Question 5 - 8761

Beta Blocker Systems is a leading drug research and development facility. In the beginning of 2004, it was widely expected to receive approval to market a new beta blocker that it had developed internally. The new drug has significantly fewer side effects than the competing medications currently on the market.

Beta blockers are widely prescribed for a variety of medical conditions, including hypertension, angina, arrhythmias and congestive heart failure. They are also given to heart attack patients to prevent future heart attacks. Because of the widespread use of beta blockers, the market for them is large and their profitability is enormous.

Analysts put the value of the in-process research and development (R&D) for Beta Blocker Systems’ new drug at a whopping $500 million. The expected approval of the drug, and the consequent benefits to any parent company that might own it, effectively put Beta Blocker Systems into play as an acquisition candidate.

Alphanumeric Research Laboratories, originally founded by Dr. Alka Klimecki, had grown to become a conglomerate with wide-ranging interests in nanotechnology, computer software, biotech, and other industries heavily reliant on research and development. Because of Alphanumeric’s diverse asset base, it was in a position to outbid other firms for Beta Blocker Systems. Alphanumeric Research Labs won the bidding war with an offer of $4.9 billion in Alphanumeric equity to buy out Beta Blocker shareholders. The transaction closed on June 30, 2004. (All balance sheet figures are calculated as of this date.) Alphanumeric recorded the acquisition as a purchase.

The buyout was a windfall for Beta Blocker Systems shareholders. Although the company had very valuable research facilities (shown on its balance sheet at $500 million below its fair market value), it had only $75 million in cash, not enough to fund the necessary development and marketing of the drug on its own without adversely impacting ongoing operations. It had also mismanaged its inventory, allowing much of it to become obsolete and forcing a write-down to its fair market value of $800 million.

The good news on Beta Blocker’s balance sheet was that it had virtually no debt. Owners’ equity stood at $3.335 billion, with the rest of the liabilities side of the balance sheet captured by a small level of current liabilities. However, this lack of debt seriously diluted the return to equity shareholders. Beta Blocker would have earned $40 million in net income in FY2004 (equally distributed throughout the year) if the acquisition had not taken place, providing a paltry return on owners’ equity.

Alphanumeric Research had an even more remarkable lack of leverage. Current liabilities of only $20 million paled in comparison with Alphanumeric’s stunning $4.530 billion in owners’ equity. Alphanumeric also managed its inventory much better than Beta Blocker Systems had. Its balance sheet showed only $500 million in inventory, all of which was current. In fact, Alphanumeric’s inventory had a fair market value 20 percent higher than book value.

Dr. Klimecki was pleased that the acquisition would further reduce Alphanumeric’s already miniscule total liabilities/owners’ equity ratio because of the additional equity issued to fund the purchase. The auditor, Nancy Alsen, added that the current assets/current liabilities ratio would also improve due to the write-up of inventory to fair market value.

Alphanumeric also had $50 million in cash. The remainder of Alphanumeric Systems’ assets were its research facilities, which had a fair market value of $4.2 billion, much larger than the $3 billion fair market value of Beta Blocker’s facilities.

Both Alphanumeric Research Laboratories and Beta Blocker Systems use fiscal years that match the calendar year and report in accordance with IAS standards. They amortize tangible assets over 20 years, and use the straight-line method for depreciation and amortization of both tangible and intangible assets.

Part 1)
What is the amount of goodwill (in millions) that Alphanumeric will record on its June 30, 2004 balance sheet to reflect the acquisition of Beta Blocker Systems?

Part 2)
What is the book value of long-term assets (in millions)on Alphanumeric’s consolidated balance sheet immediately after the acquisition?

Part 3)
What is the level of equity (in millions) on Alphanumeric’s consolidated balance sheet immediately following the acquisition?

Part 4)
What is Beta Blockers’ contribution (in millions) to Alphanumeric’s FY04 net income (assuming they are both profitable and face a 40 percent tax rate)?

Part 5)
Which statement about U.S. GAAP and IAS GAAP is FALSE?

Part 6)
Regarding Klimecki’s and Alsen’s statements about the impact of the Beta Systems acquisition on Alphanumeric’s consolidated balance sheet:

答案如下

Question

Part 1)
Your answer: C was incorrect. The correct answer was D) $565.

In order to calculate the value of goodwill, we first need to construct a balance sheet for Beta Blocker Systems.

We know that Beta Blocker Systems had fixed assets on the books that carried a market value of $3 billion and a book value $500 million lower (or $2.5 billion). We also know that they had $75 million in cash, and $800 million in inventory (both at book and at fair market). We also know that the patent had a value of $500 million. Thus we can calculate that the asset side of the balance sheet for Beta Blocker Systems was ($75 million cash + $800 million inventory + $2.5 billion fixed assets) = $3.375 billion at book value and ($75 million cash + $800 million inventory + $3 billion fixed assets + $500 million in-process R&D) = $4.375 billion at fair market value, before the calculation of goodwill.

We are told that Beta Blocker Systems had owners’ equity of $3.335 billion and the only other item on that side of the balance sheet was current liabilities. Thus we know that current liabilities must have equaled ($3.375 billion BV assets - $3.335 billion equity) = $40 million current liabilities before the acquisition. Goodwill equals the acquisition value of $4.9 billion minus the net fair market value of assets acquired of ($4.375 billion - $40 million liabilities) = $4.335 billion, for ($4,900 million - $4,335 million) = goodwill of $565 million.

