Consider the following premerger information about Firm X and Firm Y:
Assume that Firm X acquires Firm Y by paying cash for all the shares outstanding at a merger premium of $3 per share.Also assume that 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?

Question

Consider the following premerger information about Firm X and Firm Y: 
Assume that Firm X acquires Firm Y by paying cash for all the shares outstanding at a merger premium of $3 per share.Also assume that 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?

Quizplus · Accepted Answer

First, we need to find the total cost of acquiring all the shares of Firm Y, which can be calculated as:
Total cost of acquiring Firm Y = Number of shares of Firm Y × (Market price per share + Merger premium)
= 50,000 × ($25 + $3)
= $1,400,000

Next, we need to calculate the total equity of the combined firm XY using the purchase method of accounting. According to this method, the assets and liabilities of the acquired firm are recorded at their fair values at the time of acquisition. Any excess of the cost of acquisition over the fair value of the net assets acquired is recognized as goodwill.

Since neither firm has any debt, the fair value of the net assets acquired is simply the sum of the fair values of the individual firms' assets and liabilities. Using the information provided, we can construct the following balance sheet for the individual firms:

Firm X
Assets: $900,000
Liabilities: $300,000
Equity: $600,000

Firm Y
Assets: $1,000,000
Liabilities: $200,000
Equity: $800,000

The fair value of the assets and liabilities of the combined firm XY can be calculated as follows:
Assets: $900,000 + $1,000,000 = $1,900,000
Liabilities: $300,000 + $200,000 = $500,000

Therefore, the total equity of the combined firm XY is:
Total equity = Total assets - Total liabilities
= $1,900,000 - $500,000
= $1,400,000

Finally, we need to add the goodwill to the total equity. The goodwill is equal to the excess of the cost of acquisition over the fair value of the net assets acquired, which in this case is:
Goodwill = Total cost of acquiring Firm Y - Fair value of net assets acquired
= $1,400,000 - ($1,900,000 - $500,000)
= $1,400,000 - $1,400,000
= $0

Since there is no goodwill in this case, the total equity of the combined firm XY is simply $1,400,000. Adding the merger premium of $3 per share, we get the total equity per share as:
Total equity per share = Total equity / Total number of shares outstanding
= $1,400,000 / 100,000
= $14

Finally, we can calculate the value of the total equity of the combined firm XY as:
Value of total equity = Total number of shares outstanding × Total equity per share
= 100,000 × $14
= $1,400,000

Therefore, the best choice is C, $1,352,000.

Consider the Following Premerger Information About Firm X and Firm