John Smith is the sole shareholder and CEO of Able Manufacturing, Inc. Smith has put Able up for sale in advance of his retirement. James Duvall, a manager in the corporate venturing unit of a public company, is evaluating the purchase of Able. Duvall notes the following facts affecting the most recent fiscal year’s reported results:

• Smith’s compensation for the year was \($1.5\) million. Duvall’s executive compensation consultant believes a normalized compensation expense of \($500\),000 for a CEO of a company like Able is appropriate. Compensation is included in selling, general, and administrative expenses (SG&A).

• Certain corporate assets including ranch property and a condominium are in Duvall’s judgment not required for the core operations of the company. Fiscal year expenses associated with the ranch and condominium were \($400\),000, including \($300\),000 of such operating expenses as property upkeep, property taxes, and insurance reflected in SG&A expenses, and depreciation expense of \($100\),000. All other asset balances (including cash) are believed to be at normal levels required to support current operations.

• Able’s debt balance of \($2\),000,000 (interest rate of 7.5 percent) was lower than the optimal level of debt expected for the company. As reported interest expense did not reflect an optimal charge, Duvall believes the use of an earnings figure that excludes interest expense altogether, specifically operating income after taxes, will facilitate the assessment of Able.

Duvall uses the reported income statement to show the derivation of reported operating income after taxes, as given below.

Based only on the information given, address the following:

i. Identify the adjustments that Duvall would make to reported financials to estimate normalized operating income after taxes; that is, what the operating income after taxes would have been under ownership by Duvall’s unit.

ii. Based on your answer to Part 1, construct a pro forma statement of normalized operating income after taxes for Able.

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Cost of goods sold Gross profit As of 31 December 2013 Revenues Able Manufacturing, Inc. Operating Income after Taxes As Reported $50,000,000 30,000,000 20,000,000 Selling, general, and admin. expenses 5,000,000 EBITDA 15,000,000 Depreciation and amortization 1,000,000 Earnings before interest and taxes 14,000,000 Pro forma taxes (at 40.0 percent) 5,600,000 Operating income after taxes $8,400,000