We can construct a balance sheet for Beta Blocker Systems as of the acquisition date:

Beta Blocker Systems Balance Sheet
As of June 30, 2004
(millions of dollars)
	Book Value	Fair Market Value
Cash	$75	$75
Inventory	800	800
Plant & equipment	2,500	3,000
In-process R&D		500
Goodwill		565
Total Assets	$3,375	$4,940
Current liabilities	$40	$40
Equity	3,335	$4,900
Total liabilities and equity	$3,375	$4,940

Part 2)
Your answer: C was incorrect. The correct answer was B) $8,065.

In order to calculate the value of assets on the consolidated balance sheet, we first need to have a balance sheet for Alphanumeric as of the acquisition date.

We know that Alphanumeric had $20 million in current liabilities and $4.530 billion in owners’ equity, for a total of $4.550 billion in liabilities plus owners’ equity. Thus, that must also have been the book value of its assets.

We know that Alphanumeric systems had $500 million in inventory (at book value), $50 million in cash, and the rest was its research facilities, which would be listed under plant & equipment (P&E). The value of P&E equals total assets minus inventory minus cash, or ($4,550 million - $500 million - $50 million) = $4,000 million. We can construct the balance sheet for Alphanumeric as of the acquisition date. Note that we do not need to know the fair market value of Alphanumeric’s assets in order to construct the consolidated balance sheet.

Alphanumeric Research Laboratories Balance Sheet As of June 30, 2004 (millions of dollars)
Cash	$50
Inventory	500
Plant & equipment	4,000
Total assets	$4,550
Current liabilities	$20
Owners’ equity	4,530
Total liabilities and owners’ equity	$4,550

Combining the book value balance sheet at Alphanumeric with the fair market value balance sheet for Beta Blocker Systems we can construct the consolidated balance sheet:

Alphanumeric Research Laboratories Consolidated Balance Sheet As of June 30, 2004 (millions of dollars)
	Alphanumeric	Beta Blocker	Consolidated
Cash	50	75	125
Inventory	500	800	1,300
Plant & equipment	4,000	3,000	7,000
In-process R&D		500	500
Goodwill		565	565
Total assets	$4,550	$4,940	9,490
Current liabilities	$20	$40	60
Owners’ equity	4,530	$4,900	9,430
Total liabilities and owners’ equity	$4,550	$4,940	9,490

Long-term assets would be P&E, in-process R&D, and goodwill, for a total of ($7,000 + $500 + $565) = $8,065 million.

Part 3)
Your answer: C was incorrect. The correct answer was D) $9,430.

Using the balance sheet data calculated in question 2, equity on Alphanumeric’s consolidated balance sheet equals the combined equity from Alphanumeric at book and Beta Systems at market value, for a total of ($4,530 + $4,900) = $9,430.

Part 4)
Your answer: B was incorrect. The correct answer was A) -$70.

We know that Beta Blocker would have earned $40 million in FY2004 as a stand-alone company. We also know that their fiscal year is the calendar year, and the acquisition took place on June 30, 2004, so only half of Beta Blocker’s $40 million “net income” contributes to Alphanumeric’s FY04 net income. However, Beta Blocker’s $20 million “contribution” as a stand-alone company is partially offset by the higher depreciation and amortization costs that Alphanumeric faces under the purchase method. There was no revaluation of inventory in the acquisition because Beta Blocker Systems’ inventory valuation already reflected its fair market value.

The value of Beta Blocker’s fixed assets rises by ($3 billion - $2.5 billion) = $500 million. Using straight-line depreciation over twenty years, the incremental depreciation on Beta Blocker’s assets is ($500 million / 20 years) = $25 million per year. At a tax rate of 40 percent, the after-tax reduction in Beta Blocker’s contribution to Alphanumeric’s net income is [(1 - .40) x $25 million] = $15 million per year. Under IAS GAAP, Alphanumeric must amortize the $500 million value of in-process R&D over four years, or at a rate of ($500 million / 4 years) = $125 million per year. At a 40 percent tax rate that causes an after-tax reduction in net income of ((1 - .40) x $125 million) = $75 million per year. There is no amortization of goodwill because goodwill acquired after March 31, 2004 cannot be amortized under IAS GAAP.

The contribution of Beta Blocker to Alphanumeric’s net income will be the $20 million it would have earned as a stand-alone company over the second half of the year, less the $15 million incremental depreciation and the $75 million incremental amortization, or a total of (20 – 15 – 75) = -$70 million.

Part 5)
Your answer: D was incorrect. The correct answer was B) Both require capitalization of in-process R&D.

Only IAS GAAP permits the capitalization of in-process R&D. U.S. GAAP requires in-process R&D to be written off. The current ratio under either standard generally rises because of the markup of inventory valuations to fair market value.

Part 6)
Your answer: C was correct!

Using the balance sheet data constructed in question 2, we can calculate that Alphanumeric’s total liabilities/owners’ equity ratio was ($20 million / $4,530 million) = 0.4% before the acquisition and ($60 million / $9,430 million) = 0.6% after the acquisition. This occurs despite the additional issuance of equity because of the higher liabilities/equity ratio at Beta Blocker and consolidation of the balance sheets. Thus Klimecki’s statement is incorrect. We do not need to calculate the value of the current assets/current liabilities ratio pre- and post-acquisition because we know that Alsen’s statement must be incorrect because there is no revaluation of inventory in this instance. Alphanumeric’s inventory does not get revalued and Beta Blocker Systems’ inventory was already on the books at market value.

thanks

good

tx

太谢谢了。

非常感谢！

晕，好麻烦，偶在国外啊