan rates equivalent for each of Harvey Norman's debts. What is the weighted average cost of debt for Harvey Norman using the book-value weights and the market-value weights? Does it make a difference in this case if you use book-value weights or market-value weights?

4. You now have all the necessary information to calculate the weighted average cost of capital for Harvey Norman. Calculate the weighted average cost of capital for Harvey Norman using book value weights and market value weights. Assume Harvey Norman has a 30% tax rate. Which cost of capital number is more relevant?

5. You used Harvey Norman as a pure play company to estimate the cost of capital for HCL. Are there any potential problems with this approach in this situation?

 

 

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Emu Electronics

Emu Electronics is an electronics manufacturer located in Box Hill, Victoria. The company's managing director is Shelly Chan, who inherited the company from her father. The company originally repaired radios and other household appliances when it was founded more than 50 years ago. Over the years, the company has expanded, and it is now a reputable manufacturer of various specialty electronic items. Robert McCanless, a recent MBA graduate, has been hired by the company in the finance department.

 
One of the major revenue-producing items manufactured by Emu Electronics is a smart phone. Emu Electronics currently has one smart phone model on the market and sales have been excellent. The smart phone is a unique item in that it comes in a variety of colours and is pre-programmed to play Jimmy Barnes's music. However, as with any electronic item, technology changes rapidly, and the current smart phone has limited features in comparison with newer models. Emu Electronics has spent $750 000 developing a prototype for a new smart phone that has all the features of the existing one, but adds new features, such as Wifi Tethering. The company has spent a further $200 000 for a marketing study to determine the expected sales figures for the new smart phone.

 
Emu Electronics' production manager has produced estimates of the costs associated with manufacture of the new smart phone. Variable costs are estimated at $205 per unit and fixed costs for the operation are expected to run at $5.1 million per year. The estimated sales volume is 64 000 units in Year 1; 106 000 units in Year 2; 87 000 units in Year 3; 78 000 units in Year 4; and 54 000 units in the final year. The unit price of the new smart phone will be $485. The necessary manufacturing equipment can be purchased for $34.5 million and will be depreciated for tax purposes over a seven-year life (straight-line to zero). It is believed the value of the manufacturing equipment in five years' time will be $5.5 million. 
Net working capital for the smart phones will be 20% of sales and will have to be 
purchased at the end of the year. The cost of the raw materials is reflected in the variable unit cost. Changes in NWC will first occur at the end of Year 1 based on the first year's sales. Emu Electronics has a 30% corporate tax rate and a 12% required return. 
Shelly has asked Robert to prepare a report that answers the following questions:

QUESTIONS 

1. What is the payback period of the project? 

2. What is the profitability index of the project? 

3. What is the IRR of the project? 

4. What is the NPV of the project? 

5. How sensitive is the NPV to changes in the price of the new smart phone? 

6. How sensitive is the NPV to changes in the quantity sold? 

7. Should Emu Electronics produce the new smart phone? 

8. Suppose Emu Electronics loses sales on other models because of the introduction of the new model. How would this affect your analysis?

 

 

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Corporate - Mergers - Restructuring

QUESTION 1

1.       Which of the following statement about value of control is true?

	a.	The value of control is greater for a well-managed firm than for a poorly managed one.
	b.	The value of control should accrue to acquirer shareholders because the current management is not running the firm optimally.
	c.	The value of control increases with the management skills of the acquirer firm.
	d.	The value of control is part of value of synergy.

QUESTION 2

1.       Corox is a chemical manufacturing company, planning to acquire a competing firm Grad. The analyst has estimated that Corox's standalone value is $562 million, and Grad's standalone value is $312. The analyst also thinks that Grad is not performing at par with industry peers due to poor management. With a new management team and appropriate restructuring, Grad's value is estimated to be able to increase by $50 million. Finally, the analyst estimates the value of the two companies after acquisition to be $1.2 billion, assuming Corox has successfully restructured Grad. Based on these estimates, what should be the analyst's estimated value of synergy between Corox and Grad?

	a.	$276 million
	b.	$326 million
	c.	$50 million
	d.	Not enough information

QUESTION 3

1.       Sanyon is considering the acquisition of Bacer in a share for share transaction in which the acquirer would pay $40 for each share of target's common stock. Right now, Sanyon's stock price is $50, and the target share price is $25. What should be the exchange ratio?

	a.	0.8
	b.	0.5
	c.	1.25
	d.	2

QUESTION 4

1.       Follow up question 4, based on your own estimates, the exchange ratio should be 0.6. Assume that 0.6 is the fair ratio, but Sanyon goes forward with their offer (as in question 3). Which of the following will happen to the shareholders of the two companies if the acquisition is complete?

	a.	There is wealth transfer from acquirer shareholders to target shareholders.
	b.	There is wealth transfer from target shareholders to acquirer shareholders.
	c.	There is no wealth transfer between acquirer and target shareholders.
	d.	More information is needed.

