If a Company Uses the Purchase Method to Account for a Merger

question 8

Multiple Choice

If a company uses the purchase method to account for a merger, which of the following is true?
I. Prior year's statements must be restated as if merged companies had always been one company.
II. Net income of combined companies will probably be lower than net income of two separate companies added together.
III. Goodwill is never recorded.
IV. Assets of acquired company will be recorded on acquirer's books at their fair value.

• A) II, III and IV
• B) I, II and III
• C) II and IV
• D) I and III
• Target Company is trading at $20 a share and has 1M shares outstanding. Acquirer Corp. is trading at $50 a share and has 2M shares outstanding. Acquirer offers Target's shareholders of one share of its stock for every two shares of Target Company. For the year ending 12/31/06, Acquirer and Target had earnings of $5M and $2M, respectively. The book value of Target's net assets is $12M and fair value is $15M as of 12/31/06. The book value of Acquirer's net assets is $35M and fair value is $48M as of 12/31/06.

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Definitions:

Population Growth Rate

The rate at which the number of individuals in a population increases in a given time period, expressed as a fraction of the initial population.

Financial Distress

A situation where a company struggles to meet or has difficulty paying off its financial obligations to creditors.

Agency Costs

Expenses, either direct or indirect, that are borne by a principal as a result of having delegated authority to an agent. An example is the costs borne by shareholders to encourage managers to maximize a firm’s stock price rather than act in their own self-interests. These costs may also arise from lost efficiency and the expense of monitoring management to ensure that debtholders’ rights are protected.

Bankruptcy Costs

Expenses and fees associated with the process of declaring bankruptcy, including legal, administrative, and any potential asset liquidation costs.