Chapter 1, Problem 1DYS

EXCEL CASE 1

On January 1, 2018, Acme Co. is considering purchasing a 40 percent ownership interest in PHC Co., a privately held enterprise, for $700,000. PHC predicts its profit will be $185,000 in 2018, projects a 10 percent annual increase in profits in each of the next four years, and expects to pay a steady annual dividend of $30,000 for the foreseeable future. Because PHC has on its books a patent that is undervalued by $375,000, Acme realizes that it will have an additional amortization expense of $15,000 per year over the next 10 years—the patent’s estimated remaining useful life. All of PHC’s other assets and liabilities have book values that approximate market values. Acme uses the equity method for its investment in PHC.

Required

1. 1. Using an Excel spreadsheet, set the following values in cells:
   • Acme’s cost of investment in PHC.
   • Percentage acquired.
   • First-year PHC reported income.
   • Projected growth rate in income.
   • PHC annual dividends.
   • Annual excess patent amortization.
2. 2. Referring to the values in (1), prepare the following schedules using columns for the years 2018 through 2022.
   • Acme’s equity in PHC earnings with rows showing these:
     • Acme’s share of PHC reported income.
     • Amortization expense.
     • Acme’s equity in PHC earnings.
   • Acme’s Investment in PHC balance with rows showing the following:
     • Beginning balance.
     • Equity earnings.
     • Dividends.
     • Ending balance.
   • Return on beginning investment balance = Equity earnings/Beginning investment balance in each year.
3. 3. Given the preceding values, compute the average of the projected returns on beginning investment balances for the first five years of Acme’s investment in PHC. What is the maximum Acme can pay for PHC if it wishes to earn at least a 10 percent average return on beginning investment balance? (Hint: Under Excel’s Data tab, select What-If Analysis, and the Goal Seek capability to produce a 10 percent average return on beginning investment balance by changing the cell that contains Acme’s cost of investment in PHC. Excel’s Solver should produce an exact answer while Goal Seek should produce a close approximation. You may need to first add in the Solver capability under Excel’s Tools menu.)

To determine

Using an Excel spreadsheet, set the following values in cells:

• Acme’s cost of investment in PHC.
• Percentage acquired.
• First-year PHC reported income.
• Projected growth rate in income.
• PHC annual dividends.
• Annual excess patent amortization.

Explanation of Solution

The required values are presented in excel sheet as follows:

Growth rate in income	10%
Dividends	30000
Cost	700000
Annual amortization	$   15,000
1st year PHC income	$ 185,000
Percentage owned	40%
	2018	2019	2020	2021	2022
PHC reported income	$   74,000	$      81,400	$   89,540	$   98,494	$    108,343
Amortization	$   15,000	$      15,000	$   15,000	$   15,000	$      15,000
Equity earnings	$   59,000	$      66,400	$   74,540	$   83,494	$      93,343
Beginning balance	$ 700,000	$    747,000	$ 801,400	$ 863,940	$    935,434
Equity earnings	$   59,000	$      66,400	$   74,540	$   83,494	$      93,343
Dividends	$ (12,000)	$    (12,000)	$ (12,000)	$ (12,000)	$    (12,000)
Ending balance	$ 747,000	$    801,400	$ 863,940	$ 935,434	$ 1,016,777
ROI	8.43%	8.89%	9.30%	9.66%	9.98%
Average	9.25%

To determine

Referring to the values in (1), prepare the following schedules using columns for the years 2018 through 2022.

Acme’s equity in PHC earnings with rows showing these:

• Acme’s share of PHC reported income.
• Amortization expense.
• Acme’s equity in PHC earnings.

Acme’s Investment in PHC balance with rows showing the following:

• Beginning balance.
• Equity earnings.
• Dividends.
• Ending balance.

Explanation of Solution

Growth rate in income	10%
Dividends	30000
Cost	700000
Annual amortization	$   15,000
1st year PHC income	$ 185,000
Percentage owned	40%
	2018	2019	2020	2021	2022
PHC reported income	$   74,000	$      81,400	$   89,540	$   98,494	$    108,343
Amortization	$   15,000	$      15,000	$   15,000	$   15,000	$      15,000
Equity earnings	$   59,000	$      66,400	$   74,540	$   83,494	$      93,343
Beginning balance	$ 700,000	$    747,000	$ 801,400	$ 863,940	$    935,434
Equity earnings	$   59,000	$      66,400	$   74,540	$   83,494	$      93,343
Dividends	$ (12,000)	$    (12,000)	$ (12,000)	$ (12,000)	$    (12,000)
Ending balance	$ 747,000	$    801,400	$ 863,940	$ 935,434	$ 1,016,777
ROI	8.43%	8.89%	9.30%	9.66%	9.98%
Average	9.25%

To determine

Compute the average of the projected returns on beginning investment balances for the first five years of Acme’s investment in PHC. Find the maximum amount which Acme can pay for PHC if it wishes to earn at least a 10 percent average return on beginning investment balance.

Explanation of Solution

The average of the projected returns on beginning investment balances for the first five years of Acme’s investment in PHC is as follows:

Growth rate in income	10%
Dividends	30000
Cost	639794
Annual amortization	$   15,000
1st year PHC income	$ 185,000
Percentage owned	40%
	2018	2019	2020	2021	2022
PHC reported income	$   74,000	$      81,400	$   89,540	$   98,494	$    108,343
Amortization	$   15,000	$      15,000	$   15,000	$   15,000	$      15,000
Equity earnings	$   59,000	$      66,400	$   74,540	$   83,494	$      93,343
Beginning balance	$ 639,794	$    686,794	$ 741,194	$ 803,734	$    875,228
Equity earnings	$   59,000	$      66,400	$   74,540	$   83,494	$      93,343
Dividends	$ (12,000)	$    (12,000)	$ (12,000)	$ (12,000)	$    (12,000)
Ending balance	$ 686,794	$    741,194	$ 803,734	$ 875,228	$    956,571
ROI	9.22%	9.67%	10.06%	10.39%	10.67%
Average	10.00%