QUESTION 5

1.       If the sources of synergy is economy of scale in COGs, which of the following statements is true?

	a.	Combined firms' sales should be bigger than the sum of the two firms' sales.
	b.	Combined firms' sales growth rate should be higher than the weighted average of the two firms' sales growth rate.
	c.	Combined firms' COGs should be bigger than the weighted average of the two firms' COGs.
	d.	Combined firms' profit margin should be higher than the weighted average of the two firms' profit margin.

QUESTION 6

1.       The split of synergy between the target firm and the acquirer depends on the relative negotiation power between the two. Which of the following will tilt the negotiation power towards the target, leading to a higher offer premium?

	a.	Target firm is located in Ireland whose marginal tax rate is 15% lower than acquiring firms' effective tax rate in the US.
	b.	Parent company of the target firm is financially distressed and is in dire need for cash.
	c.	Acquiring firm has unique expertise on zero-based budgeting, and is expected to achieve cost savings in the target company after the acquisition is complete.
	d.	Target company's founder passed away and his grown-up children have no interest in managing the company and want to sell.

QUESTION 7

1.       (Questions 7-9 are based on the following information.)

American Health Care, a pharmaceutical firm, announces that it will be acquiring Healthcare Associates, a hospital management firm. The following table summarizes the expected cash flows to the firm at each of these firms, run independently, and the expected cash flows from the combined firm with synergy benefits. The cost of capital for both firms, run independently, is 10%; the combined firm will have the same cost of capital. The expected growth rate in the cash flows after year 2 is 5%, for the firms run independently. And the combined firm is expected to be able to grow faster at 5.5% after year 2.

Expected Cash Flows
Company	FCF1	FCF2	Growth Rate after Year 2
AHP	100	120	5%
HA	60	69	5%
Combined (with Synergy)	172	203	5.5%

Question 7. Estimate the value of the combined firm with synergy.

	a.	5083.35
	b.	4257.37
	c.	3899.81
	d.	3581.81

QUESTION 8

1.       (See Question 7. for background information.)

Estimate the value of synergy.

	a.	675.56
	b.	616.18
	c.	1501.54
	d.	812.70

QUESTION 9

1.       (See Question 7. for background information.)

Assume that Healthcare Associates was fairly valued before the acquisition. American Health Products had 100 million shares outstanding at $22.83 per share, before the acquisition. If American Health Products paid a premium (over the market price) of $800 million for Healthcare Associates, what would you expect will happen to American Health Product's stock price on the announcement?

	a.	Increase because of the expected synergy benefits
	b.	Decrease because the AHP overpaid for HA
	c.	Increase because AHP pays less than they gain from synergy benefits
	d.	Not enough information

 

 

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M&A - case study

PART A: case study (General Motors)

The internet is a good place to get information that is useful to you in your study of accounting. For example, you can find information about current events, professional accounting organizations, and specific companies that may support your study.

 

At the new General Motors, we are passionate about designing, building and selling the world's best vehicles.  This vision unites us as a team each and every day and is the hallmark of our customer-driven culture.

In fact, there are a lot of exciting things to share about our company.  Our story starts on November 18, 2010, when we completed the world's largest initial public offering, emerging with a solid financial foundation that enables us to produce great vehicles for our customers and build a bright future for employees, partners and shareholders.

Leading the way is our seasoned leadership team who set high standards for our company so that we can give you the best cars and trucks.  This means that we are committed to delivering vehicles with compelling designs, flawless quality and reliability, and leading safety, fuel economy and infotainment features.  All are intended to create that special bond that can only happen between a driver and their vehicle.

Making the world's best vehicles can only happen with the world's greatest employees.  We take great pride in our work, and take great care to deliver exceptional cars and a positive ownership experience to our customers around the world.

Access the GM home web page at: www.gm.com From GM's home page and then "The Company", click on "FINANCIAL INFORMATION", followed by "Reports and results", then select the year 2013 to display and download the "Annual report and accounts" 2013 on Form PDF.

Note: the financial statements of GM are available at:

www.gm.com/annualreport/downloads/2013_GM_Annual_Report.pdf

Instructions Use the annual report and accounts of 2013 to answer the following questions:

 

1.      What is GM management strategy? And how do they achieve these strategies?

2.      What is the responsibility of management toward the financial reporting?

 

3.      In the annual report GM mentioned that they measure certain asset and liabilities using fair value measurement, according to FASB there are three level hierarchy for the fair value measurement technique explain them? Mention example from the balance sheet for asset and liabilities that were measured at fair value for each level.

 

 

4.      Write a memo explaining: (Hint: Explain and support your memo by suitable figures from the GM's annual report.)

a-   What was the composition of identifiable and unidentifiable intangible assets reported by GM 2013?

b-   How do GM account for their intangible asset and the goodwill?

c-   How much impairment did GM report from the intangible assets and goodwill?

d-  Why did GM impair the goodwill, if any?

