P Company is considering the acquisition of S Inc. To assess the amount it might be willing to pay, P makes the following computations and assumptions:
A.S Inc. has identifiable assets with a total fair value of $8,000,000 and liabilities of $5,300,000. The assets include office equipment with a fair value approximating book value, buildings with a fair value 30% higher than book value, and land with a fair value 60% higher than book value. The remaining lives of the assets are deemed to be approximately equal to those used by Barkley, Inc.
B.S Inc.'s pretax incomes for the years 2010 through 2012 were $700,000, $900,000, and $550,000, respectively. P believes that an average of these earnings represents a fair estimate of annual earnings for the indefinite future. However, it may need to consider adjustments for the following items included in pretax earnings:
Depreciation on Buildings (each year) 580,000
Depreciation on Equipment (each year) 30,000
Extraordinary Loss (year 2012) 200,000
Salary expense (each year) 150,000
C.The normal rate of return on net assets for the industry is 20%.
Required:
Assume further that P feels that it must earn a 15% return on its investment, and that goodwill is determined by capitalizing excess earnings. Based on these assumptions, calculate a reasonable offering price for S, Inc.
2.On January 1, 2011, Pacer Company paid $1,920,000 for 60,000 shares of Lennon Co.'s voting common stock which represents a 45% investment. No allocation to goodwill or other specific account was made. Significant influence over Lennon was achieved by this acquisition. Lennon distributed a dividend of $3.30 per share during 2011 and reported net income of $1,090,000. What was the balance in the Investment in Lennon Co. account found in the financial records of Pacer as of December 31, 2011?