Equity and Acquistion Method Question in CFAI Mock Morning methods, current, Goodluck

HuskyGrad2010

Hi All,

I seriously think that the explanations for questions 32, and 36 are wrong.

Q32: Why is cash not subtracted when calculating the current assets for both acquisition and proportional consolidation methods?

Q36: Why would you use the acquisition method when you have to use the Equity method under US GAAP

Kindly help me with the above two and Goodluck to all.

xilinx_altera

Q32 - why would you remove cash? Cash is a current asset. Maybe you are confusing enterprise value, which is equal to mv of debt and equity minus cash and equivalents.

Q36 - it says "If". Just because you GAAP tells you to account for an investment in one manner, doesn't mean you can't do it for purposes of analysis... or if the CFA exam asks you to do it....

zhaoyp

You might also be confusing "current asset" with "working capital", which does indeed exclude cash, and is used to determine free cash flow.

stalkey

Since cash was used to pay for the acquisition, the current asset must be reduced by that amount. If you are using Schweser , you can check it on Volume 2, page 22, the 2nd last paragraph (right after figure 4). Thats why i was confused.

RMontgomery

I don't have the stuff in front of me but i believe the balance sheet is "immediately following the acquisition", so the cash would have already been spent and the pro forma balance sheet will already exclude the spent amount.

iteracom

Excellent Observation MARKCFAIL. If it was prior to acquisition, cash would have been reduced. Thanks for clearing this mess.

SpyAli

I agree with MarCFAIL because the balance sheet said "immediately following the acquisition." However, CFAI's answer for #33 is inconsistent, because to calculate the long-term debt to total asset ratio they deduct the $500mm sales price of the acquisition from total assets.

What gives?

Here's hoping the real exam isn't full of so many problematic interpretations.

wilslm

Just noticed how in the "fine print" of the passage, it says "The balance sheet was prepared immediately following the acquisition, but the projected income statements do not reflect the acquisition"

I guess that doesn't really address the balance sheet, but one way or the other, it seems like the answer to Q33 and Q34 are inconsistent with their treatment of the acquisition cost.

Anyone think otherwise?

thecfawannabe

Yes.. the cash is not subtracted since the balance sheet was prepared immediately following the acquisition.. However, like gjertsen pointed out, CFAI's answer for #33 is inconsistent, because to calculate the long-term debt to total asset ratio they deduct the $500mm sales price of the acquisition from total assets... I dont think $500 should be deducted for the long term debt capitalisation ratio

flyinggirl

It should be deducted, because they are asking you to use proportionate consolidation INSTEAD of equity method. Equity method includes the purchase price, at cost, of $500 mm as a net asset, so you need to back this out before you apply proportionate.

Then you apply proportionate which is 50% of total assets of the company (notice total assets, not total net assets).