                                                                                                           

5.      According to chapter 1, there are 3 legal forms of business combination explain them and mention form the annual report example of latest business combination done in 2013 – 2012.

 

6.      According to IASB, there are conditions where the company owns more than 50% in the subsidiary but they do not consolidate the financials, explain the conditions, and mention examples from the annual report with reasons of non-consolidations.

 

 

PART B: case study

Using the equity method solve the following:

 

Jackson Corporation has acquired 90% of Sole Company stock for $202,500 on January 1, 2013, when Sole Equity consisted of $150,000 capital stock and $34,000 retained earnings.

 

·         Sole company land was undervalued by $14,000 in time acquisition.

·         Any excess differential above the $14,000 which was mentioned above should be allocated to Patent, the patent has useful life of 10 years.

·         Sole distributed cash dividends of $16,000 .

Separate Company financial statements for the year ended December 31, 2013 for Jackson Corporation and its Subsidiary Sole Company provided below

 

 

	Jackson	Sole
Incomes statement and retained earnings 31, Dec 2013
Sales	$400,000	$100,000
Income from Sole	$17,600	-
Cost of goods sold	$(250,000)	$(50,000)
Operating expenses	$(100,600)	$(26,000)
Net income	$67,000	$24,000
Add: retained earnings, 1 Jan 2013	$177,000	$34,000
Less: dividends	$(50,000)	$(16,000)
Retained earnings 31 Dec. 2013	$194,000	$42,000
Balance sheet 31, Dec 2013
Cash	$18, 000	$15,000
Receivable – net	$80,000	$25,000
Dividends receivable from Sole	$14,400	-
Inventories	$95,000	$10,000
Investment in Sole	$218,800	-
Land	$65,000	$30,000
Building- net	$170,000	$80,000
equipment- net	$130,000	$50,000
Total asset	$784,000	$210,000
Account payable	$90,000	$10,000
Dividends Payable	-	$16,000
Capital stock	$500,000	$150,000
Retained earnings	$194,000	$42,000
Total equity and liabilities	$784,000	$210,000

 

 

USE Equity method

1.      Calculate the following:

o    unamortized excess amount and

o    the amount to be allocated to the Patent

 

2.      Calculate the adjusted income from subsidiary for

o   the parent and

o   the NCI

3.      Record the elimination entries required 

 

 

 

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Transfer pricing case study

PART A: Transfer Pricing and Variances

Gamma Company produces cars. Two of the profit centers, Tires centre and Assembly centre, were in conflict over the price of tires. External suppliers of tires offered Rania, the manager of the Assembly centre, the same type and quality of tire for $200. Rania used to buy these tires internally for $300 each. 

 

Jamil the CEO of the company called for a meeting with the managers of both centers in order to solve the issue. Kamil the manager of the Tires Centre explained that:

"The tires we produce have been a trusted brand for over 60 years and are distributed by Gamma Company to members all over the globe. Our tires have long been recognized as a leading private brand since 1954."

 

Tires Center: Cost per tire

	$
Direct materials	95
Direct labor	54
Variable overheads	25
Fixed overheads	36
Total cost	210

 

Rania answered that the external suppliers offered the same specifications and quality for a $100 less, and that she should be able to buy them internally at least at the same price.

 

Required:

The CEO wishes to more fully assess the situation prior to finalizing his recommendations. He plans to present the findings of his analysis at the next board meeting. Specifically, as a consultant, he asked you to:

 

1. Advise and justify whether the Assembly Centre should to buy tires from inside or outside the firm. (130 words)

2.      Based on your answer in the previous requirement, provide and justify a proper transfer price. (130 words)

3.      The Tires Centre had a capacity of 40,000 tires per year, and the Assembly Centre use around 90,000 tires per year. The Tires centre could sell all of its production externally for $300. Based on these special circumstances provide a recommendation for Gamma Company whether these two centers should buy/sell internally or externally. Justify your answer. (50 words)

4.      Explain why setting transfer prices by Gamma can be controversial when a product is being transferred between two profit centers. (130 words)

5.      The Accountant of Gamma Company provided you the following information:

 

Required:

Discuss the performance of the company for the past year. Show your workings. (400 words)                        

      PART B: Controlling cash flow for business growth

Cash flow is of vital importance to the health of a business. One saying is: 'revenue is vanity, cash flow is sanity, but cash is king'. What this means is that whilst it may look better to have large inflows of revenue from sales, the most important focus for a business is cash flow.

Required:

Based on the case study answer the following questions:

1.      Describe what is meant by 'cash flow budget'. (130 words)

2.      Explain how a cash flow forecast can help a business now and in the future. Give examples. (100 words)

3.      Analyze why cash is considered to be more important to a business than revenue or profit. (250 words)

4.      Evaluate the importance of cash flow to a business of your choice. Explain how a recession would most likely affect this business. (170 words)

 

 

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