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Hardin Tool Company
Author(s):
Reece, James S.
Functional Area(s):
   Financial Accounting
Setting(s):
   For Profit
Difficulty Level: Intermediate
Pages: 2
Teaching Note: Available. 
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First Page and the Assignment Questions:

The management of Pratt Engineering Company had agreed in principle to a proposal from Hardin Tool Company to acquire all its stock in exchange for Hardin securities. The two managements were in general agreement that Hardin would issue 100,000 shares of its authorized but unissued stock in exchange for the 40,000 shares of Pratt common stock. Hardin's investment banking firm had given an opinion that a new public offering of 100,000 shares of Hardin common stock could be made successfully at $8 per share. Depending on how the details of the acquisition were structured, it could be accounted for either as a purchase or as a pooling of interests.

Condensed balance sheets for the two companies, projected to the date of the proposed acquisition, and condensed income statements estimated for the separate organizations, are given in Exhibit 1. The income statements reflect the best estimate of results of operations if the two firms were not to merge but were to continue to operate as separate companies. There were no intercompany receivables or payables, and no intercompany sales or other transactions were contemplated.

An appraiser had been retained by the two firms and had appraised Pratt's net assets (assets less liabilities) at $600,000. The difference between this amount and Pratt's $441,000 book value was wholly attributable to the appraiser's valuation of Pratt’s plant and equipment.

Although an exchange of common stock was the most frequently talked about way of consummating the merger, one Pratt shareholder inquired about the possibility of a package consisting of 50,000 shares of Hardin common stock, and $400,000 of either cumulative preferred stock with a 10 percent dividend or debentures with a 10 percent interest rate. Under either of these possibilities, the transaction would be accounted for as a purchase.

Assignment

  1. Prepare consolidated balance sheets as of the proposed acquisition date, assuming the exchange of 100,000 shares of Hardin common stock, (a) on a pooling of interests basis and (b) on a purchase basis.
  2. Assuming that in its first year of operations the combined company would achieve the same results of operations as the sum of the two firms’ independent operations, what would be the combined company's net income and earnings per share on a pooling basis? On a purchase basis? (Assume a goodwill amortization period of 40 years, an average plant and equipment life of 10 years, straight-line depreciation, and an income tax rate of 35 percent. Round results--except earnings per share--to the nearest thousand dollars.)
  3. As an advisor to Hardin, would you recommend that the transaction be consummated on a purchase basis or on a pooling basis?
  4. What would be the combined net income and earnings per share under (a) the preferred stock package and (b) the debenture package? Is either of these proposals preferable to the all-common-stock proposal?