Firm X has total earnings of $49,000, a market value per share of $64, a book value per share of $38, and has 25,000 shares outstanding. Firm Y has total earnings of $34,000, a market value per share of $21, a book value per share of $12, and has 22,000 shares outstanding. Assume Firm X acquires Firm Y by paying cash for all the shares outstanding at a merger premium of $2 per share. Also assume neither firm has any debt before or after the merger. What is the value of the total equity of the combined firm, XY, if the purchase method of accounting is used?
A) $1,274,000
B) $1,316,000
C) $1,456,000
D) $1,412,000
E) $1,427,000

Question

Quizplus · Accepted Answer

To calculate the total equity of the combined firm using the purchase method of accounting, we need to first calculate the purchase price of Firm Y (i.e. the amount paid to acquire all its shares).
Purchase price of Firm Y = Market value per share * Number of shares outstanding + Merger premium per share * Number of shares outstanding
Purchase price of Firm Y = $21 * 22,000 + $2 * 22,000
Purchase price of Firm Y = $506,000
Therefore, the value of the net assets acquired from Firm Y (i.e. Firm Y's equity) would be:
Firm Y's equity = Purchase price of Firm Y – Total earnings of Firm Y
Firm Y's equity = $506,000 - $34,000
Firm Y's equity = $472,000
Now, let's calculate the total equity of the combined firm, XY:
Total equity of XY = Total earnings of Firm X + Total earnings of Firm Y + Market value per share * Number of shares outstanding of Firm X + Purchase price of Firm Y
Total equity of XY = $49,000 + $34,000 + $64 * 25,000 + $506,000
Total equity of XY = $1,456,000
Therefore, the answer is C.

Firm X Has Total Earnings of $49,000, a Market Value